a. Collective

“Collective” in this context refers to a multitude of investors’ capital being pooled.^[18] Investors are generally those who financially contribute to the pooled assets and/or the investment fund and at the same time benefit from the investment activities of the fund.^[19]

163Pooling entails the transfer of assets to a single body, namely the fund. This does not necessarily mean, however, that this single body must be of a corporate form or have a legal personality.^[20] Therefore, pooling includes all sorts of legal instruments such as contracts, trusts, corporate forms, and partnerships.^[21]

The “collective” character of CIUs distinguishes them from individual portfolio management activities as regulated by MiFID or individual/segregated investments.^[22] The transfer of assets to a collective pool of investments (i.e. the CIU) entails a transfer of ownership with certain effects in the event of insolvency: if the CIU is subject to insolvency proceedings, “the individual investor cannot reclaim the invested capital, nor can the investor separate it from the fund’s insolvency estate.”^[23] All investors therefore share the same fate should the CIU become insolvent.

b. Investment

“Investment”, in the sense of investment fund regulation,^[24] delineates financial activities aiming at the generation of benefits for investors from actively operating a business or engaging in commercial activity.^[25] Moreover, investment means the acquisition of assets with the objective of generating profits or income therefrom.^[26] The following four elements form the basis of the term “investment”: (1) the use of assets (2) having the objective of generating income, (3) lasting for a certain duration, (4) by virtue of participating in a future value development.^[27]

c. Undertaking

The term “undertaking” does not presuppose a given legal form or even legal personality. An undertaking comprises two elements: first, the involvement of 164third-party managers, thereby distinguishing CIUs from self-management; and, second, a change in legal title in the assets which, after the transfer, results in the investors facing the same fate in the event of insolvency.

By contrast, self-management occurs where investors (collectively) take investment decisions (e. g. in self-managed investment clubs).^[28] In reality, the distinction between self-management and third-party management can be blurry with respect to various aspects including investors’ veto rights and their general right to decide collectively about the underlying investment(s). We argue that third-party management is to be interpreted broadly, allowing some discretion whereby the implementation of an investment strategy, which may already be determined in the constituting documents, could be sufficient to amount to third-party management. By contrast, third-party management is not established where investors exercise a day-to-day investment decision discretion and hold unlimited authority to take investment decisions.^[29]

a. Raising Capital

Article 4 (1) (a) (i) AIFMD requires the raising of capital as a first criterion. Here, capital is to be understood broadly: the raising can take place once or several times, may aim to reach any amount,^[32] and contributions thereto can be in cash or in kind.^[33] Capital can be raised “from the public,” as required by UCITSD,^[34] but also from other groups like professional investors and state actors. There is also no minimum quantitative threshold.^[35]

The European legislator excludes from its definition of raising capital the cases of family offices that do not raise “external capital.”^[36] The raising of capital must contain steps towards active collection, as opposed to existing wealth that is managed and invested.^[37] According to ESMA, “raising” is a “commercial activity of taking direct or indirect steps by an undertaking or a person or entity acting on its behalf (typically, the AIFM) to procure the transfer or commitment of capital by one or more investors to the undertaking for the purpose of investing it in accordance with a defined investment policy.”^[38]

b. 166Number of Investors

A “number of investors” as prescribed by Article 4 (1) (a) (i) AIFMD is established if at least two investors make contributions.^[39] If any rule or the constituting documents prohibit the presence of more than one investor, according to ESMA^[40] such undertaking is still considered to raise capital from a number of investors if the single investor either “invests capital which it has raised from more than one legal or natural person with a view to investing it for the benefit of those persons; and consists of an arrangement or structure which in total has more than one investor for the purposes of the AIFMD.”^[41] ESMA’s broad interpretation of “a number” is driven by the existence of (e. g.) master/feeder structures where only one feeder fund invests in another investment fund.

