With reference to the regulatory categorisation of investment funds in the European Union, investment funds are categorised as either an undertaking for collective investment in transferable securities otherwise abbreviated as (UCITS) or alternative investment funds (AIFs). In Cyprus, a ‘UCITS’ is defined in the Law on Open-Ended Undertakings for Collective Investment (UCI Law) (78(I)/2012), which incorporates the EU UCITS IV Directive (2009/65/EC).
The term ‘UCITS’ corresponds to a regulatory category. Thus, in order for an investment fund to qualify as a UCITS within the meaning of the UCI Law, it must be authorised as such pursuant to the law and not merely operate in accordance with its provisions.
The knowledgeable authority for the authorisation and supervision of UCITS in Cyprus is CySEC (Cyprus Securities and Exchange Commission). After its authorisation, it is required that a UCITS must operate in accordance with the UCI Law on an ongoing basis and cannot convert into any other type of investment fund. UCITS can always be distinguished from AIFs, because UCITS are authorised and categorised as such by CySEC. Additionally, they may categorise themselves as UCITS in their marketing documents and communications following the said prior authorisation of CySEC.
On the other hand, the term ‘AIF’ is a legal term introduced by the EU Alternative Investment Fund Managers (AIFM) Directive (2011/61/EU), which has been incorporated into Cypriot law through the AIFM Law as amended (56(I) 2013). According to the AIFM Law, the term ‘AIF’ encompasses, without prejudice to any exemptions provided for therein, all investment funds that do not qualify as UCITS, irrespective of their regulatory categorisation. Therefore, unlike UCITS, which always require authorisation and regulatory categorisation as such by CySEC, an investment fund will qualify as an AIF, within the meaning of the AIFM Law, irrespective of its regulatory categorisation and even if it is not subject to authorisation and supervision; it is sufficient that the vehicle operates as an investment fund without being authorised or registered with any authority. Hence, from a Cypriot perspective, the term ‘AIF’, as defined in the AIFM Law, is a generic legal term encompassing all regulated and unregulated non-UCITS collective investment schemes in Cyprus. However, given that the AIFM Law regulates AIFMs for example, legal persons authorised by CySEC to offer at least risk and portfolio management to AIFs, rather than the investment funds themselves, it does not dictate whether AIFs must be regulated in Cyprus or how many types of regulated AIF are or should be available. That is a subject for national legislation to decide.
Adopted concept of investment fund regulation
UCITS are regulated under the UCI Law and form the first axis of investment fund regulation in Cyprus. The reason for considering UCITS as the first axis of investment fund regulation is not only historical, given that UCITS were introduced under EU law in 1985 but also because it is closely associated with the overall concept of the regulation of investment funds since, as an EU member state, Cyprus is obliged, to provide for the existence, authorisation and supervision of UCITS. According to the UCI Law, UCITS may accept investments from possibly everyone, irrespective of the sophistication or net worth of the prospective investor. On the other hand, the AIFM Directive, leaves it to each EU member state to determine whether it will allow unregulated AIFs within its territory or whether it will subject all AIFs to regulation and supervision. In accordance with the AIFM Directive’s objectives, the AIFM Law seeks to regulate Cyprus-based AIFMs directly; as to Cyprus-based AIFs, these are indirectly regulated through a series of obligations incumbent on the Cyprus or EU-based AIFM of a Cypriot AIF (e.g. safekeeping of assets, disclosure and reporting). These indirect obligations are triggered if the AIFM in question manages aggregate portfolios of AIFs above certain thresholds which are prescribed in the AIFM Law. Otherwise, as mentioned above, the AIFM Law does not intervene in the regulatory status of an investment vehicle qualifying as a Cyprus-based AIF, in order to require its authorisation and supervision. Moreover, the AIFM Law imposes no requirements on a Cypriot AIF whose manager in aggregate manages portfolios of AIFs below the prescribed thresholds or which is below the prescribed thresholds itself, if self-managed. Therefore, it is Cypriot dedicated legislation that decides:
- as to whether Cypriot AIFs are subject to authorisation;
- the extent of regulation of Cypriot AIFs whose management falls below the prescribed thresholds; and
- in the case of Cypriot AIFs whose management falls above the prescribed thresholds, those aspects of regulation which are not covered by or may apply in addition to the indirect obligations imposed by the AIFM Law.
The loyal regulation of AIFs in Cyprus, through the AIF Law (131(I)/2014), subjects any investment vehicle that has been established in accordance with Cypriot law and qualifies as an AIF to regulation and supervision. Besides a small number of AIFs that are regulated by the Cyprus Stock Exchange (CSE) and are known as CSE investment entities, all other vehicles that qualify as AIFs are subject to the AIF Law. AIFs that fall under the AIF Law are subject to licensing and supervision by CySEC and are categorised according to the type or number of investors targeted, as stated below:
- AIFs targeting private investors (i.e. the public, as made clear in Article 37(1) of the AIF Law);
- AIFs targeting a limited number of up to 75 well-informed and/or professional investors;
- AIFs targeting well-informed and/or professional investors.
This therefore means that unregulated investment funds in Cyprus which qualify as AIFs and benefit from no exemptions must apply for authorisation from CySEC.
In conclusion, the axes of direct investment fund regulation in Cyprus are therefore the UCI Law and the AIF Law, with some AIFs falling under the regulation of the CSE, for historical purposes.
