Since the turn of the millennium, there has been an increase in the variety and use of capital structures of a company. Under the well-known and widely accepted Modigliani and Miller theorem (“M-M theorem”), regulators would be able to achieve any particularly desirable mix of debt and equity in banks at negligible cost, since leverage (banks' debt: equity ratio) would then be irrelevant to lending and its pricing[1]. Although it is proposed by the M-M theorem that the capital structure of a company[2], i.e. how the combination of debt and equity is managed, is irrelevant for the value of the firm, this classical theorem has been challenged by many other theorems, such as the ‘trade-off’ theory, the ‘agency costs’ theory, and ‘pecking-order’ theory (Ferran, pp. 54-56)[3].

Alternative investment vehicles have recently been more popular, especially in terms of the private equity and the leveraged finance markets, notably after the rather abrupt entrenchment in the marketplace due to the credit crunch of the 2007-2008 crises (Yates & Hinchliffe, p.170)[4]. This increase in popularity gave rise to a need in the regulation of the alternative investment market, especially in terms of private equity investments. Particularly, during the last decade, fast changes in the global economic environment triggered asset management to social and economic change. In the meantime, the lack of stability in long-term investment returns increased the need for sustainable long-term investment returns and the attention paid to alternative asset management[5].

Overview of the Concept of Alternative Investment

Investment funds are specially formed investment vehicles, created only with the purpose of gathering assets from investors, and investing those assets in a diversified pool of assets. Such investment in investment funds provides small investors with the opportunity of exposure to a professionally-managed and diversified range of financial or other assets.

Before the explanation regarding the alternative investment concept, please note that since its introduction in 1985, an undertaking for collective investments in the transferable securities (“UCITS”) fund has evolved into a European brand with international recognition, especially after its regulation at the European level. The final directive on UCITS, i.e. Directive 2009/65/EC on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities adopted on 23 July 2014 (“UCITS Directive”) has offered European investors a wide range of high quality and safe investment products. UCITS funds gained popularity, not only in Europe, but also in South America and Asia among investors preferring not to invest in a single limited public company, but rather to invest in diversified unit trusts, spread out within the European Union (“EU”)[6].

In contrast to the UCITS, the term "alternative investment funds" (“AIF”) corresponds to all investment funds that are not already covered by the UCITS Directive. This includes hedge funds, funds of hedge funds, venture capital, and private equity funds and real estate funds.

Overview of the Concept of Private Equity as a Type of Alternative Investment

Private equity” could be broadly defined as investment in equity securities in unquoted companies, i.e. companies that are not listed in public stock exchanges (Yates & Hinchliffe, pp. 2). On the other hand, if we look at the term “private equity firm,” it is an investment manager that raises a pool of capital, such as pension funds, funds of funds and wealthy individuals which is typically in the form of private equity funds, to invest (Yates & Hinchliffe, pp. 8-10). “Private equity investors” are typically institutions or individuals in the form of private equity firms operated by investment professionals or business angels.

Overview of Directive on Alternative Investment Fund Managers

Overview of the Concept of Alternative Fund Managers

As expressed before, AIF refers to investments other than the traditional investments in stocks, bonds, cash or real estate, but rather to investment funds that are not already covered by the UCITS Directive. The management of such AIFs is regulated by the EU directive titled Alternative Investment Fund Managers Directive (“AIFMD” or “Directive”) numbered 2011/61/EU and dated 8 June 2011. Alternative Investment Fund Managers (“AIFMs”) are EU fund managers that manage AIFs, such as hedge funds and private equity funds, irrespective of whether the funds are EU or non EU AIFs, and managers that manage EU AIFs or market one or more AIFs in the EU, regardless of whether such AIFs are EU AIFs or non-EU AIFs. The AIFMD’s regime applies to all such managers so long as they manage such funds that are marketed in the EU without any condition as to where they are based[7].