c. Investment in Accordance with a Defined Investment Policy

To pass the AIF test, the AIFMD does not limit the eligible assets and investment policies upfront, nor does it require asset diversification.^[42] Instead, Article 4 (1) (a) AIFMD protects investors through a “defined investment policy” whose objective it is to provide a “pooled return” on the pool, as identified in ESMA guidelines.^[43] Meanwhile, ESMA requires that the CIU is subject to a legally binding investment policy that:^[44]

1. is determined and fixed at a moment at which the investors declare themselves bindingly available to invest (which does, however, not foreclose later amendments to the investment policy);

2. is determined in the constituting documents of the AIF and forms a part thereof or is referenced by them; and

3. 167includes certain investment specifications, especially guidelines or constraints regarding investment assets, strategies, geographical regions, leverage, minimum holding periods of the assets, and the degree of diversification.^[45]

Changes to the investment policy must be disclosed to and approved by the investors, and when it is not approved investors must be able to redeem the fund units.^[46]

The requirement of a defined investment policy excludes so-called black-box funds or blind pools, but this should not be used to circumvent the application of AIFMD.^[47] Therefore, it is recommended that black-box funds also be included in the scope of AIFMD by assuming that giving the AIFM full discretion with respect to investments can of itself be deemed an investment policy.^[48] All in all, an investment policy broadly includes “any guidelines given for the management of an undertaking that determine investment criteria other than those set out in the business strategy followed by an undertaking having a general commercial or industrial purpose.”^[49]

d. For the Benefit of the Investors

A fourth criterion to be met to pass the AIF test is that the investments made by the AIF must benefit the investors. This distinguishes AIFs from archetype trusts or foundations where the beneficiaries differ from the settlors.^[50]

A benefit is not a strict profitability requirement, yet some type of return (e. g. a tax discount) is inherent to the criterion so that the investment made and returns received are not fully disproportionate.^[51] In the absence of any benefit, the contribution is not considered an investment, but rather a donation.

a. Setups and Variants

A traditional family office comprises a family and wealth management vehicle, established as a foundation, trust, holding, limited partnership, or CIU.^[53]

Family offices can differ with regard to who performs management of, and advises on, family affairs, and who legally owns the underlying infrastructure (besides the family members, this could be employees of the wealth management vehicle, external providers, or a limited partnership with an external general partner and family members acting as limited partners). Distinctive types of family offices are single-family offices, “family and friends” offices, and multi-family offices.^[54]

Single-family offices manage the wealth of a single family (> EUR 500 million), whereas multi-family offices serve several families as clients. Furthermore, single-family offices have the advantage of being flexible and individual; yet they incur comparatively high administration expenses. Meanwhile, multi-family offices capitalize on economies of scale, are therefore less expensive and more attractive to families with smaller overall wealth, and their service approach is less individualized.^[55] “Family and friends” offices are family offices somewhere in between single- and multi-family offices, serving a limited circle of persons related to the wealth of one family at the center.

The following two elements determine whether a family office qualifies as a regulated activity: (1) how the entry or exit of family members takes place; and (2) the degree of dispersion of the family. On the latter element, while the 169wealth is often accumulated by one entrepreneur, some families decide to transfer the entrepreneurship from one generation to the next and involve at least some family members actively in the firm, with remaining family members compensated financially. Over generations, family members not only multiply, but mindsets also tend to change from entrepreneurship closely linked to the business that created the wealth initially, towards mere investment.^[56] Where clashes of perspective prevail, tension among members, destabilization, and even dissolution of family office vehicles may follow. EU investment fund regulation, which demands equal treatment of investors subject to the constituting documents,^[57] is from the outset ill-suited to regulate inter-family affairs governed by hierarchy and family-wide policies and approaches. These various factors render the qualification of family offices as regulated activities complicated.

