Definition of Alternative Investment Funds and Project Finance Companies

FINANSTILSYNET Postboks 1187 Sentrum 0107 Oslo Circular Definition of Alternative Investment Funds and Project Finance Companies CIRCULAR: 9/2019 DATE: 04.06.2019 THE CIRCULAR APPLIES TO: Managers of Alternative Investment Funds Securities Firms

Definition of Alternative Investment Funds and Project Finance Companies 2 | Finanstilsynet 1 Introduction The Act on the Management of Alternative Investment Funds of 20 June 2014 No. 28 (the AIF Act) regulates the management and marketing of alternative investment funds. What constitutes an alternative investment fund is defined in Section 1-2, letter a). For the AIF Act to achieve its intended purpose and for investors to receive the protection assumed, accurate classification of the investment structure is required. If an alternative investment fund is involved, a manager must be appointed for the fund. The manager is obligated under the AIF Act to ensure that the interests of investors and the fund are safeguarded throughout the fund's entire lifespan, including the establishment phase. This circular elaborates on what is considered an alternative investment fund and what Finanstilsynet (the Norwegian Financial Supervisory Authority) will base its supervisory practice on. The circular is particularly directed at the classification of so-called project finance / single-asset companies, syndicates, and similar structures (hereinafter referred to as "project finance companies"). The assessment criteria are also general, and the circular will therefore have applicability to other investment structures, such as crowdfunding. 2 Project Finance Companies Project finance companies can be established for all types of investment objects, but are particularly common in shipping and commercial real estate. Establishment typically occurs when an organizer, usually a securities firm, identifies a larger object, such as a ship or a commercial property, for which it will offer investors the opportunity to invest through acquisition. The organizer negotiates a purchase contract with the owner of the object, and the completion of the acquisition is normally conditional on the organizer securing financing. Financing is established by raising equity capital from investors and through loan financing. Marketing often takes place under exemptions from prospectus rules by securities firms and with the help of an information memorandum or a so-called term sheet. When a sufficient number of investors have subscribed, the purchase can be completed, and the organizer can withdraw from the company. The company is then handed over entirely or partially to the investors, but central functions related to e.g., operations and accounting are often outsourced to service providers affiliated with the organizer. The Securities Trading Act imposes strict requirements on, among other things, handling of conflicts of interest, cost disclosure, good business practice, etc. In many cases, however, the safeguarding of investors' interests appears to have been less prominent in setting the conditions that should apply to the project company and the investors. This is particularly the case where the projects are not initiated by the investors and are directed at customers with limited knowledge to make an independent assessment of the project. The negotiation of both the purchase price for the investment object and the establishment of agreements for outsourced services is carried out by parties that withdraw after the investor community is established, and who generally do not bear the risk of the project's development. Start-up costs, which constitute part of the subscription amount, often appear disproportionately high and significantly reduce the return potential. Finanstilsynet's experience is also that there is little transparency regarding negotiations, valuations, and

Definition of Alternative Investment Funds and Project Finance Companies Finanstilsynet | 3 outsourcing in the subscription material presented to investors. For alternative investment funds, the manager's responsibility towards the fund and investors will apply throughout the project's lifespan, and marketing of the project to non-professional investors will require special permission from Finanstilsynet. It is Finanstilsynet's assessment that project finance companies are often to be considered as alternative investment funds under the AIF Act. Project finance companies will normally manage funds collectively on behalf of several investors, have a defined strategy that gives expectation of aggregated return, and are usually structures that have a number of investors without prerequisites for involving themselves actively in the daily operations. Securities firms and others planning to establish a project finance company or another type of collective investment structure must assess whether it concerns an alternative investment fund. Securities firms must take a position on the classification at the latest in connection with the product approval process under the Securities Trading Act. Securities firms that are distributors must make an independent assessment of the investment structure prior to invitation to subscription. It is important that a careful assessment is made of the characteristics of the planned project. If it concerns an alternative investment fund, as mentioned, an AIF manager must be appointed for the fund, cf. AIF Act § 2-1. See point 5 below regarding the AIF manager's responsibility for the business. 3 Legal Starting Point AIF Act § 1-2 letter a) defines alternative investment funds as follows: "alternative investment fund: a vehicle for collective investment that is not a UCITS, cf. Securities Funds Act § 1-2 first paragraph no. 4, and which raises capital from a number of investors with the aim of investing the capital in accordance with a defined investment strategy for the benefit of the investors" The definition of alternative investment fund is broad and is intended to cover all types of funds that are not UCITS. The definition contains the following criteria:

