Distribution of small Slovak investment funds: will these funds be more accessible to a wider range of investors?

The legislative storm in the National Council of the Slovak Republic in June 2023 also resulted in some relaxation of the criteria for the distribution of small Slovak investment funds[1]. The amendment to the Collective Investment Act reduced the financial limit for a qualified investor (for the purposes of distribution of securities or participations of small Slovak investment funds) from EUR 100,000 to EUR 50,000 and at the same time increased the threshold for the share of qualified investors in the net asset value of a small Slovak investment fund from 20% to 30%. However, the primary target group of investors for whom small Slovak investment funds are intended are still professional investors. Apart from the limited group of per se professional investors, small Slovak investment funds are primarily interested in those investors who are treated as professional investors at their own request. The criteria for assessing whether an investor qualifies as a professional investor are defined in the Securities Act[2] and are based on MiFID II[3]. And it is at the European level that the European Commission, as part of the implementation of the Capital Markets Union Action Plan[4], has proposed to extend the definition of professional investor under MiFID II, which ultimately has the potential to expand the range of persons to whom securities and equity holdings of small Slovak investment funds can be offered.

Current legislation

According to the currently applicable legislation[5], securities and participations of small Slovak investment funds may be distributed only to (i) professional investors[6] and (ii) qualified investors[7]. The Collective Investment Act directly refers to the term professional investor in Section 8a(a)(1) of the Collective Investment Act. 2 to 7 of the Securities Act. Professional investors[8] can be divided into two categories:

1. Per se professional investors[9], i.e. entities that automatically qualify as professional investors, e.g. financial institutions, called. large commercial companies, state authorities, local authorities or even the NBS and the ECB;
2. Professional investors who can qualify as such (after meeting the statutory criteria) at their own request.[10]

The inclusion of qualified investors as persons to whom it is possible to distribute securities and participations of small Slovak investment funds is a relative novelty in the Collective Investment Act. Until 31.12.2022, it was possible to distribute securities and participations of small Slovak investment funds only to professional investors. Partly thanks to our efforts, Act No. 208/2022 Z. z. extended the possibility of distribution of securities and equity participations of small Slovak investment funds also to qualified investors whose investment in such funds is at least EUR 100 000. At the same time, however, the following conditions have been set:

1. the number of qualified investors investing in one small Slovak investment fund does not exceed 50 persons;
2. the share of qualified investors in the net asset value of the small Slovak investment fund does not exceed 20 %; and
3. share of qualified investors in the total value of small Slovak investment funds managed by the registered manager[11] shall not exceed 20 %.

The above-mentioned criteria will be relaxed with effect from 1 January 2024 (again partly thanks to us), in accordance with Act No. 315/2023 Coll., which also amended the Collective Investment Act, so that (i) the minimum investment of a qualified investor will be reduced to EUR 50,000.[12] and (ii) increase the threshold for the share of qualified investors in the net asset value of a small Slovak investment fund from 20% to 30%. Given our relatively extensive experience in establishing and operating investment funds in Slovakia, we perceive market demands for a relaxation of these requirements. At the same time, however, we understand the NBS’s concerns, which stem primarily from experience in the Czech market.

Based on the investment criteria for qualified investors set above, it is obvious that small Slovak investment funds must still be distributed primarily to professional investors (without whom the above limits for participation of qualified investors cannot be achieved). Therefore, while the expansion of the distribution options for securities and equity holdings of small Slovak investment funds to include qualified investors is a welcome change, a significant boost to the distribution of small Slovak investment funds would be a relaxation of the criteria under which investors could be deemed to be professional investors on their own application.

A legislative initiative at European level that includes easing restrictions for investors to be considered professional investors

The European Commission’s objective in the above-mentioned Capital Markets Union Action Plan is that consumers should be able to take full advantage of the investment opportunities offered by capital markets and that retail investors should be able to[13] are able to achieve better investment results from participation in EU capital markets than before.

The European Commission’s legislative initiative in this respect is a proposal for a Directive amending Directives (EU) 2009/65/EC, 2009/138/EC, 2011/61/EU, 2014/65/EU and (EU) 2016/97 as regards Union rules for the protection of retail investors (“theDraft Directive“).

The draft Directive includes a number of measures, including measures that are expected to increase the protection of retail investors and lead to better quality investment products for retail investors that deliver better value for money (i.e. better quality and more cost-effective products). Part of the measures under the Draft Directive also include a relaxation of the criteria for an investor to be considered a professional investor. The draft Directive states that the relaxation of the criteria is intended to ensure a more appropriate classification of investors and to reduce the administrative burden.

Currently, MiFID II requires investors who may be treated as professional investors on request to have an adequate assessment of their expertise, experience and knowledge, such assessment to provide reasonable assurance that, given the nature of the intended investment, the investor will be able to make investment decisions and understand the risks involved. At the same time, at least two of the following criteria must be met during such an assessment[14]:

1. the investor has executed transactions of significant size in the relevant markets at an average frequency of 10 transactions per quarter over the previous four quarters;
2. the size of the investor’s portfolio of financial instruments, defined as the aggregate of cash deposits and financial instruments , exceeds EUR 500 000; and
3. the investor works or has worked for at least one year in the financial sector in a professional position that requires knowledge of the transactions or services envisaged.

