Regulation’s update for small fund managers: new requirements

18.05.2022 Estonian parliament adopted changes for Investment Funds Act (IFA), which may significantly affect economic activity of small fund managers without license issued by the Estonian Financial Supervision Authority (EFSA). In this article will be described main changes and Gofaizen & Sherle legal team’s opinion regarding future approach to such fund managers.
According to the EFSA recommendation IFA’s changes shall mitigate the risks posed by unauthorised small fund managers without EFSA’s license. The risks relate in particular to retail investors and Estonia’s investment environment’s reputation. In the view of the EFSA, there is a concern that the Estonian registration label is being exploited to attract less informed retail investors who may not understand that the registration with the EFSA does not in reality mean supervision of the small fund managers. In addition to this, there’s also an issue with regulatory approach, that not all small fund managers are licensed by Estonian Financial Intelligence Unit as required by law.

New IFA provides for cases where the EFSA has the right to reject a registration application of a small fund manager. No new requirements are introduced as grounds for refusal of registration, but the provisions already existing in the IFS for fund managers are enforced. The amendment is based on the experience of the EFSA with applications for registration where the small fund manager does not in fact comply with the requirements of the IFS but there is no basis for refusal of registration in the IFA. Consequently, the provision in the IFA governing the registration of small fund managers is clarified and the EFSA is empowered to refuse registration to an small fund manager who does not comply with the requirements laid down in the IFA for a fund manager established in Estonia. For example, in the period 2019-2021, the EFSA has registered 35 small fund managers, 10 of which, according to the EFSA, have no connection with Estonia. According to the EFSA’s assessment, registration as a small fund manager in Estonia is used as an opportunity to obtain the “EU quality mark”. The status quo is also being exploited to attract less informed retail investors, who may not understand that registration with the EFSA does not in reality mean supervision of the fund manager.

Requirements for information submitted to investors

In accordance with § 265¹of IFA, the information (incl. advertising) to be disclosed by small fund manager shall be true and unambiguous and shall not be misleading. The information to be disclosed may include data and estimates to be published concerning the fund, the purpose of the publication of which is to inform the public of the fund’s activities or financial position, the development of the net asset value of the fund’s units or shares and other necessary facts.
Fulfillment of this requirement may be controlled by EFSA in the course of straitened supervision as described below.

Local substance requirement

The grounds for refusal of registration has been extended and the EFSA is given the right to refuse registration if the information provided by the small fund manager does not unambiguously show that the small fund manager is domiciled in Estonia. The requirement of domicile is already laid down in IFA § 304 (2). The purpose of this provision is to ensure that fictitious small fund managers with no connection to Estonia do not appear on the Estonian market. Domicile is the place of establishment within the meaning of Section 29(1¹) of the General Part of the Civil Code Act (GCCA). The place of establishment of a legal person is the place where it has its permanent and continuous business or other statutory activities, according to § 29(2) of the GCCA. The economic activity of the small fund manager may be considered to be the management of the fund within the meaning of IFA § 305, i.e. the administration, offering and other activities of the fund. However, the provision to be inserted does not preclude that the fund’s investors and investments may not be located outside Estonia. Since, according to § 29(2) of the GCCA, the place of establishment of a legal person may also be understood as a place of other statutory activities, which may render the scope of the concept of place of establishment vague, the provision to be inserted in the IFA emphasizes that an application may also be rejected if the first essential element of the concept of place of establishment (the place of permanent and continuous economic activity of the person in Estonia) is not fulfilled. In addition, the EFSA is under no obligation to accept a registration application if the small fund manager provides incorrect or misleading information to the EFSA.

Enhanced supervision after registration

The EFSA has received right to remove a small fund manager from the register on its own initiative in certain cases, including in the event that the activities of the small fund manager should constitute grounds for refusal of the registration application as specified in § 453(5¹) of IFA. This will ensure that, for example, the requirement of domicile and place of business must be fulfilled not only at the time of registration but also during the management of the fund.
In addition to aforementioned, the EFSA has the right to remove small fund manager from the register in the following cases:

• the small fund manager has not commenced the activity (fund management) within six months of registration;
• where the small fund manager has made false statements in the application for registration which were material to the decision to register. False statements means that the small fund manager knowingly provided the EFSA with false information and such information had to be material to the decision to register, i.e. the false statements concerned the compliance of the small fund manager or the application with the requirements of the IFA, such as those on which the registration depends;
• if the small fund manager provides misleading information or advertising;
• if the small fund manager has committed money laundering or infringed the rules on money laundering and terrorist financing laid down by law.

Effect to existing and new market participants

In comparison to previous regulation, new requirements will oblige small fund managers to pay more attention to publicly available documentation and its correctness. It will positively affect Estonian financial market and allow to make better environment for retail investors. Tightening requirements for local substance together with giving more rights to supervision authority allows to create more jobs in such small fund managers, through the circumstance, that more small fund manager’s personnel shall be permanently located in Estonia. Such approach will also allow to perform supervision under such companies more effectively.
However, the EFSA supervision and tendency of changes in small fund managers regulation may take Estonia away from the purpose of AIFMs Directive and Estonian legislation, introduced in 2017, to make investment funds available for small groups of investors without significant efforts. Nevertheless, Estonia still remains one of jurisdictions, where AIFs may be offered to retail investors (with relevant limitations) and it makes it attractive for newcomers, due to reputation of jurisdiction, attractive tax system and good position in international ratings (e.g. ease of doing business, etc.).