Fund managers across the globe have long been apprehensive about the Alternative Investment Fund Managers Directive (AIFMD), a package of measures drawn up by European authorities to regulate the alternative funds industry after the 2008 financial crisis. It brings within its fold entities such as hedge funds, private equity funds, real estate funds and other alternative investment vehicles that were previously not regulated (such as under the UCITS Directive) and therefore criticized for lack of transparency.
The AIFMD seeks to achieve the twin objectives of (1) subjecting this industry to uniform regulatory standards and (2) to foster cross-border marketing of funds across the various EU nations (a ‘passport’ system) through deregulation and creation of a level playing field.
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The AIFMD rules come into effect on July 22 (tomorrow), the deadline for applying to the applicable regulatory authority for authorization as an AIFM.
A ‘wait-and-see’ approach
A survey of 56 managers by European fund structuring firm Alceda and London-based researcher Kepler Partners found that only a third were compliant, whereas a fifth were still preparing to submit applications by the July 22 deadline with only a week to go.
Of particular concern was the finding that nearly 41% of the respondents had limited understanding of the AIFMD’s consequences, and could be ‘sleepwalking’ into problems, according to George Reutter of Kepler Partners.
Scepticism at a high
Fund managers were negatively biased to the AIFMD, according to the findings of a survey earlier this month by Preqin, a leading database on the alternative assets industry.
“As the 22 July 2014 authorization deadline for the AIFMD approaches, Preqin’s survey reveals that the proportion of managers that feel the AIFMD will have a negative impact on the hedge fund industry is at an all-time high,” said Amy Bensted, Head of Hedge Funds Products for Preqin. “Fund managers have been endeavouring to meet or navigate the regulatory burdens imposed by the AIFMD over the past 12 months, but many are still concerned about both the cost of compliance and the risks arising as a result of the lack of clarity or guidance,” she says.
Preqin’s survey found that 59% respondents thought the AIFMD would have negative fallout on the industry. US managers were particularly critical with as many as 71% saying the Directive will hurt the industry. In a related finding, 40% of US managers said they did not plan to actively market in the EU, and in the short-term, would take recourse to reverse solicitation.
Woeful state of readiness
Another survey of 116 asset managers and fund administration service providers by Confluence Technologies found that 34% of AIFMs were still unprepared to meet the AIFMD Transparency Reporting requirements. Nearly 28% of respondents felt that in general AIFMs were still sitting on the fence and reviewing their options, while a third thought that AIFMD’s regulatory burden is its “single greatest challenge.”
“The Confluence survey highlights the lack of readiness within the industry ahead of the AIFMD deadline despite being less than a fortnight away,” said Melvin Jayawardana, Confluence’s European Markets Manager. “European asset managers and fund administrators face big challenges getting up to speed on the full ramifications of the directive and the scope of work it will require of their back-office operations.”
Predicted bottleneck becomes a reality
Bloomberg’s ‘AIFMD Special Report’ of July 2014 also examines the readiness of both funds and regulators for the July 22 deadline, as well as analyses how the AIFMD will impact the popularity of Europe as an investment jurisdiction.
According to Mark Mannion, head of business development for Bank of New York Mellon Corp, speaking to Bloomberg’s Darshini Shah, authorisation applications from funds have predictably bunched up towards the later end of the transitional period, creating a workload challenge for EU regulators.
Even though regulators are working additional shifts, or outsourcing to meet this demand, the complexity of the task, as well as the comprehensive volume of documentation required to be reviewed makes it unrealistic to expect that it would be completed by July 22, thinks Mannion.
Jerome Wigny, partner at Luxembourg-based law firm at Elvinger, Hoss & Prussen, blamed both increasing regulations imposed by politicians as well as tardiness on behalf of funds to take timely steps for compliance.
“The problem is indeed the flow of regulation and the fact that many groups could not only concentrate on AIFMD, whether it’s European rules like the Markets in Financial Instruments Directive, or U.S. ones like the Foreign Account Tax Compliance Act ,” says Wigny. “Plus all of the deadlines for these are too short – they’ve been imposed by politicians and they are creating a risk by trying to fix something.”
Besides, many managers started the process to late, he says. Timely compliance would have been possible for first movers who accepted all the difficulties.
Implications for applicants pending approval
Given this situation, Mannion thought it unlikely that fund managers without an authorization in hand would face any regulatory sanction – they would most likely be permitted to continue operating as they were under their pre-AIFMD regulatory regime.
“However, managers who have yet to receive their authorisation will certainly not be able to avail of the marketing passport under AIFMD,” he said. “Managers who find themselves in this situation will have to be very careful in relation to the distribution activities in the EU.”
