This article was first published in Edition 135 of the AIMA Journal
Joint ventures (JVs) often establish a corporate vehicle, such as a private limited company (the JV Vehicle), which holds the money received from the parties to advance the JV’s commercial goals. For example, a property JV may bring together a real estate manager with a real estate capital provider to pursue a business venture in building new properties. The money received from the capital provider would usually be put into the JV Vehicle, which is managed in accordance with the underlying JV agreement.
While JVs are not new and are common arrangements set up by firms, there are implications if the structuring of such arrangements falls within scope of regulation. Specifically, JV participants should take care to ensure their arrangements do not amount to the setting up, directly or indirectly, of an alternative investment fund (AIF).
The Alternative Investment Fund Managers (AIFM) Directive (2011/61/ EU) (AIFMD) came into force on 22 July 2014 and is the primary piece of legislation governing the operation and management of an AIF. As the UK was an EU member at the time, it on-shored the AIFMD through the AIFM Regulations 2013 (SI 2013/1773) and the Financial Conduct Authority (FCA) Handbook (UK AIFMD).
Managers of UK AIFs (i.e., funds domiciled in the UK that meet certain criteria, as we will explore below) must comply with the provisions of the UK AIFMD. The UK AIFMD does not generally apply to JVs, but the arrangements must be closely scrutinised to determine whether a JV in fact meets the definition of an AIF. If it does, the JV parties will need to comply with the UK AIFMD. The rules are prescriptive and, where not considered from the initial structuring stage, may result in additional costs and on-going regulatory obligations (such as the need to appoint a depository, periodic reporting requirements and further marketing restrictions in addition to the standard UK financial promotions regime).
This article discusses some of the factors that firms should consider when structuring their JV arrangements to determine whether they fall in-scope of the UK AIFMD.
What is an AIF?
An AIF is a collective investment undertaking (CIU) which raises capital from a number of investors with a view to investing it in accordance with a defined investment policy for the benefit of those investors, and which is not a UK undertaking for collective investment in transferable securities (UCITS). Four key elements must therefore be satisfied in order for a proposed JV to be an AIF, namely that the JV:
- is a CIU;
- has a defined investment policy;
- raises capital with a view to investing that capital for the benefit of those investors in accordance with the investment policy mentioned in (b) above; and
- is not a UK UCITS.
If a JV Vehicle meets the definition above it will be deemed an AIF. It is therefore crucial that JV parties ensure the structuring of such arrangements fall out-of-scope if they are not intended to constitute an AIF. In order to be classified as an AIF, all elements of the definition above must be satisfied.
What is a collective investment undertaking?
A collective investment undertaking, or CIU, is one which raises capital from a number of investors with a view to investing that capital in accordance with a defined investment policy for the benefit of those investors (i.e., it satisfies (c) above), and its units can be repurchased or redeemed, directly or indirectly out of its assets (at the holder’s request).
It is important to note that the definition of an AIF refers to a CIU and not a collective investment scheme (CIS). While the two concepts overlap considerably, a CIU may be a body corporate (although not technically required to be) whereas a CIS cannot be a body corporate unless it is an open-ended investment company (OEIC), a limited liability partnership (LLP) or one of certain other types of mutual body. Therefore, where a JV Vehicle is incorporated as a UK company, the JV parties must consider whether it meets the definition of an OEIC and if it does (or if it is an LLP or relevant mutual body), they should also consider the regulatory requirements regarding operating a CIS.
The European Securities and Markets Authority (ESMA) highlights in its ‘Guidelines on key concepts of the AIFMD’ that there are certain characteristics of a vehicle (i.e., the JV Vehicle) that would show the undertaking is indeed a CIU. These characteristics, which are replicated in the FCA’s Perimeter Guidance Manual (PERG), are that:
- the vehicle does not have a general commercial or industrial purpose;
- it pools together capital raised from its investors for the purpose of investment with a view to generating a pooled return for those investors; and
- its unitholders / shareholders as a collective group have no day-to-day control.
What should you consider when structuring a JV to fall out of scope of AIFMD?
Some common themes must be considered when structuring a JV to ensure it is not an AIF. The FCA’s PERG provides guidance on this which, even post-Brexit, references and is largely based on ESMA’s Guidelines. According to the guidance in PERG, factors suggesting that a proposed JV will not fall within the definition of an AIF include where:
- The arrangement has a general commercial or industrial purpose as opposed to a specified investment purpose.
Where, for example, the JV is established by a real estate operator and a real estate capital provider to build properties, this is less likely to constitute an AIF as the focus of the JV arrangement is on the parties’ commercial goals rather than an investment focus. Similarly, if the parties came together in the proposed project before the JV was structured, had a pre-existing business relationship or were carrying on similar activities in partnership prior to the set-up of the JV, this would help evidence that the JV has a commercial rather than a pure investment focus.
- There is no defined investment policy.
A defined investment policy for these purposes is a policy about how the vehicle’s pooled capital is to be managed to generate a pooled return for its investors. Factors likely to indicate the existence of a defined investment policy include where there is a legally enforceable requirement for the vehicle or its manager to follow the policy, or where the policy specifies investment guidelines that prescribe (for example) the type or geographical location of assets that can be invested in and/or certain strategies that must be followed.
- All of the JV parties have day-to-day control over the assets of the JV Vehicle as opposed to being merely passive investors.
The FCA’s guidance makes clear that the requirement for the JV parties to have day-to-day control must go beyond the ordinary exercise of decision or control that a party might have through voting at shareholder meetings. Many firms therefore ensure that the underlying JV agreement gives control rights, which may include enhanced ‘reserved matter’ rights to ensure the parties have joint control over the JV Vehicle and are not merely passive investors (which would be more akin to an investment fund). If the underlying JV agreement contains restrictions such as control provisions that do not allow all of the parties to participate in the active management of the JV, the arrangement is more likely to constitute an AIF.
- The JV does not seek to raise external capital from investors who are not party to it.
The guidance explains that the definition of an AIF envisages a distinction between the undertaking that raises capital and the parties who invest capital – where there is no such distinction, as is often the case in a JV where commercial parties come together on their own joint initiative, there is no external capital and therefore no AIF.
Consequences of inadvertently operating an AIF
Care must be taken to ensure the JV parties comply with the relevant regulatory regime. If a JV is found to be an AIF, the parties may be subject to enforcement action as ‘managing an AIF’ is a regulated activity in the UK under article 51ZC, Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (SI 2001/544). If the parties are found to be ‘managing an AIF’ without the requisite FCA authorisation, this is a criminal offence which can result in imprisonment of up to two years and the possibility of an unlimited fine. The FCA may also wish to take enforcement action for any failure to comply with UK AIFMD (for example failing to appoint a depository if required, to comply with investor information requirements or to meet the relevant reporting requirements imposed on managers of an AIF).