The criteria set in this way are relatively strict, and in practice we also encounter the fact that it is quite difficult for small Slovak investment funds (or their managers) to find investors who could meet these criteria. Taking into account that small Slovak investment funds can only be distributed on the territory of the Slovak Republic and taking into account the size of the Slovak market, the number of potential investors who can qualify as professional investors in this way is objectively low.

The draft Directive relaxes the above criteria as follows:

1. Reduces the size criterion for an investor’s portfolio of financial instruments, defined as the sum of cash deposits and financial instruments, from an amount exceeding EUR 500 000 to an amount exceeding EUR 250 000 on average;
2. It expands the third criterion of ‘professional competence and experience’ to read: ‘the client (investor) has worked or has worked for at least one year in the financial sector or has carried out activities in the capital markets that require the buying and selling of financial instruments and/or the management of a portfolio of financial instruments, in a professional position that requires knowledge of the transactions or services envisaged’;
3. It adds a fourth criterion: ‘the client (investor) can provide the firm with evidence of recognised education or training that demonstrates its understanding of the relevant transactions or services contemplated and its ability to assess the risks appropriately’; and finally
4. In the case of legal persons, it allows them to be treated as a professional investor if they meet two of the following criteria: (i) total balance sheet: EUR 10 000 000; (ii) net turnover: EUR 20 000 000; or (iii) own resources: EUR 1 000 000. At the same time, in this case, the relevant distribution entity will be required to assess whether the representative of the legal person responsible for investment transactions on behalf of that legal person understands the relevant transactions or services contemplated, is able to make investment decisions in accordance with the legal person’s objectives, needs and financial capacity, and is able to make an appropriate assessment of the risks.

If the above changes were adopted and approved as part of the legislative process in the European Union, as part of the Draft Directive, they would have the potential to significantly broaden the range of investors who could be considered professional investors on their own application. They would also have the potential to significantly expand the number of small investment funds in Slovakia, as we currently know from our experience that there is a relatively widespread appetite for foreign solutions. First of all, it would be necessary to meet 2 out of 4 criteria (not 2 out of 3), which creates room for other new combinations when evaluating a particular investor as a professional investor. Second, by reducing the financial limit of the portfolio of financial instruments from an amount exceeding EUR 500 000 to an amount exceeding EUR 250 000 on average, the “entry bar” for investors is halved.

Conclusion

We welcome the legislative initiative in the form of the Draft Directive as a step in the right direction. At the same time, however, it should be noted that the administrative burden of assessing whether an investor can be treated as a professional investor may not ultimately be significantly reduced. Assessment of the fourth criterion of education, i.e. training, will require careful examination of whether such education, or. training sufficient to enable the investor to understand the relevant transactions contemplated and to be able to assess the risks appropriately. On the other hand, the reduction of the financial limit of a portfolio of financial instruments does not in itself have an impact on the procedure and processes for assessing that portfolio of financial instruments.

Of course, the Draft Directive may still be subject to significant changes during the legislative process and, ultimately, its final form may differ significantly. However, one of the set objectives, namely the easing of restrictions for investors to be considered as professional investors, clearly determines the direction in which the categorization of professional investors and, consequently, the distribution of small Slovak investment funds will go.

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[1] For the purposes of this Article, the term “small Slovak investment fund” shall mean a collective investment undertaking pursuant to Section 4(4)(a) of the Act on Collective Investment Undertakings. 2 lit. (b) of Act No. 203/2011 Coll. on Collective Investment, as amended (hereinafter referred to as the “Collective Investment Act“);

[2] Act No. 566/2001 Coll. Securities Act, as amended (the “Securities Act“);

[3] Directive 2014/65/EU of the European Parliament and of the Council of 15. of May 2014 on markets in financial instruments amending Directive 2002/92/EC and Directive 2011/61/EU (“MiFID II“);

[4] Available here: https://finance.ec.europa.eu/capital-markets-union-and-financial-markets/capital-markets-union/capital-markets-union-2020-action-plan_en (cited as of 25.9.2023);

[5] As of 25.9.2023;

[6] § 4 para. 4 of the Collective Investment Schemes Act;

[7] § 31d of the Collective Investment Act;

[8] The Securities Act uses the term “professional client”, but since this article is concerned with the distribution of small Slovak investment funds, we use only the term “professional investor”;

[9] § 8a para. 2 lit. (a) to (d) of the Securities Act;

[10] § 8a para. 2 lit. (e) the Securities Act;

[11] A legal person carrying out the management of alternative investment funds to which the exemption under § 31a par. 1 of the Collective Investment Schemes Act;

[12] The term “qualified investor” shall be unified for the purposes of the Collective Investment Schemes Act;

[13] The official translation of the Draft Directive uses the term “retail” investors;

[14] Section II.1 of Annex II to MiFID II;

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