Reverse solicitation update: ESMA and the Commission consider how to gather data

• United Kingdom
• Europe

• Financial services and markets regulation
• Investment funds and asset management

11-04-2022

ESMA recently published its correspondence in relation to the Commission’s Request for support in relation to the report on reverse solicitation.

As part of its evaluation of the Cross-Border Distribution of Funds Regulation (EU 2019/1156) (“CBDF”) the Commission asked ESMA for information on the extent to which asset managers rely upon reverse solicitation.  The Commission will submit an official report to the European Parliament and Council in Q1 2022.

Reverse solicitation in the EU

Reverse solicitation is the name given to the circumstances in which a prospective client approaches an investment fund or its manager on its own exclusive initiative.  The inquiry must not be in response to advertising or marketing of any kind.  While EU Member State National Competent Authorities (“NCAs”) take a range of views on reverse solicitation, all of them construe it narrowly.

The coming into force of the CBDF in August 2021 brought concerns about reverse solicitation to the fore.  The funds industry pointed out that the new rules on pre-marketing were unclear and may severely limit, if not make impossible, the use of reverse solicitation.  Under the CBDF, any subscription made within 18 months of pre-marketing activity is considered notifiable marketing.  Consequently, commencing any pre-marketing activity prohibits reliance on reverse solicitation for a period of 18 months and at present it is unclear how broadly those rules should be interpreted.

ESMA’s letter reveals that almost all NCAs have no readily available information on the use of reverse solicitation either via asset managers or investor associations.  Only CONSOB in Italy and CySEC in Cyprus were able to provide significant data.  In both cases that detail revealed some surprisingly high levels of reverse solicitation involving professional investors, although in both cases it appears that there may be specific market conditions which explain that, for instance, the way in which professional investors set up property funds in Italy.

In absence of hard data, some NCAs attempted to estimate what level of reverse solicitation may be occurring in their markets.  CNMV in Spain, in reliance of its knowledge that Spanish funds are rarely marketed outside Spain, argued that the proportion of fund assets held by individuals not resident in Spain, 1.36%, could be used as a proxy for the scale of reverse solicitation.

ESMA notes that the lack of hard data is due to the lack of any obligations on NCAs to collect data on reverse solicitation.  With reverse solicitation coming under closer scrutiny following the UK’s departure from the EU, it would seem possible, perhaps even probable, that in its review of CBDF the Commission will recommend that NCAs begin to collect such data.

Bureaucrats rarely collect data to no end.  If data on reverse solicitation does end up being collected, it seems inevitable that the data will be used to inform policy formation.

Reverse solicitation in Ireland

It is unclear if CBDF will have the effect of restricting the right enshrined in AIFMD for professional investors in the EU to invest in an AIF on a reverse solicitation basis.

Recital 70 of AIFMD provides that “This directive should not affect the current situation, whereby a professional investor established in the European Union may invest in AIFs on its own initiative, irrespective of where the AIFM and/or the AIF is established.”

The use of the phrase ‘on its own initiative’ in Recital 70 is key to the definition of marketing in AIFMD, which is “a direct or indirect offering or placement at the initiative of the AIFM or on behalf of the AIFM of units or shares of an AIF it manages to or with investors domiciled or with a registered office in the Union.”  

Accordingly, if investors initiate contact with the AIFM, rather than the AIFM approaching the investors, then AIFMD does not apply and the AIFM is not considered to be ‘marketing’.  This process is known as reverse solicitation.

The Central Bank of Ireland (the “CBI”) has not issued any guidance or stipulated any requirements for firms to report on instances of reliance on reverse solicitation.  The extent to which firms in Ireland are relying on reverse solicitation is difficult to gauge, as are the challenges associated with collecting such data. 

