Shipping project finance – new regulatory intricacies
Project financing has historically been a popular investment scheme and source of capital in Norway for shipping projects. The Norwegian regulatory authorities have however recently published guidelines regarding the application of the alternative investment fund regime on project finance entities and it is important that issuers, advisors, arrangers and investors are aware of the pitfalls of being captured by the wide definition of an alternative investment fund, and what steps they can take in order to adapt to the regulations.
An alternative investment fund (an “AIF”) is defined as a collective investment undertaking which raises capital from a number of investors with a view to investing that capital for the benefit of those investors in accordance with a defined investment policy.
Alternative investment fund
This definition is deliberately very broad, and is derived from the European Alternative Investment Fund Manager Directive (the “AIFMD”) from 2011. The AIFMD was introduced into Norwegian law through the Norwegian Alternative Fund Manager Act (the “AIFM Act”) in 2014. The very broad definition of an AIF captures a vast array of different investment schemes, and could certainly be interpreted as capturing shipping project finance, investor syndicates and certain single asset companies all of which were previously unregulated and typically placed with relatively limited documentation to investors under the private placement regime.
The consequence of being caught by the AIFM Act, is that issuers must appoint either an internal or external manager who shall broadly speaking be responsible for the portfolio management and risk management of the AIF. If the issuer exceeds certain thresholds (500 MEUR for unleveraged, closed ended funds, and 100 MEUR for leveraged funds), or is marketed towards retail investors, the appointed manager must hold a regulatory license with the Norwegian Financial Supervisory Authority (“FSA”) and the fund must be approved for marketing in Norway by the FSA. In such a case, the manager will be subject to several burdensome requirements. For non-Norwegian undertakings, both located within the EU and outside, the AIFM Act sets out detailed conditions and rules for marketing of such funds to Norwegian investors. For Norwegian sub-threshold AIFs (i.e. AIFs which, i.a., do not exceed the aforementioned thresholds of 500 MEUR or 100 MEUR) and which are only marketed to professional investors domiciled in Norway, a more light touch regime applies.
AIFMD and project finance
For many shipping project finance investment schemes, being captured by the full requirements of the AIFM Act is not an attractive proposition due to compliance costs, time to market and investor preference. But whilst registration and managing a sub-threshold AIF is manageable for most arrangers, it will limit the pool of eligible investors for the project and therefore potentially make raising of the requisite capital more challenging. It is therefore important to clarify the regulatory status of any proposed investment scheme as early as possible in the process of raising capital for such projects.
That said, it is not always straightforward to determine whether a specific project falls within or outside the scope of the AIFM Act. In order to assist market participants, the European Securities and Markets Association (“ESMA”) has issued guidance (the “ESMA Guidance”) on the definition of an AIF. Notably, the ESMA Guidance excludes undertakings which have a “general commercial or industrial purpose”, as opposed to a “general financial purpose”. Furthermore, ESMA excludes undertakings where the investors have “day-to-day discretion or control”, as opposed to an undertaking where all operational matters are left with a manager. The broad definition of an AIF, when read in combination with the relatively unclear exclusions from the scope set out by ESMA, has left project finance arrangers and investors with a high degree of uncertainty regarding the application of the AIFM Act. Perhaps because of this uncertainty, in the five years since the entry into force of the AIFM Act, most arrangers in both the shipping project finance and the larger real estate project finance markets have chosen to define their projects as non-AIFs.
The new FSA Guidelines
In June 2019, the FSA published new guidance on the application of the AIFM Act for project finance undertakings. The backdrop for the specific Norwegian FSA guidance was partly the uncertainty in the Norwegian market concerning project finance, but also that certain unregulated arrangers had launched real estate investment schemes which attracted attention in the local financial press due to an exorbitant level of fees, negative returns and extensive conflicts of interests. The FSA guidance is however more generally directed at all forms of single asset-companies, investor syndicates and similar structures (i.e. project finance), whether arranged by investment firms or others, and clearly states that such schemes will “often” be captured by the AIF definition in the AIFM Act. The FSA guidance generally follows the ESMA Guidance, and clarifies to some extent the concepts of “general commercial or industrial purpose” and “day-to-day discretion or control” in the context of project finance undertakings.
The FSA Guidance also sets out certain important parameters that may be used when determining whether or not a specific project falls within or outside the AIFM Act. These are (i) the quantity and “quality” of the investors, (ii) the degree of commercial versus financial purpose of the project (asset play versus no defined exit strategy), (iii) the degree of investor control and participation in the management of the undertaking and (iv) the degree of outsourced activities. To take some simplistic examples a large bareboat project seeking investment from retail investors has a high probability of being caught by the definition of an AIF, whereas a club deal with experienced shipping investors who are active participants in the shipping market will likely fall outside the definition. Not all projects are so clear cut however and all projects must therefore be assessed on a case by case basis in order to determine whether they fall within the definition of an AIF or not, with the rationale for the assessments made being clearly documented. Depending on the outcome of the assessments, it will then be important to ensure that any required disclaimers are made and that the transaction documentation is adapted as appropriate in line with the adopted assessment.
Following the FSA guidance, the choice for issuers and arrangers of shipping project finance deals is usually to (i) choose between a ‘club deal’ with a limited amount of investors or otherwise structure the scheme in a way that excludes it from the AIF definition, or (ii) to register the fund as an AIF and limit the marketing to professional investors.
Wikborg Rein has extensive experience in both shipping project finance, and in dealing with the application and scope of the AIFM Act for such collective investment schemes.
AIFMD – the Alternative Investment Fund Managers Directive (EU/2011/61) including delegated regulations, as implemented in Norway through the Norwegian Act on Alternative Investment Fund Managers (20 June 2014 No. 28).
To regulate the managers of alternative investment funds (AIFM), e.g. the portfolio management and risk management of an alternative investment fund (AIF), the depositary function for an AIF, valuation of an AIF, reporting to authorities, investor information, remuneration and marketing of AIFs within the EU and EEA.
AIFMs managing AIFs. Limited impact on AIFMs managing AIFs with aggregated value of assets under management (AUM) of EUR 100 million (leverage included) or with aggregated value of AUM of EUR 500 million (no leverage and 5 year lock-in) for the management and marketing of AIFs within the EU and EEA.
To regulate all AIFMs due to the financial risks they entail, and to protect investors from investment fraud or losses, and to harmonize legislation for AIFMs.
Project Finance (typically real estate and shipping projects) has recently been scrutinized by the Norwegian Financial Supervisory Authority and consequently arrangers, issuers and investors should carefully assess the regulatory status of any project before raising capital.