1. There is a vehicle for collective investment that is not a UCITS.
2. Capital is raised from a number of investors.
3. The aim is to invest the capital in accordance with a defined investment strategy for the benefit of the investors. The European Securities and Markets Authority (ESMA) has in "Guidelines to key concepts of the AIFMD"1 (ESMA/2013/611) given some guidance on how the definition should be understood. Finanstilsynet bases its view that a concrete assessment must be made of whether an investment structure falls within the law's definition, and that ESMA's guidelines will be directive. 1 https://www.esma.europa.eu/system/files_force/library/2015/11/2013- 611_guidelines_on_key_concepts_of_the_aifmd_-_en.pdf

Definition of Alternative Investment Funds and Project Finance Companies 4 | Finanstilsynet 4 The Definition in AIF Act § 1-2 letter a) 4.1 Vehicle for Collective Investment For an investment structure to be considered an alternative investment fund, it must be a vehicle for collective investment that is not a UCITS fund. A collective investment means that funds are managed collectively on behalf of several, in contrast to individual portfolio management. It is irrelevant which organizational form is used, which assets are invested in, whether the alternative investment fund is listed or not, and whether the structure is open or closed. It also has no significance for the assessment whether the investment is in one or more objects. Finanstilsynet's opinion is that a structure to which capital is raised from investors with the purpose of investing the capital collectively and generating returns for these investors, as a general rule, will be considered a vehicle for collective investment, and thus is an alternative investment fund. This is assumed provided that it does not concern a UCITS fund. 4.1.1 Delimitation against companies engaged in ordinary business activities In assessing whether there is a vehicle for collective investment, it must be delimited against companies that primarily engage in ordinary business activities and not financial activities. In most cases, the delineation is unproblematic. If the company's activities consist of activities such as purchase, sale and/or exchange of goods with a markup to the next link in the chain, there will not be a vehicle for collective investment. Similarly, companies where the activity consists of processing raw materials or semi-finished products into finished products will usually have an industrial purpose, and thus fall outside the definition. For certain businesses, borderline cases may arise. This will be particularly the case where the vehicle has a financial purpose, but where there are also commercial activities. In real estate syndicates, for example, investors at the time of subscription are promised a return through appreciation of the property, but the investment will simultaneously presuppose commercial activities through the operation of the property and maintenance/renewal of lease agreements until realization time. In such cases, a concrete assessment must be made of what is the structure's primary purpose. In the assessment, among other things, business model, organizational structure, investment horizon, internal competence, and investment strategy will be relevant factors. How the vehicle or company is organized with regard to the degree of internal competence and employees will be relevant factors in the assessment of whether ordinary business activities are conducted. That there are neither employees, resources nor internal competence to perform operational tasks suggests that ordinary operations or production activities are not the central purpose of the vehicle. In traditional real estate syndicates, for example, it is often used a limited liability company as the owner of the property and which investors receive shares in at the issuance. The company itself has neither organization nor employees to manage the daily operations of the property, but has outsourced all tasks already before investors come onto the ownership side. It is Finanstilsynet's opinion that structures where the limited liability company is essentially an instrument for placing the investor's capital without expectation that the company should stand for the operations, are normally to be considered a vehicle for collective investment.

