In an industry survey that was conducted by Multifonds last year, 63 percent of respondents, with combined assets exceeding $16 trillion, thought that the Alternative Investment Fund Managers Directive (AIFMD) would make Europe a more attractive jurisdiction for alternative fund investors. With the introduction of AIFMD, alternative investment fund managers will be able to market their funds across European markets more easily, potentially making Europe a more attractive venue for non-EU hedge funds. But there is also a potential downside if additional regulatory costs mean that funds choose to domicile outside from Europe as a result.
Growth opportunity for Europe in alternatives
Increasing institutional investor allocation to hedge funds and growth in retail absolute-return funds such as alternative UCITS, combined with AIFMD, are causing convergence between the traditional long-only and the hedge fund market. For example, investors may want daily liquidity and UCITS-levels of risk management in hedge funds; conversely retail funds may take on alternative characteristics such as a long-short strategy, more derivative instruments or performance fees.
We are already seeing evidence of this convergence across our client base, with a significant growth over the last few years in alternatives to complement our market-leading position in UCITS funds. For example, of the $165 billion of offshore-domiciled funds (Cayman Islands, Bermuda, British Virgin Islands funds) now on the Multifonds investor platform, $50 billion are performance fee equalisation, series or limited partnership assets and this figure is expected to rise to $150 billion on the platform in the next year. Sixty-nine percent of our survey respondents agreed that AIFMD will be a catalyst for convergence, so we may well see acceleration of this convergence as the July 2013 deadline approaches and AIFMD comes into force.
AIFMD offers another potential avenue for gathering assets for alternative funds. Fund managers will be able to establish AIFs (alternative investment funds) to attract investment that previously came directly from high net worth end investors or via an alternative UCITS distribution structure. An AIF structure will give distribution capabilities similar to a UCITS structure, but without the same limitations on eligible asset and risk controls. This will give non-EU alternative funds more opportunities to sell and market their funds across Europe. This assumption was supported by the survey findings, where 72 percent of respondents agreed that non-EU managers would set up European operations to take advantage of AIFMD.
The race towards AIFMD
As the deadline for AIFMD looms, the different European jurisdictions are at varying stages of readiness. But which of these will be best positioned should the inflow of alternative assets into Europe happen as more funds domicile and undertake administration in Europe?
First off the starting blocks was the Netherlands, which was the first jurisdiction to adopt AIFMD. However, being first does not necessarily lead to being the most successful. We believe that the long-established centres of fund administration, Ireland and Luxembourg, will benefit most. The real trick will be to bring the efficiency that is associated with traditional funds together with the flexibility that is associated with hedge funds in terms of asset classes, structures and incisive fees.
Our view is that Ireland is well positioned for alternatives given its position as the leading domicile for alternative funds in the EU. Many funds and administrators have their funds domiciled in Ireland as qualified investor funds (QIFs), which will become the basis for AIFs once that structure is adopted in law by Ireland in 2013. The Irish government appears to be encouraging the industry to grow by adapting and introducing legislation to attract further alternative investment activity. The Central Bank of Ireland (CBI) is attempting to leverage existing regulation, such as the QIF structure, to optimise the EU regulation requirements laid out in the AIFMD. The recently released CBI handbook gives managers advice when seeking authorisation in Ireland. Overall then, Ireland, as a recognised fund centre for alternatives combined with an extensive track record of UCITS distribution, should see net inflows as a result of the growth following AIFMD.
Luxembourg is also well positioned as it is already one of the major onshore European domiciles for alternatives. Luxembourg’s version of its draft rules are likely to be transposed into law in August this year to meet AIFMD’s requirements with local law compliancy, which may also make Luxembourg one the first jurisdictions to implement the directive.
Luxembourg is well established as the leading UCITS domicile and recognised as having a strong distribution network with a strong focus on the retail market. The real challenge for Luxembourg will be to bring the efficiency that is associated with traditional funds together with the flexibility that is associated with hedge funds in terms of asset classes, structures and performance/incentive fees, when compared to other relatively lower cost domiciles and administration centers.
However, Luxembourg’s distribution strength alone will not guarantee the growth of Luxembourg-domiciled AIFs. If the cost of administration is materially higher than in other centres, managers will likely look to locations with lower labour costs that can deliver lower administration fees. As a result, the systematic automation of the AIF operating model via efficient processing systems is critical to the success of Luxembourg for AIFs and indeed as a UCITS centre.
Luxembourg and Ireland are also both bringing in special limited partnership structures into law in another move to make Europe a more attractive jurisdiction for investors. Under this arrangement, where incentive and management fees are allocated to each individual investor, these products can be administered and domiciled onshore while retaining the same limited partnership structures that they have now offshore.
Another of the front-runners in this race is the UK. The Financial Services Authority (FSA) has already issued a consultation paper on AIFMD, so the process is well underway. In Germany, implementation of AIFMD will be via the German Investment Code (GIC)—the last draft of which was issued last October—and will be effective in law by the July 2013 deadline. Spain, France, Belgium and Italy are trailing the pack at the moment and yet to release any specific text for implementation. Whether any of these countries will actually see any inflows over and above the more typical alternative administration centres such as Ireland and Luxembourg remains to be seen.
Word of warning
Until AIFMD comes into force, we will have to wait and see whether it will indeed succeed in bringing the predicted new inflow of alternatives business to Europe and attracting it away from the well-established offshore domiciles. But there is no reason for complacency. The potential downside for Europe is that if the cost of implementing the new regulations is prohibitively high for fund managers, they may re-domicile their funds offshore, outside of Europe.
For example, the biggest concern identified in our survey was depository liability (57 percent saw depository liability as the most challenging element of the directive), which could add anywhere from 1 to 200 basis points, depending on levels of liability. In this scenario, it is very unlikely with the current levels of low interest rates and returns that a ‘2 and 20’ fund becoming a ‘4 and 20’ would be a very attractive proposition. Of course, if a fund re-domiciled outside of Europe, it couldn’t be officially marketed to European investors, but many hedge funds haven’t ever ‘marketed’ their funds to European investors in the first place.
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KPMG
Georges Bock
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