Travers Smith's Alternative Insights: Private wealth and private capital

A regular briefing for the alternative asset management industry.

Investment platforms like Moonfare – which offer individual investors access to a range of alternative investment funds – have proved popular. And for good reason: countless surveys reveal that the returns achieved by institutional investors in their private capital portfolios have outperformed those from the public markets over the last decade, especially in Europe. Individual investors want access – and, as the private markets seek to grow and diversify their sources of capital, fund managers are keen to oblige. Retailisation is coming to alternatives.

But the industry knows that it must tread carefully. Retail, in this context, does not mean everyone: alternative asset managers are currently focused on raising capital from high-net-worth individuals (HNWIs), not the retail market more broadly.

Quite rightly, Europe's investor protection rules make it very hard to distribute private funds unless the target investors are institutional or can demonstrate high levels of wealth or sophistication. Navigating these rules can be a challenge. However, national regulators and European policymakers have already shown a willingness to help, and they could be about to take some significant further steps.

Many EU member states (and the UK) have domestic laws that allow distribution of unregulated private funds to individual investors who meet certain wealth and sophistication criteria, and there are distribution channels – including private banks – that already take advantage of them. For example, "well-informed" investors can be admitted to a Luxembourg SIF (specialised investment fund) or RAIF (reserved alternative investment fund) as a matter of Luxembourg law, and each country then has different tests that must be applied to targeted individuals – although some countries do not allow retail distribution at all.

A number of alternative investment fund managers – Blackstone being a prominent recent example – are launching so-called "Part 2" funds in Luxembourg. These are regulated alternative investment funds, governed by Part 2 of a 2010 Luxembourg law, which are – as a matter of Luxembourg law – allowed to be sold to all retail investors, without the "well-informed investor" hurdle that applies to SIFs and RAIFs. That's helpful, because it eases some ongoing compliance burdens, but still requires country-by-country analysis.

One of the first pan-EU innovations was the 2013 venture capital fund regulation (EuVECA). This offered a pan-EU marketing passport to a newly defined category of "semi-professional" investors – essentially, those who can commit a minimum of €100,000 – as well as to "professional" (mostly institutional) investors. But, despite some helpful reforms that took effect in 2018, the regime is restricted to a relatively small part of the asset class and not helpful for those who want to invest in private debt or buyout funds.

The EU's 2015 Long Term Investment Fund (ELTIF) law went even further: the ELTIF structure offers a full EU retail passport for funds that can comply with its rules. Unfortunately, some of those rules made it cumbersome to distribute and operate, meaning that take up has been poor. The European Commission's proposed reforms – still being debated by the European legislators – are promising, and would sweep away many of the restrictions that have held the ELTIF back.

Although there is some way to go, if these proposals did survive, they could fuel the current push for private wealth without adding significant burdens for managers...

However, for those private fund managers focused on HNWIs, the ELTIFs full retail passport – although undoubtedly making distribution easier – will remain unattractive if there are too many strings attached. In that regard, special domestic licences required to operate the ELTIF and continuing investment restrictions might not be a price worth paying. In any event, the final shape of the reformed ELTIF is still unclear: while the European Parliament has sought additional improvements to the regime – for example, to permit ELTIF funds-of-funds – it is also trying to introduce additional requirements that may inhibit its wider adoption.

But help may be at hand – curiously enough, also from the European Parliament. Future reforms to the pan-EU Alternative Investment Fund Managers Directive (AIFMD) proposed by the Parliament's Rapporteur – the lead MEP on the file – would make the unregulated structure more attractive. Indeed, for accessing HNWIs, the change could even render the reformed ELTIF redundant.

The AIFMD, passed in 2013, created new regulatory burdens for private fund managers, but came with a highly significant benefit: a full marketing passport for "professional investors". Many international fund managers have established AIFMD-regulated managers in the EU – mostly, but not exclusively, in Ireland and Luxembourg – to take advantage of this passport. At the moment, the definition of "professional investor" makes it very difficult for an individual investor to qualify, however wealthy. But the European Parliament's draft report on forthcoming AIFMD reforms suggests that, in effect, the "semi-professional" passport in EuVECA should be extended to any EU fund managed by an AIFMD-regulated manager – giving EU funds passported access to (among others) any EU investor committing a minimum of €100,000.

That's a promising development – although, as yet, the suggestion has not been approved by other political parties in Parliament, and is not in the EU Council's compromise proposal. It may not, therefore, survive the negotiations that will now ensue within the Parliament, and then with the Council and the Commission. Nor would it be a complete solution, because managers of such funds would still have to produce the burdensome Key Information Document (KID) that is designed for retail investors.

Although there is some way to go, if these proposals did survive, they could fuel the current push for private wealth without adding significant burdens for managers – while not opening the floodgates to all individual investors. For broader distribution, the ELTIF would still have its place, especially if the current proposed reforms to the ELTIF are approved, but unregulated funds may yet turn out to be a more efficient way to get passported access to Europe's HNWIs.

Large alternative asset managers will keep their fingers crossed – as might the high net worth individual investors who could stand to benefit.

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