At the same time, family offices always possess two of the three constituent elements of a CIU, namely being “collective” and involving the pooling of assets. We thus review in turn the cases where an “undertaking,” the raising of capital, and an investment policy are subject to discussion as a precondition for applying financial regulation.

b. Undertaking: Third-party Management?

At least one passive participant, and thus third-party management, is usually present in professionally managed multi-family offices. In cases of single-family offices as well as “family and friends offices,” the question needing to be answered is whether every (family) participant involved in the pooling of assets is equally involved in the investment decisions. If this is indeed the case, third-party management is not established and thus the “undertaking” criterion is not satisfied.”

Yet, the more numerous the participants, the less likely all of them are permanently involved, particularly, of course, children and elderly participants. According to ESMA’s strict guidelines,^[58] a single investor not involved in investment decisions speaks in favor of finding third-party management (or at least a MiFID-regulated service provision).^[59]

c. 170Raising Capital?

Family offices must also raise capital to qualify as an AIF.

Raising of capital is not established if the family assets were pooled before the family office was set up, as in such cases the undertaking is considered only a vehicle for managing existing assets. This occurs where wealth was transferred from the family founder (the matriarch or patriarch) to the other members. For that reason, as its default perspective on “raising [external] capital,” AIFMD excludes family offices prima facie from its scope.^[60]

The series of events in reality may, however, lead to a different qualification, for instance where family wealth was originally pooled, was then separated and distributed for good, and then pooled again in some new vehicle. The same is true for several families that “seek, of their own accord, the same AIFM, for instance, for the set-up and wealth structuring purposes.”^[61] This pooling in multi-family offices does not necessarily require targeted communication by the multi-family office towards new clients. The several families involved may also jointly pick a suitable multi-family office that suits their needs, based on recommendations from different families. Here, the office itself, as an undertaking, would not perform the “active” element as required to establish “raising of capital.”

Three considerations help to identify where the “raising of capital” has been performed.

First, one may look at the origin of the group’s or family’s wealth. ESMA defines a “pre-existing group” – as opposed to a raising of capital – as “a group of family members, irrespective of the type of legal structure that may be put in place by them to invest in an undertaking and provided that the sole ultimate beneficiaries of such legal structure are family members, where the existence of the group pre-dates the establishment of the undertaking.”^[62] If the family’s wealth is the only asset under management, as is the case in archetypal single-family offices, there is no raising of capital.^[63] Where family members do not make investment decisions themselves, asset management and investment advice are subject to MiFID.^[64]

171Second, the family relations may be explored. Family members are defined by ESMA as spouses, persons living with a family member “in a committed intimate relationship, in a joint household and on a stable and continuous basis” as well as direct relatives, siblings, uncles, aunts, first cousins, and “dependants of an individual.” If such family members only invest the undivided wealth of a family tree, even where the family office requires a commercial activity due to its size and organizational structure, the raising of capital is not established.^[65]

Third, the presence of external investors contributing wealth to the family office strongly indicates an AIF(M) rather than a non-regulated family office.^[66] External investors are persons without a (present or previous) link to the family.

d. Investment Policy?

To qualify as an AIF, the family office must invest in accordance with a defined investment policy. In practice, it may well be that the respective investment policy is decided on an ad-hoc basis among the family members or spontaneously arranged in some other way; often, the matriarch or patriarch invest based on their gut feelings, and override the suggestions of others. In these cases, no AIF exists due to the lack of a genuine investment policy.

Yet, family offices can opt-in to an AIF by laying down a (pre-determined) agreement meeting the requirements of an investment policy laid out supra, at II.2.c. Note also that, in line with the intention to avoid circumvention of AIFMD, such a requirement is construed broadly whereby any document called a “family policy” or a “family constitution” may qualify.

e. Intermediate Results

From an intermediate perspective, the application of the CIU and AIF tests yield the result that multi-family offices, where one service provider serves many different family offices and takes investment decisions on their behalf, qualify as an AIF regulated by the AIFMD (or a MiFID-eligible entity, respectively). By contrast, archetypal single-family offices are not subject to AIFMD 172(but are also outside the scope of MiFID^[67]) because of a lack of raising of capital (and the absence of a provision of a service for others^[68]).

