Considerations On AIFM Compliance For Family Offices Investment Vehicles
The phenomenon of family offices has been ramping up since 2000. The single-family structure is the most traditional one, even though nowadays we see many more entities in charge of managing and investing the wealth of multiple families, with a more sophisticated approach and hedge fund type style of investment.
Whilst these entities may have a very different regulatory treatment in Europe and in the US, considerations are somewhat convergent and results identical with regards to the application of some European regulations, AIFMD in particular. Both European and US based family offices are not immune from AIFMD under certain circumstances and need to carefully design the structure of investments and co-investments deployed in Europe in order to manage overall exposure to AIFMD.
Regulatory considerations on structures – US vs EU
Though one of the pillars of the internal structure of family offices is the provision of investment advice - and this is a common feature across the world - the regulatory treatment and categorisations of family offices in the United States is different than in Europe.
In the United States, pre-Dodd-Frank, family offices would apply for an exemption under the Investment Advisor Act. With the advent of the new legislative framework, a definition of family office was introduced directly under the Investment Advisor Act and the qualifying conditions remained by and large the same used for the exemption. The introduction of a definition also brought more clarity in respect of the features of family offices, with some secondary regulation issued by the SEC to better identify the most typical features of family offices, from ownership structures and board composition through to non-investment advisory services provided.
Family offices in Europe do not enjoy an ad-hoc regulatory definition and are categorised simply on the basis of the regulated services provided; certain family office structures in Europe are also able to stay out of the regulatory radar altogether because the management of the wealth of a single family is not seen as a threat to the economy or the system and therefore they are not required to undertake a path of regulation.
Family offices involved with the management of wealth of multiple families lend themselves to a more complicated regulatory treatment than the single-family model, with more regulation to abide by and licenses to obtain for the regulated services offered by the multi families.
The role of external capital for AIFMD compliance purposes
If family offices are, by and large, private investment advisors and are regulated as such, what is the concern for AIFMD compliance? When does AIFMD come into play for family offices, if at all? Typically, this comes in the investment phase, when vehicles are created, and investments are deployed from a pool with other investors.
The AIFMD contains an exclusion from its scope for investment undertakings that are utilized to invest the private wealth of investors which do not raise external capital. In other words, investment vehicles used for the capital of a single family are not considered to be Alternative Investment Funds (AIF). Whilst this does not equate to saying that family offices investment structures are not at risk of being caught at all by AIFMD, it is an interesting starting point for the analysis. As highlighted in the Perimeter Guidance Manual of the UK FCA, the assessment of whether an investment vehicle used by a family office is caught under AIFMD is based on the concept of capital and the differentiation between internal and external capital. Given that an AIF, by definition, is used to raise capital that is external to the organisation in charge of managing the AIF, in the instances where there exists in an investment structure an element of external capital, those vehicles are caught by the provisions of AIFMD.
Therefore, multi-family office investment vehicles, are very likely to be caught by AIFMD. Also, in instances where a single-family office would participate in an investment alongside other entities shall most likely be treated as AIFs.
But that’s not all. AIFMD compliance is not exclusively a concern for European family offices. In fact, there are territorial effects within AIFMD that extend also to non-EU entities in all cases where European investors are concerned. So, in a scenario where a non-European family office would co-invest with European investors, the specific vehicle would be considered to fall under the AIFMD and the principle of private placement under the AIFMD, in addition to any gold-plating provision in force in the specific domicile.
Wolf in sheepskin?
The US type of family office is a different animal than the EU version altogether. It is worth mentioning that since 2015, a trend has emerged of hedge funds transitioning to the family office model. Due to a combination of poor performance, increased requirements for transparency, disclosure and costs for regulatory compliance, former hedge fund managers – some of them very well-known- decided to return capital to their outside investors and manage their money under the much lighter regulatory regime applicable to their families and employees. This trend has contributed to the evolution of a concept of family office in the US that is very close to a hedge fund rather than an institution that takes care of preserving the wealth of a single family and to provide life events related services. We see that this is increasingly becoming the case also in Europe.
We believe that when managing significant amount of assets, those entities should receive the attention of regulators and their activities should fall under existing regulations because they can realistically contribute to the systemic risks that the very regulations are trying to prevent.
Attilio Veneziano is Managing Director of Veneziano & Partners
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