Definition of Alternative Investment Funds and Project Finance Companies Finanstilsynet | 5 Which investment horizon is promised can, in case of doubt, be indicative for the assessment. Companies engaged in ordinary business activities, or e.g., operation of real estate, will generally have a long-term time perspective. Typically, this could be companies aiming to establish themselves in a market. Traditional project finance companies, on the other hand, will normally have a limited time horizon, with a more or less clearly expressed exit strategy in the form of realization of the investment object and subsequent liquidation of the fund. Investments in traditional project finance companies are often illiquid, with a weak or absent secondary market, and investors' real opportunity for redemption therefore often presupposes realization of the investment object. Finanstilsynet's opinion is that participation in project finance companies where investors are promised a return based on, among other things, realization of the investment object suggests that there is a financial purpose rather than regular operations. That rental/management functions are also performed in the period leading up to a future sale will then have less significance for the assessment. Also where the project finance company has no clear exit strategy, but where over time buys and sells assets, e.g., properties, in the portfolio, it may concern an alternative investment fund. Such systematic buying and selling indicates that it is not operation of the object, but fluctuation in values that is primary in the strategy. Other factors for the assessment will include, among other things, the degree of commercial operation in the concrete vehicle. In real estate syndicates, it will be relevant to assess the duration of lease contracts against the investment structure's expected lifespan. Low tenant volatility with few and long-term lease contracts may indicate that regular operations are subordinate to the financial purpose. This is particularly the case where the duration and conditions of the lease contracts suggest no or limited activity related to maintenance and renewal of tenancies. For project finance in shipping, which normally has higher volatility and shorter horizon, an assessment must be made of whether the contractual framework etc. lies within ordinary business for this type of objects. Project finance companies where guidelines have been laid down or justified expectations have been built up among investors that the company's accumulated surplus should be paid out as dividends to investors, may be interpreted as the company not having an ordinary operational purpose. When the vehicle's dividend policy results in modest funds for further development or improvement of the investment object, this suggests that regular operations are subordinate. Other factors than those mentioned above may be relevant for the assessment of whether an investment structure has ordinary business activities as its purpose. Since the question must be resolved based on a concrete overall assessment, the outcome of the assessment of the individual factors will not necessarily be decisive for the classification. 4.1.2 Investors' ongoing control or influence over daily operations If investors have ongoing control or influence over daily operations, this is a factor that suggests that it does not concern a vehicle for collective investment. With ongoing daily influence or control over the vehicle is meant something beyond the ordinary rights the individual shareholder has to exercise authority at the general meeting.

Definition of Alternative Investment Funds and Project Finance Companies 6 | Finanstilsynet In assessing whether investors have such influence and control, it is weighty whether investors have a real opportunity to exercise daily influence and control over the ongoing management in a way that goes beyond an ordinary shareholder's general influence. Ongoing influence or control is understood as a permanent decision-making competence over the operational matters, including the daily operations of the assets. That shareholders are free in the choice of the board, which is again responsible for the daily management, will e.g., not be sufficient. Investors as a group must have ongoing control or influence over daily operations. It is therefore not sufficient that one or more investors are granted such influence. It is assumed that all investors have the same formal and real opportunity to exercise daily direct influence and/or control. Investment vehicles, e.g., a real estate syndicate, may have articles of association containing a clause giving the right to realization if shareholders representing a sufficient percentage of share capital demand it. Such a realization clause may be a right that goes beyond ordinary shareholder rights. The percentage that must be achieved to demand realization, which is often more than 20 percent, will in practice lead to minority shareholders not having the opportunity to activate such a clause. Such mechanisms will therefore not give the ongoing control or influence that is required. Investors must not only have a formal opportunity, but also actually have the necessary competence to exercise daily influence and control. Non-professional investors often lack relevant competence. If investors do not realistically have such knowledge or competence, investors are not considered to have sufficient ongoing influence and control. The same applies where there is formally greater influence through articles of association/ shareholder agreements etc., but where the use of the right is practically subject to restrictions, e.g., through additional costs, fees, and loss of rights etc. In investment structures with an investor group of some size, there will be a presumption against that investors have sufficient daily control and influence. This applies in particular to project finance companies that include consumers as investors. Where the investor group consists of a large proportion of smaller non-professional customers and consumers, e.g., preparation and drafting of proposals for the board will normally be outsourced to others. In practice, it will often be this actor's dispositions that will be significant for the operations. Investors will then generally not have the control and influence that is presupposed to fall outside the law's scope. 4.2 Invest capital "in accordance with a defined investment strategy" In an alternative investment fund, the raised capital is invested in accordance with a defined investment strategy. It is Finanstilsynet's experience that, as a general rule, there will be a defined investment strategy in an investment structure if the other conditions are met. Finanstilsynet understands the reference to "investment strategy" as meaning that there must be guidelines or a plan for how the raised capital should be managed to create returns for investors. When an invitation to subscribe in project finance companies is made, there will