Situation Before – Lack of Singularity in Regulation

In the absence of a single European fund structure for alternative investment funds, Invest Europe, formerly known as the European Private Equity and Venture Capital Association[8], (“EVCA”) used to advocate the mutual recognition of existing national structures. The EVCA was underlining that such single regulation would ensure that the entire fund’s investors and managers, regardless of their country of origin, would have the same opportunities and benefits. In order to provide a fiscally transparent structure, both for investors targeting AIFs, managers of such funds and regulatory bodies as such to work in harmony, effectively, it was believed to be essential that AIFs be mutually recognized in each European country. It was also foreseen that such a unifying legislative text would induce cross-border activity, furthering the levels of capital available for European private companies as investment targets and, ultimately, returns for underlying trans-national institutional investors[9].

Aim of the Directive

The AIFMD pursues to regulate the managers of AIFs, including hedge funds, private equity funds, and retail funds. The Directive brings forward a dynamic regulatory process, where there are many implementing measures, on which the European Commission has asked European Securities and Markets Authority (“ESMA”)[10] to provide advice[11]. The Directive also includes reforms on delegation, the appointment of independent valuers and custodians, leverage and risk management, and transparency and marketing, and establishes a legal framework for the authorization, supervision and oversight of managers of a range of AIFs, including hedge funds and private equity[12]. The AIFMD’s most substantial aim is to achieve greater transparency and stability to the manner in which these kinds of funds operate by monitoring the risks that AIFMs pose to their investors, counterparties and other financial market participants and to financial stability, and permitting AIFMs to provide services and market their funds across the internal market, subject to compliance with strict requirements[13].

José Manuel Barroso, holding the post as the President of the European Commission at the time, stated his opinion in 2010 regarding the then upcoming adoption of the Directive as follows:

"The adoption of the directive means that hedge funds and private equity will no longer operate in a regulatory void outside the scope of supervisors. The new regime brings transparency and security to the way these funds are managed and operate, which adds to the overall stability of our financial system.[14]"

Impact of the Directive on Private Equity Investments

In accordance with Articles 36 and 42 of the AIFMD, non-EU AIFMs and non-EU AIFs managed by EU AIFMs are subject to the national private placement regime (“NPPR”) of each of the Member States where the AIFs are marketed or managed. However, the AIFMD seeks to progressively replace the NPPR with the concept of “passport” for AIFMs to offer their services in different countries on the basis of a single authorization. According to this “passport” regime, once an AIFM is authorized in one EU member state and complies with the rules of the Directive, the AIFM is entitled to manage or market funds to professional investors throughout the EU (Eur-Lex). Initially, the Directive administers so that such “passport” is reserved to EU AIFMs and AIFs, but to be potentially extended[15].

ESMA Advises on Extension of Funds Passport to 12 Non-EU Countries

In general, ESMA is expected to carry out an active role in the establishment of a common supervisory culture by promoting common supervisory approaches and practices. In terms of the “passport” concept with regard to non-EU AIFs, the ESMA has a strategy to look at each non-EU country individually to develop a comprehensive assessment methodology based on the criteria set out in the AIFMD; namely, i) investor protection, ii) market disruption, iii) competition and iv) the monitoring of systemic risk. The Directive provides that where ESMA considers that there are no significant concerns in relation to these four elements, ESMA should issue positive advice[16]. In this regard, as a pioneering example to such extension of the passport under the Directive, the ESMA has recently published its Advice in relation to the application of the AIFMD passport to non-EU AIFMs and AIFs in twelve countries. These countries are Canada, Guernsey, Japan, Jersey and Switzerland, Hong Kong, Singapore, Australia, United States, Bermuda and the Cayman Islands, as well as the Isle of Man[17].

Conclusion and Future Projections

According to PwC, by 2020, the trend of AIFs will have largely developed (PwC). While AIFMD implements a comprehensive framework for the regulation of AIFMs within Europe, such activity targeted on AIFs will provide an alternative for those investors seeking a profitable and reliable alternative to the UCITS with the extensive requirements with which AIFMs must comply[18].

Regulations in Turkey as a Non-EU Example

As per the regulations with regard to fund managers that are foreign, relative to the country wherein the investment is targeted, it is also worth noting that under the Capital Markets Board Communique numbered VII-128.4 titled Communique Regarding Foreign Capital Market Instruments, Depository Receipts and Foreign Investment Fund Shares published on the Official Gazette dated 23 October 2013 and numbered 28800, foreign capital market instruments to be sold through a public offering or without a public offering are subject to an application to the Capital Markets Board.