While “family and friends offices” fall within the scope of AIFMD (and MiFID) only in certain cases depending on their setup, the condition of third-party management, as required by investment fund regulation, is met where not all investors are involved in the investment decision. The “raising of capital” may be established where the “friends” are not (current or former) family members. Finally, where an investment policy is lacking, the services provided may still be subject to MiFID.

a. “Holding” Definition

Holding companies are explicitly exempted under the AIFMD.^[69] To clarify, a holding company is defined by AIFMD as a company

“with shareholdings in one or more other companies, the commercial purpose of which is to carry out a business strategy or strategies through its subsidiaries, associated companies or participations in order to contribute to their long-term value, and which is either a company:

(i) operating on its own account and whose shares are admitted to trading on a regulated market in the Union; or

(ii) not established for the main purpose of generating returns for its investors by means of divestment of its subsidiaries or associated companies, as evidenced in its annual report or other official documents.”^[70]

Four features thus characterize a holding company:

1. (1) The holding of stocks or participations;

2. (2) Business strategies or commercial activity;

3. (3) Stimulation of long-term value in stocks and participations; and

4. 173(4) Acting on the holding’s own behalf and having shares admitted to trading on a regulated EU market or not having been founded for the primary purpose of obtaining an economic return for the investors through the disposal(s) of subsidiaries or related companies.

Among these four features that mark out a holding, three of them can also apply to investment funds, depending on the setup. For instance, both holdings and funds hold participations, while an investment company can list its shares and then becomes a listed company, whereas a fund manager usually seeks long-term value. The one remaining distinguishing factor is then whether there exists a “business strategy” or “commercial activity” (which would mean the presence of a holding) or an “investment strategy” (which would denote the existence of a fund).

The distinction between a holding company and a fund is not immediately evident. For that reason, the distinction between the two has been discussed in several jurisdictions^[71] and has practical significance. For instance, one of the world’s largest institutional investors, Berkshire Hathaway, qualifies as an “investment holding” in the US; the term indicates that Berkshire Hathaway is something in between a holding and a fund.

We cannot recapitulate the full discussion here.^[72] Suffice to say, a number of concepts have been developed to assist in distinguishing a CIU from a holding company. The most important of these include: (1) certain national tax laws defining wealth management and the concept of “investing” to determine whether business tax (“Gewerbesteuer”) may be charged^[73] (here, tax laws may be of assistance in defining the same thing for CIUs); (2) US law on investment contracts, which provides extensive case law^[74] delineating the holding company from investment activities, which may also serve as inspiration for the European concepts; and (3) a two-level “sole profit” test, which supports qua174lification as a CIU if both the investors and the AIF merely look for profit and neither the investors nor the AIF pursue a corporate purpose.^[75]

These concepts provide assistance but not crystal-clear guidance. We thus approach the issue by first distinguishing between operating and non-controlling holdings.

b. The CJEU on Operating Holdings

To determine what constitutes “operating holdings,” the Court of Justice of the European Union (CJEU) has provided insightful guidance. In particular, the CJEU developed the concept of “operating holdings” in the context of state aid cases in 2006.^[76]

The CJEU emphasized the following two criteria to define operating holdings: a) direct or indirect involvement in the management of the holdings (i.e. involvement in the day-to-day business); and b) control over the underlying business. The control element rests on company law (e. g. a majority of voting rights allowing for the appointment of the management of the company, or by way of a control contract, establishes control).

c. Non-controlling Holdings: Typology

The same criteria would not be useful in the case of non-controlling holdings. Accordingly, we believe that a typology is the best available tool for the adequate delineation of an AIF from a holding company. This typology revolves around a non-exhaustive list of indicative elements, drawing on the constituent documents and publications of the entity as well as substantive indicators.^[77]