Greg Beechey and Tamasin Little, financial markets partners at law firm King & Wood Mallesons SJ Berwin, make the point that July 22 is a deadline for firms to make applications, but not for regulators to grant them. “So, in some respects, it’s not a real deadline at all,” they say. In the UK, firms would continue to operate in the interim period till authorisation, they observe.
They agree, however, that until such time as firms are fully authorized as AIFMs, they would not be permitted to access the AIFMD marketing passport. “For European firms looking to market across Europe under the passport, any delay to their authorization and ability to access the passport will be very serious.”
The availability of suitable service providers is another challenge confronting fund managers says Petra Hollis, managing director of London-based hedge fund consultant Laven Partners, speaking to Bloomberg’s Melissa Karsh.
“In addition to amending your policies or your compliance manuals, the big hold-ups are that you have to find service providers,” she says. “For instance, you might have to appoint a depository, or a depo-lite, or you might have to get an independent valuation agent.”
Clients already experienced with UCITS would overcome this hurdle easily, but a manager starting from scratch find “might be confounded” while picking the right service provider.
Non-EU locations not enamoured of AIFMD
Greg Beechey and Tamasin Little commented that fund managers in non-EU locations such as Hong Kong, China and Australia were baffled and frustrated by AIFMD, and particularly the fact that different EU countries have varying regulatory burdens under the same EU regulation.
US managers have been slow to adopt AIFMD compliance. “There appears to be a low level of awareness about AIFMD among US managers and so they are not acting with the urgency that the legislation requirements,” says Derek Delaney, managing director of DMS Offshore Investment Services Europe Ltd and quoted in Bloomberg’s report.
Estimating that over 80% of US managers have not made changes to their marketing for AIFMD, Delaney attributes the phenomenon to regulatory fatigue. “US managers have had to deal with major legislation and other regulatory requirements, such as FATCA and form PF filing with the SEC,” he says. Other reasons driving US managers’ indifference are ignorance, a fear of the compliance costs and indecisiveness on how to continue to access Europe in the post-AIFMD world.
However, another reason, according to Patrick Ghali, managing partner of hedge fund advisory Sussex Partners, could be that the US market for hedge funds and funds of hedge funds is very buoyant at the moment. “US managers are able to raise sufficient capital to take up all the capacity they have available without having to venture too far offshore,” he observes.
According to Joseph Henkel, head of global solutions for SEI Investments Company (NASDAQ:SEIC), small and medium-sized US managers may exit the EU, opening up a field of opportunity for ‘funds of funds. “They could provide diversity to EU investors through reverse solicitation capabilities with US managers,” he points out. Another trend could emerge – that of US managers concentrating more on Asian markets because of the latter’s lower costs of compliance and the growing wealth market in that region.
However, according to Derek Delaney, over $1 trillion is sitting on the side-lines in Europe in the form of cash or low return investments that has the potential to revert to the alternative investment market. “Without being AIFMD-registered, US managers would be unable to access this and other investment opportunities,” he says.
An alternative route to the EU for US managers
Joseph Henkel outlined to Bloomberg’s Darshini Shah an alternative route for US fund managers seeking to achieve AIFMD compliance: the DMS AIF Platform and Management Company offering, with DMS Offshore acting both as an umbrella fund as well as the complying AIFM.
“A US manager will have their sub-fund created under the umbrella structure with DMS providing the risk management duties but delegating the portfolio management for the sub-fund to the US manager,” clarifies Henkel. “In these cases, US managers are able to be fully compliant under AIFMD and avail of the EU passport for their alternative strategies without taking on the significant cost and time outlay associated with relocating their offices, infrastructure and personnel to an EU domicile.”
Jerome Wigny claims the regulation might end up costing less than anticipated for its implementation. “Partly for lobbying purposes, certain parties were claiming that AIFMD would be so expensive and impractical, but the overall cost is significantly lower than what was expected,” he says.
He does clarify, however, that cost would be unimportant for the very large sized managers. “Of course if you have a € 20 million fund, the costs are almost unbearable compared to before.”
The additional investor protections and safeguards would help to increase confidence among existing investors while opening up hedge funds and alternatives to new investors, simultaneously alleviating some of the concerns that are legacies of the global financial crisis, observes Ghali.
“As the well-established UCITS framework has done, the AIFMD provides a new label for alternative products,” says Laurent Guillet, CEO of Amundi Alternative Investments. “This directive successfully combines performance drivers with investment limits that are less restrictive than for UCITS, particularly in terms of asset eligibility, liquidity and portfolio concentration,” he says.
The regulation could establish stability in the market and its participants and provide a fillip to growth of the industry including better harmonisation, says Guillet.
“It secures a regulatory framework with mandatory use of a depository, increased oversight and responsibilities, an obligation to segregate assets held in custody, a clear separation between the risk and investment functions, quarterly reporting to the regulator and improved and more comprehensive information for investors.”