Passporting Practice Ahead

According to the preliminary timeline for the dynamic regulatory process for alternative investment vehicles, by 22 October 2018, the ESMA will issue its opinion as to whether to turn-off domestic private placement regimes. Finally, it is hoped that by 22 January 2019, depending on the ESMA’s recommendation, the European Commission may turn-off private placement[19].

Gradually, the aim of creating a secure EU framework for monitoring and supervising alternative investment funds, including hedge funds, private equity, venture capital funds, real estate funds and investment trusts is reached. While a parallel regulatory regime is in place for Turkey, there is still no progress regarding a grant for Turkish AIFs. However, it is highly likely that the ESMA will keep issuing its opinion for other non-EU countries about passports for AIFs based on such countries, hopefully also including Turkey.

(First published on the website of Erdem & Erdem Law Office in December 2016)

[1]  FSA Materials: Discussion Papers and Feedback > 2009 > Discussion Paper 09/2: Financial Services Authority A regulatory response to the global banking crisis > Annex 1 The costs and benefits of regulatory capital requirements > The Modigliani-Miller Theorem (Accessed on 29/12/2016 through Lexis Library database).

[2]  Miller M. and Modigliani, F, 'The cost of capital, corporation finance, and the theory of investment', The American Economic Review, 1958, 48:3, pp. 261-297; 'Corporate income taxes and the cost of capital: A correction', American Economic Review, 53:3, 1963 pp. 443-53.

[3] Ferran, E, Principles of Corporate Finance Law, pp. 54-56.

[4] Yates, G. and Hinchcliffe, M. A Practical Guide to Private Equity Transactions (CUP 2010), Chapter 6 "Debt Funding"(“Yates & Hinchliffe”).

[5]  Alternative asset management 2020 Fast forward to centre stage – PwC 2015 - (Accessed on 03/01/2017) (“PwC”).

[6] Undertakings For The Collective Investment Of Transferable Securities – UCITS (Accessed on 30/12/2016).

[7] Alternative Investment Fund Managers Directive (AIFMD)—timeline Lexis PSL: Financial Services >Financial Services regulation >getting started; EU FS regulation—timelines >Alternative Investment Fund Managers Directive (AIFMD)—timeline (Accessed on 29/12/2016 through Lexis Library database).

[8] EVCA becomes ‘Invest Europe: The Voice of Private Capital’ dated 1 October 2015 accessed at (Accessed on 30/12/2016).

[9] Private Equity Fund Structures in Europe / An EVCA Tax & Legal Committee Special Paper – June 2010 – European Private Equity & Venture Capital Association.

[10] Lexis PSL Corporate > Financial services regulation for corporate lawyers; ESMA > Guide to the European Securities and Markets Authority (ESMA) (Accessed on 29/12/2016 through Lexis Library database).

[11] FSA Materials: Reports and Occasional Papers (Archive 31/3/2013) > Financial Services Authority Anual Report 2010/11 > Section 3 Delivering market confidence > Over-the-counter (OTC) derivative markets > Alternative Investment Fund Managers (AIFM) Directive

[12] Hedge funds and private equity funds — rules for managers (Accessed on 28/12/2016) (Eur-Lex)

[13] Alternative Investment Fund Managers Directive (AIFMD)—timeline Lexis PSL: Financial Services >Financial Services regulation >getting started; EU FS regulation—timelines >Alternative Investment Fund Managers Directive (AIFMD)—timeline

[14] “European Commission statement at the occasion of the European Parliament vote on the directive on hedge funds and private equity” dated 11 November 2010 and numbered MEMO/10/573 (Accessed on 28/12/2016)

[15] (Accessed on 29/12/2016 through Lexis Library database)

[16] ECON hearing on AIFMD passporting 11 October 2016 (Accessed on 29/12/2016 through Lexis Library database)

[17] ESMA Press Release dated 19 July 2016 and numbered ESMA/2016/1138

[18] Questions and Answers Application of the AIFMD dated 16 December 2016 and numbered ESMA/2016/1669

[19]   Financial Services > Financial Services regulation—getting started; EU FS regulation—timelines > Alternative Investment Fund Managers Directive (AIFMD)—timeline ( (Accessed on 26/12/2016)