By Harry Barnes, Principal Compliance Consultant
The definition of an alternative investment fund (AIF) can be broader than often expected, and some special purpose vehicles (SPVs) can also be deemed to be an AIF according to UK regulation.
When firms are creating an SPV structure, it’s important that the regulatory classification of the vehicle is understood, as there are a number of regulatory implications when a structure is deemed an AIF. This is especially critical for firms without the Financial Services and Markets Act (FSMA) Part4A permission to manage an AIF, as the inadvertent creation of an AIF may mean the firm is acting outside of its regulatory permissions.
The basic definition of an AIF
There are four high-level criteria for a vehicle to be considered an AIF:
- The entity is a collective investment undertaking
- It raises and invests funds for the benefit of its investors
- It makes those investments in line with a defined investment policy, and
- It is not a UCITS fund
The first three of these will be examined further below, but it should be noted that all four criteria must apply for the entity to be deemed an AIF.
A collective investment undertaking
There are three factors that determine if an entity is a collective investment undertaking in the eyes of the UK’s Financial Conduct Authority (FCA):
- The entity doesn’t have a general commercial or industrial purpose, i.e. it’s not pursuing a business strategy predominately involving commercial activity (the buying/selling of goods or the supply of services), industrial activity (the production of goods or construction of properties), or a combination of both
- The entity pools capital from multiple investors to generate a return for those investors. In this context, a pooled return does not mean each investor requires an equal share of the return or that returns are on the same terms for each investor. Pooled return also doesn’t require multiple investment assets; a single investment generating a return for multiple investors can be sufficient to meet this definition
- The entity doesn’t permit its investors to have day-to-day control. When considering whether the investors have day-to-day control, the regulator’s guidance is clear that the control must go significantly further than just exercising voting rights as shareholders – e.g. appointing the entity’s board and/or controlling its day-to-day operations
Raising capital from investors
The capital-raising requirement is subject to clear guidance from the FCA, which also cites the ESMA guidance on this issue. Capital-raising in this context involves the entity itself, or an entity acting on its behalf (such as its alternative investment fund manager (AIFM), portfolio manager or another entity arranging the capital raising), taking direct or indirect steps to procure the commitment or transfer of capital by one or more investors to the relevant entity for the purposes of the entity investing it.
Defined investment policy
The FCA, and ESMA, take quite an expansive view as to what counts as a ‘defined’ investment policy. Any policy setting out how the pooled capital raised by the entity will be managed to generate a return for investors is considered ‘defined’. There are a number of factors that regulators consider indicative of there being a ‘defined’ investment policy:
- The investment policy is determined and fixed by the time the investors commitments become binding
- The policy is in a document that forms part of (or is referenced by) the rules or instruments of incorporation of the entity
- There’s a legal obligation to investors to adhere to the policy
- The policy specifies investment guidelines, which can include asset, strategy type (e.g. geography) or restrictions (such as on leverage, holding periods or risk diversification)
It should be noted that it’s possible for a ‘defined’ investment policy to exist even if that policy is to invest in one specific asset.
Common exemptions
There are some common types of SPV that are (either usually or always) exempt from being an AIF, including:
- Single investor structures including acquisition vehicles – This can include where an existing fund makes an investment via an SPV, as the investor capital is pooled at the fund level not the SPV level
- Joint ventures – In situations where the investors maintain day-to-day control of the entity (as is common in joint ventures), the SPV would not be considered an AIF. A joint venture may also not meet the capital-raising test. This reasoning can also apply to some co-investment structures
- Securitisation SPVs – These entities are specifically excluded within the Alternative Investment Fund Managers Directive (AIFMD)
- Carried interest vehicles – These entities are generally not considered to be AIFs as they can usually rely on either the employee participation scheme exemption or the fact that there may be no capital-raising where employees only invest nominal sums.
How we can help
At IQ-EQ we have an expert team who can advise on fund and SPV structures, as well as the regulatory implications associated with the various options.
To find out more about the support available from IQ-EQ’s expert UK compliance consulting team, contact us today.