Definition of Alternative Investment Funds and Project Finance Companies Finanstilsynet | 7 in general be a sufficient plan for the investment to be able to conclude that there is a defined investment strategy. The type of investment objects, or whether to invest in one or more objects, has no significance for the assessment of whether there is a defined investment strategy. That the strategy is to invest in one object, e.g., a property or a ship, therefore does not exclude that a vehicle has an investment strategy. Project finance companies that invest in one single object will simultaneously rarely only have the value of the object statically on the balance sheet. There will be plans for earning on the object and handling of costs related to necessary services. In addition, there will often be assumptions about distributions to investors. In addition, such companies will often have provisions on debt ratio and leverage/gearing. These matters will normally be set down in guidelines or regulations, and thus constitute part of the project finance company's investment strategy. Project finance companies that invest in one object will, as described, normally have a more or less expressed or expected exit strategy, as well as guidelines for the management of the investment until this point in time. Such project finance companies will from this have several similarities with the investment strategy of other classic alternative investment funds and which are directly regulated in the law, e.g., feeder funds, 2 which invest in a single recipient fund. That the investment strategy is defined means that it is determined and set at the latest before investors commit to injecting capital. There is a presumption against that investors will commit to an investment without there being a framework or mandate for how the invested capital should be managed. Whether the investment object is identified prior to the occurrence of investors' commitment is not decisive in this context. Similar to ESMA, Finanstilsynet otherwise presupposes that an investment structure cannot circumvent the provisions of the AIF Act by giving the board full freedom to make investment decisions. 5 Concluding Remarks The appointed AIF manager is responsible for both the management and marketing of an alternative investment fund, and must ensure that the business is aligned with the AIF Act. The manager must ensure that the interests of investors, the funds' interests, and market integrity are safeguarded in the best possible way throughout the fund's entire lifespan, including the establishment phase. This means in practice that the AIF manager must be appointed before the conditions for establishment and the agreements otherwise are set. This includes that the AIF manager must be appointed in advance of negotiation of the conditions for the acquisition of an investment object. Finanstilsynet emphasizes that the AIF manager must ensure compliance with the requirements for correct and independent valuation of the fund's assets (the investment object) in AIF Act § 3-10 with regulations. The manager must also ensure that the fund and investors will not be burdened with unnecessary costs. That the manager also has responsibility for the marketing of the fund, including marketing that occurs in connection with placement of shares in issuances, means that the AIF manager must enter 2 Cf. AIF Act § 1-2 letter f)

Definition of Alternative Investment Funds and Project Finance Companies 8 | Finanstilsynet into an agreement for outsourcing if others than the manager, usually a securities firm, are to stand for the marketing of the fund. An alternative investment fund must either be managed by an external manager or managed internally by the fund's bodies. An AIF manager must under specific conditions either have a license, cf. AIF Act § 2-2 or be listed in Finanstilsynet's register of AIF managers, cf. AIF Act § 1-4. AIF managers that manage funds with a total management capital below certain thresholds, and that are not to be marketed to non-professional investors, must be registered in a register kept by Finanstilsynet, cf. AIF Act § 1-4. If the fund is to be marketed to non-professional investors, it is required that the manager has a license and a special marketing permission under AIF Act § 7-1. 3 See Finanstilsynet's circular 11/2016 Legal frameworks for the business of registered AIF managers for more information on licensing and registration requirements, as well as who is considered a non-professional investor in questions about marketing. 4 Shares in existing project finance companies that must be considered as alternative investment funds, but which have not previously been classified as such, cannot be marketed forward without the fund appointing an AIF manager who ensures compliance with the requirements in the AIF Act. Regarding what is considered marketing, reference is made to point 3 in circular 11/2016. 3 The requirement for permission to market alternative investment funds to non-professionals under the AIF Act does not apply to marketing of alternative investment funds that are national securities funds. 4 Cf. also Securities Trading Act § 10-7, cf. §§ 10-6 and 10-8.

FINANSTILSYNET Postboks 1187 Sentrum 0107 Oslo POST@FINANSTILSYNET.NO WWW.FINANSTILSYNET.NO