175 AIF indicators include the holding of “fractional units of blue-chip companies” and occasional trades therewith, as well as the holding of “individual, large shares with the aim of selling these at a profit post re-structuring or stabilization.”^[78] These AIF indicators can be manifested by: the investment policy; a limitation period for the company that forces management to wind-up the company after a certain period of time; a carried-interest arrangement assigning profits to management for the sale of assets; and/or a long lock-up period for investors with a redemption right only after the expiry of the lock-up period.^[79]

On the contrary, holding companies tend to hold larger stakes in controlled companies and implement a common strategy and uniform management across these companies as determined by control agreements, sales relationships, etc. Moreover, they are generally constituted in order to control a company on a long-term basis with respect to the overall strategy of the subsidiaries. Sometimes, tax laws provide for a specific tax regime for holding companies, which requires that they hold shares for a long period in order to benefit from these provisions.^[80]

a. Third-party Management?

Applying the CIU and AIF tests to joint ventures raises questions similar to those discussed previously, for instance whether self-execution in their own 176 interest stands at the forefront of the joint venture, or whether it demonstrates an element of third-party management.

Quite often, the direct involvement of partners in daily affairs tips the tide towards self-management. Joint ventures regularly come with their respective partners’ direct involvement (similar to controlling holdings, see above), because the partners want to pursue a certain purpose beneficial to their main operations by setting up the joint venture (e. g. securing stable, low-price delivery of raw materials for their production activities).

b. Business or Investment Strategy?

Where professional third-party management is employed, the primary question regarding the distinction between joint ventures and CIUs is about the “investment” criterion as part of the “defined investment policy” – we discussed the same question at length earlier in the context of holding companies (III.2.).

Compared to holding companies, however, the delineation is established where partners agree on a business strategy (like manufacturing) by way of a joint venture agreement that also specifies control rights and the first right of delivery. In addition, a joint venture furthers the purpose of its partners’ operating business, rather than aiming to glean immediate returns from the assets invested. This annex function supports the establishment of a business strategy rather than an investment strategy.^[83]

c. Application of CIU and AIF Tests

The strict criteria of AIFMD nevertheless apply. For instance, the British Financial Conduct Authority (FCA) held that the participation of one non-professional investor in a joint venture could render it an AIF.^[84] Here, as in the case of family offices with external investors, minimum thresholds of participation could provide legal certainty.^[85]

a. CIU Criteria: “Collective”, “Undertaking”, and “Third-party Management”?

The DAOs we are concerned with herein steer investment flows into assets after bundling their participants’ contributions, hence constituting a “collective.”

As discussed in the context of family offices (supra, at II.1.b), third-party management is presumed to exist as soon as a single investor does not participate in investment decisions. For DAOs comprising many members, it is highly likely that a few of them will remain passive. This is still sufficient to establish third-party management as part of the CIU test.

DeFi platforms often operate with “default consent” rules governed by smart contracts (for example a participant’s vote is counted as in favor when they abstain). One may wonder whether these rules set aside the preliminary finding of third-party management. A default consent rule, however, is nothing less than the technological substitute for an investor’s passivity and would simply circumvent qualification as a CIU. A similar phenomenon would emerge in the provision of proxy to a body organized by the entity calling for a vote in a non-digital scenario where the absent person participates legally but not factually. Such default rules do not meet the objective of the CIU test which is to establish that members do take care of their own interests (which necessitates active member involvement) rather than relying on decisions taken under the influence of any third party. In turn, we hold that this would not be sufficient to deny the presence of third-party management.^[98]

b. 180AIF: Ad-hoc Decision-making vs. Investment Policy?

Even though DAOs may be classified as CIUs, we have not observed a single DAO requesting authorization as a fund manager under either UCITSD or AIFMD. This prompts us to ponder whether another element of the AIF test is missing. Given the direct involvement of members, the presence in DAOs of a (pre-defined) investment policy as required by Article 4 (1) (a) (i) AIFMD is in doubt.

