AIFMD – Parallel LP funds and the importance of PR

The AIFMD could lead to separate fundraising strands for EU and non-EU investors, said HarbourVest's head of strategic development in Barcelona this morning.

Amanda McCrystal spoke about the practical implications of the Alternative Investment Fund Management Directive as part of a panel discussion at a CFO-COO Summit held by the European Venture Capital Association (EVCA).

McCrystal – who sits on EVCA's technical committee – believes it is highly probable that private equity firms will end up splitting their fundraising efforts in two to avoid alienating foreign LPs. "It's likely we'll see GPs marketing one fund to non-EU investors and another fund targeting those based within the EU," she said. "There would almost certainly be different costs for each vehicle." The reason for this is that though the AIFMD only pertains to EU investors, in cases where EU and non-EU LPs are together in the same fund, all will be forced to share the costs that will arise because of the directive, regardless of whether it will affect them or not. "The question is, how willing will non-EU investors be to suddenly find themselves faced with more bureaucracy and more costs, only because there are EU investors in that fund with them?" McCrystal questioned.

In its present state, the AIFMD could also prevent a number of existing LPs from continuing to invest in private equity. Though currently at the level 2 stage (meaning that the actual rules haven´t yet been finalised), the directive has so far stipulated that those LPs who do not meet the Markets in Financial Instruments Directive (MiFID)'s definition of the term "professional investor" will not be able to invest in the asset class.

"Adopting MiFID's definition excludes a lot of typical private equity LPs, such as business angels, high-net-worth individuals and industry specialists," reveals McCrystal. "Private equity firms therefore need to work out how many of their investors are so-called non-professional investors, according to this definition." Those LPs who fall within this bracket must be identified so that when GPs look to raise a new fund, they can tailor their marketing strategy so as not to waste time on those who are unable to participate.

The good news is that the whole of MiFID is currently under review, so there will be an opportunity to revise the present definition of "professional investors" to better accommodate private equity and venture capital. The decision as to whether to allow private individuals and retail investors to hold stakes in alternative investment funds will ultimately come down to the EU member states. "GPs need to look at where their LPs are based so as to determine what rules will apply in the country where that person lives," adds McCrystal.

The very existence of venture capital firms, meanwhile, could be threatened by the need to recruit extra staff. "Most GPs are going to need more operational staff than they already have to cope with the directive, which is particularly worrying for the venture capital model, because having to recruit a complicance officer, for example, could make the difference between it being a viable business model and an unviable one," warns McCrystal.

Counting the costs
What is surprising is the speed with which firms such as HarbourVest have installed compliance officers on their pitch teams to reassure prospective investors. "Soon, pitch teams won´t be just about fielding investment professionals; they'll be about fielding reporting specialists, compliance specialists, structuring specialists and general counsels because the fund manager selection process will no longer just focus on your investment track record. Compliance and reporting are already on several LPs' lists of selection criteria."

EVCA is urging its members who have concerns about the AIFMD to liaise with their national trade bodies as well as itself and to lobby the European Securities and Markets Authority (ESMA), which is establishing the finer points of the directive. Karsten Langer, who was elected chairman of EVCA earlier this month, thinks that one way to encourage greater leniency from regulators is for firms to up their efforts to improve the industry's public image.

Referring to the PR disaster of Southern Cross, which has monopolised headlines,  Riverside Company partner Langer said last night: "When private equity has received attention, it's very often been in a negative light, which fails to recognise the powerful force that this industry is for growth in the economy. If we're understood to be a positive force and our true mission is perceived correctly, we'll encounter more favourable conditions from regulators."

He added: "Once the private equity industry becomes regulated, the chances are it will remain that way. We might as well prepare for it as best we can now."

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