Access to all types of EU investors
There are many differences between the UCI Law and the AIF Law. UCITS are subject to fixed regulation, which is provided for in the UCI Law and relevant CySEC directives and circulars. What is meant by ‘Fixed regulation’ is that the applicable provisions do not vary depending on the size of the UCITS itself or on the aggregate assets under management by the manager of the UCITS. Contrariwise, AIFs are subject to ‘variable regulation’. This means that a self-managed AIF whose assets exceed the AIFM Law prescribed thresholds or whose external management manages in aggregate AIFs whose assets under management exceed AIFM Law thresholds will be subject to both the provisions of the AIF Law and the AIFM Law and in the case of a conflict between the AIF Law and the AIFM Law, the latter will prevail. Additionally this will also be the case when the manager of an AIF or the AIF itself, if self-managed, opts in to the AIFM Law, even though the assets under management are below the prescribed thresholds. Equally, if the prescribed thresholds do not apply or there was no option to submit to the AIFM Law, then only the AIF Law will apply. Thus, the applicable provisions for AIFs vary depending on whether the assets under management are above the prescribed thresholds and whether opt-in has been applied.
Additionally, the regulation of UCITS pursuant to the UCI Law does not depend on the type of targeted investor base; nor are investors restricted from investing in UCITS because of their lack of sophistication. Therefore the UCI Law does not distinguish between retail, professional and well-informed investors, so that every investor is eligible for investing in a UCITS. On the contrary, it uses the term ‘public’ meaning, potentially everyone, without distinguishing on quantitative or qualitative grounds. In contrast, the regulation of AIFs under the AIF Law depends on the type and number of investors targeted. There are private investor (public) AIFs, which are heavily regulated and there are AIFs targeting professional and/or well-informed investors that are less regulated; and there is minimal regulation of AIFs that target up to 75 professional and/or well-informed investors. Moreover, an AIF for well-informed and/or professional investors, including an AIF targeting the limited number of 75 of those investors, reserves its units exclusively for such investors. Thus, private investors (i.e. retail) are excluded from participating in these types of AIF.
Regardless of their differences, UCITS and AIFs benefit from the so-called ‘passport’ meaning, the possibility to market their units to investors in other EU member states under observance of a prescribed notification procedure, without being subject to approval by the host member state regulator. In the case of UCITS, the passport possibility is vested in the fund itself. Once a fund has been authorised as a UCITS by CySEC, it may benefit from the passport, notwithstanding the amount of assets under management or the assets managed in aggregate by its manager.
In the case of AIFs, the passport possibility is vested in the regulatory status of its manager as an authorised AIFM, instead of the fund itself. An AIF is therefore granted a passport only when it is managed by an AIFM, whose appointment will be either mandatory because the prescribed thresholds are exceeded or optional because of opting-in. The same notion applies in the case of a self-managed AIF. Thus, for an AIF below the prescribed thresholds that has appointed an entity other than an AIFM as its manager or does not opt-in, if self-managed, no passport will be granted.
Another difference between UCITS and AIFs concerns who cross-border marketing may target when a passport right is exercised. For cross-border marketing of UCITS, the targeted investor base is the public in all EU member states meaning potentially everyone in the EU.
Nevertheless, according to current EU regulations, the cross-border marketing of an AIF may target only professional investors, such investors being professional clients, within the meaning of the EU Markets in Financial Instruments Directive (2004/39/EC) as amended. This will mean that an AIF, which has been authorised by CySEC to target private investors meaning the public in Cyprus and has appointed an AIFM (or is considered to be an AIFM itself if self-managed), may under the passport market its units only to professional investors across the EU. The same restriction applies to well-informed investors, within the meaning of the AIF Law, in an AIF that is authorised by CySEC to target professional and well-informed investors and has appointed an AIFM (or is considered to be an AIFM itself if self-managed). Given that the AIF Law’s definition of a ‘well-informed investor’ is not considered to be a professional investor, this type of AIF can make use of the passport only for its professional investor base. In conclusion, it is apparent that for fund promoters targeting investors that do not qualify as professional investors, the right vehicle would be a UCITS in order for them to market their product by means of a passport.
All investment funds in Cyprus are subject to regulation and supervision by a common regulator, CySEC. Whereas regulation of UCITS is uniform, regulation of AIFs is a matter on which EU member states have discretion. The decision taken in Cyprus was to subject all non-UCITS investment funds to regulation as AIFs under the AIF Law, as reflected in the relevant provisions. Depending on the sophistication and number of targeted investors, AIFs regulated under the AIF Law are divided into three categories:
- AIFs open to all types of investors;
- AIFs open to well-informed and professional investors only; and
- AIFs open to up to 75 professional and/or well-informed investors.
In opposition, UCITS are open to potentially everyone, without any quantitative or sophistication restrictions. Regardless of the regulatory differences, both UCITS and AIFs can be marketed across the EU on a passport basis. The UCITS passport is a tool for fund promoters that intend to target retail, within the meaning of not being professional investors, since a UCITS may solicit investments from the public. The passport offered to AIFs by means of appointment of an AIFM is a tool for fund promoters intending to solicit professional investors in general, and the AIF targeting professional and/or well informed investors is the appropriate Cypriot AIF investment vehicle to this end.