A cap applies automatically when a pre-set threshold is exceeded. If the cap is hard, it cannot be switched off by the manager. If it is soft, it can be switched off when there is sufficient liquidity, allowing the manager to satisfy redemption requests above the set level. Gates, by contrast, can be switched on by the manager once a relevant pre-set threshold is exceeded, thereby limiting the volume of redemptions. The key difference between a gate and a hard cap is that a gate involves discretion, whereas a cap applies systematically. The difference between a gate and a soft cap is that a gate can be switched on to restrict redemptions, whereas a soft cap can be switched off to allow redemptions.

All three tools pursue to avoid fire sales of assets to meet accumulated redemption requests. Fire sales are usually not made on the best economic terms and may cause a drop in net asset value (NAV) borne solely by remaining investors, while leavers are redeemed at a higher NAV determined before the fire sale.

Following AIFMD II open-ended funds managed by EU-authorized private fund managers must hardwire at least two pre-determined liquidity management tools (LMTs) in their constitutional documents, and gates are on that menu. A key aspect of a qualifying LMT is that it must be suitable and available for possible use in the best interests of investors.

As a hard cap applies automatically, it does not satisfy the principle of possible use, and automatic application rules out an assessment of whether its effects are in the best interests of investors. As such, it should not qualify as an LMT under AIFMD II. A soft cap is much closer to a gate but does not require a decision to activate; rather, it requires a decision to deactivate the cap, thereby allowing redemptions beyond the relevant threshold.

Hardwiring a gate and redemption cap in parallel and setting them at the same threshold risks undermining the gate’s effectiveness and, with it, its availability as a tool to act in the best interests of investors. However, if the gate is set at a reasonable level (e.g., 5%) and below a soft or hard redemption cap (e.g., 10%), this ensures that the gate remains effective within the bandwidth between the two.

The distinction between a gate, a hard cap and a soft cap also carries operational consequences. Gates require for example activation and deactivation procedures. Pre-set limitations generally do not trigger these requirements, since they are not exercised as managerial powers.

When launching open-ended structures, careful consideration must be given to the designation of redemption restrictions, their economic characterization and whether they can be used in parallel.

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