As set out above, there is a restriction on relying on reverse solicitation for 18 months after an AIFM engages in pre-marketing of the relevant AIF.  However, the application of this restriction remains unclear, as to whether it restricts the reliance on reverse solicitation:

• when a subscription is received from a specific investor to whom pre-marketing took place
• from investors in a particular member state in which pre-marketing took place
• in any instance following the pre-marketing of an AIF

Further guidance is required as to how the pre-marketing requirements will apply to third country AIFMs and whether national private placement regimes (“NPPR”) require amendment to prevent EU AIFMs being subject to more onerous requirements under the CBDF than those applicable to third country AIFMs under NPPR requirements.

It is anticipated that the CBI will expect firms to be able to explain and evidence on a case-by-case basis that any assertion of reverse solicitation is supported by the facts and that all appropriate regulatory approvals or authorisations are in place.

Reverse solicitation in Italy

Regulation no. 17297 of 28 April 2010 requires Italian asset management companies to provide CONSOB (the Italian financial markets regulator) with a quarterly report on their marketing activity in relation to their own and third parties’ collective investment undertakings.

This report must include information on subscriptions to collective investment undertakings which arose “without any marketing activity”, otherwise known as reverse solicitation.  This is why CONSOB possesses data on reverse solicitation subscriptions to collective investment undertakings distributed by Italian asset management companies.

Currently Italian law permits retail and professional clients to reverse solicit financial services from firms located outside the EU without those firms being required to have an authorised branch in Italy.  However, CONSOB is currently consulting on limiting the application of reverse solicitation to circumstances in which Italian clients approach EU financial services firms.  

Reverse solicitation in Luxembourg

Unlike Italy or Cyprus, Luxembourg does not require investment fund managers to report on reverse solicitation.  As such, it is difficult to estimate how frequently Luxembourg funds are approached on a reverse solicitation basis.  The AIFMD does not define the concept of reverse solicitation, however in 2015 the Luxembourg Financial Supervisory Authority (“CSSF”) provided some guidance in its frequently asked questions on AIFMD.  The CSSF explained that reverse solicitation consists of two elements: (i) the prospective investor approaches the AIF or its AIFM solely upon its own initiative, and (ii) neither the AIFM nor AIF have solicited such investor directly or through an intermediary.  The AIFM is obliged to obtain a written statement from the investor confirming that both elements of reverse solicitation are fulfilled, however, that statement is not subject to any reporting or filing obligation.

Reverse solicitation in Spain

While the Spanish regulatory system expressly recognises the provision of financial services on the basis of reverse solicitation, the extent to which this occurs in Spain is difficult to ascertain as there is no requirement to report reverse solicitation or to collect data in relation to it.  

If an investment firm or fund based in Spain provides services or activities on the basis of reverse solicitation, Spanish law (article 28 ter of Royal Decree 217/2008) provides that:

1. the financial services activity does not take place on Spanish territory; and
2. a non-EU firm which provides financial services on the basis of reverse solicitation is not permitted to market new categories of investment products or investment services to such client (although the client may request such services or products by a further reverse solicitation).

CNMV (the Spanish financial services regulator) is actively monitoring reverse solicitation practices in response to those questionable practices and behaviours that have come to their attention following the end of the Brexit transitional period at the end of 2020. 

UK firms and reverse solicitation of EU clients

ESMA warned UK firms about the limits of reliance on reverse solicitation last year, see our client briefing, “ESMA statement on UK firms relying upon reverse solicitation for the provision of services to EU clients”.

In that briefing we explained that notwithstanding the limitations imposed on reverse solicitation, the rights of natural and legal persons to free movement of capital, including the right to invest their capital in funds domiciled outside their home state, are enshrined in the EU Treaties and the UK-EU Trade and Co-operation Agreement.  Genuine reverse solicitation is a valid, legal right under both EU and UK law and financial services firms have every right to provide services to both EU and UK clients that act on their exclusive initiative to seek financial services whether within or outside their home state.

How can Eversheds Sutherland help?

Our team have been advising on regulatory interpretation and product development for the fund management industry since the 1980s and we were at the forefront of MiFID II implementation. Our in depth understanding of the sector and experience with the practical implementation of MiFID II mean that we are very well placed to guide you in complying with the changing regulatory environment.