DAOs rely on collective decision-making by active members voting on investment proposals.^[99] This seems to stand in direct contrast to a (pre-defined) investment policy.

Yet, every DAO has some pre-set limitations embedded into their overall setup, for instance where it focuses only on crypto-assets, crypto-currencies, or investments in innovative crypto businesses.^[100] We argue that these inherent limits of DAOs constitute a pre-defined investment policy. This broad understanding is in line with ESMA’s lenient approach^[101] on what exactly makes an investment policy pre-defined: ESMA deems an investment policy to exist where some sort of investment limits are in place, even without further specification of the exact investment preferences.

In turn, DAOs do qualify as AIFs and are subject to fund regulation if any restrictions on the asset selection are disclosed on the given project website or in the white paper, or are implicit in the protocols operating the DAO.^[102]

a. Investment vs. Operating Business

Due to the financial nature of the activities of crypto lending and staking platforms, the “investment” component/criterion (as opposed to simply operating a business) of a CIU is frequently satisfied. Meanwhile, note that AIFs may pursue lending as an investment activity.^[108] The CIU definition (as lex generalis) will not be applied however where the activity in question constitutes another regulated activity corresponding to a different classification (as lex specialis). This is particularly relevant where an entity provides fiat currency to one entity so that it can lend to others, potentially amounting to the business activity of deposit-taking, which is reserved for credit institutions. To avoid classification as a credit institution, DeFi schemes often require participants to transfer crypto-assets (rather than fiat currency) to the system.^[109]

b. 183Third-party Management?

As mentioned earlier, third-party management as part of the “undertaking” component of the CIU test is understood broadly, with one passive participant deemed sufficient to establish third-party management (supra, II.1.).

DeFi proponents often stress the absence of third-party management where an algorithm executes asset management. For instance, a smart contract rather than humans manages the assets, and human participants consent to the smart contract by either acquiring the very token run by the smart contract, or by registering for the DeFi application. Yet, from an investor protection perspective, we see no difference between a financial pool operated by a smart contract, and one operated by, for instance, BlackRock’s fully automated algorithms for index funds.^[110] In both cases, the decisions are determined by system design, dominated by the developers (or the developing entity, as the case may be), and dependent on the resilience and operational fairness of the scheme. Accordingly, ESMA and NCAs^[111] construe this requirement broadly in light of the primary objective of investment fund regulation, which is the protection of passive investors.

c. Investment Policy

Finally, as to the existence of a pre-defined investment policy, we start from the point laid out supra (IV.2.a) that most applications restrict the use of investment assets in some way. Where this takes place by way of a website or white paper, these limits may also be embedded into the smart contracts that execute the investment decision(s). For instance, a smart contract may be designed in a way that it can execute acquisitions of certain crypto-assets (e. g. crypto-currencies) only. Moreover, a smart contract may include even more specific restrictions, such as a maximum (e. g. 5%) exposure to a single counterparty, similar to traditional investment limits.

We see no difference here between a legally binding announcement in writing or a technically binding announcement that cannot be amended without the contribution of most members (as is necessary to amend smart contracts in most systems); both are pre-defined in our view, and thus these execution lim184its implicit in smart contracts may be best understood, collectively, as pre-defined investment policy.

A different question is whether this investment policy leads to its ultimate aim providing a “pooled return” to investors on their pooled funds. ESMA defines a “pooled return” as “the return generated by the pooled risk arising from acquiring, holding or selling investment assets – including the activities to optimize or increase the value of these assets – irrespective of whether different returns to investors, such as under a tailored dividend policy, are generated.”^[112] Whether this criterion is satisfied, and would therefore render a DeFi application a potential AIF falling within the scope of application of the AIFMD, needs to be verified on a case-by-case basis.^[113]