What has made AIFMD an attractive regulation?
Over the last 10 years, we have seen the two worlds of traditional and alternative funds converging, driven by changing investor demands. Institutional investors are now increasing their hedge fund and alternative allocations to get access to strategies and performance they’ve not had previously, but the increased levels of risk management, governance, transparency and liquidity are far more akin to a traditional fund, resulting in hedge funds becoming much more like long-only funds.
At the same time, retail investor demand for absolute return funds means that long-only funds are taking on alternative characteristics as they start to use long/short strategies and hedge fund methodologies to achieve better returns. Regulations such as the Alternative Investment Fund Managers Directive (AIFMD) and the US Dodd-Frank Act have been additional catalysts for this. With AIFMD, regulators have taken the ethos of UCITS and applied it to alternative funds—managers can now take an alternative fund, domicile it in the UK, for example, and market it to investors across Europe using the fund passport without having to register it in every location. AIFMD presents a massive opportunity for fund managers and investors alike.
From a Multifonds perspective, we are seeing increasing evidence of this convergence across our client base, primarily from fund administrators as they seek to service both long-only and alternatives efficiently and cost effectively on behalf of their clients, the fund managers. We have seen the industry changing on the back of this convergence theme, and for us, that has been good as we are well placed to support both sides, as our software already supports alternatives.
However, despite optimism over the future of AIFMD, challenges do remain. Our latest research on AIFMD, conducted earlier this year, showed that the largest outstanding issue for the industry at the moment is reporting. About 60 percent of the data comes from fund administration systems such as ours, but that’s only part of it. This data then needs to be aggregated together with additional investor and risk data, signed off by the administrator and the fund manager, and then the fund manager has to send it to the home regulator. Depending on how frequently you publish your numbers, it requires a considerable effort to get all that data together, check it, validate it and then send it out. We are just a part of that process, collecting and distributing the data down to clients.
Will the regulation change considering 66 percent are finding reporting a challenge?
AIFMD is a year old, so new funds should already be registered as alternative investment funds. The 22 July deadline was for existing funds to be transposed. Once they’re transposed, they’ll have to report to the AIFMD standards. Should they choose not to go down the alternative investment fund route, the other option for Europe is to use private placement, but some countries are trying to restrict that route. The UK, for example, is keeping private placements for now, but most alternative managers will probably go down the alternative investment fund route eventually in the EU. It’s likely to become a binary option for funds (alternative and mutual): they either become an alternative investment fund or a UCITS.
Will trading with those who decide not to be AIFMD registered become more complicated?
Theoretically, non-AIFMD registered funds cannot market their alternative funds around Europe. However, the number of countries that will allow private placement is reducing and country-after-country are replacing private replacement with alternative investment funds over time. There’s still going to be hedge funds domiciled in the Cayman Islands, selling to investors outside the EU who won’t be interested in alternative investment funds, but in Europe alternative funds’ choice is to either stay with private placement where they exist or follow the alternative investment fund route when private placement is no longer an option. Interestingly, in our recent AIFMD survey, the majority of respondents didn’t expect the directive to replace private placement any time soon, only 26 percent of respondents expected member states to remove the private placement regime earlier than 2018.
Would AIFMD make trading within the whole of Europe easier, if you are offshore?
That’s the upside. Say you are a US manager with a Cayman or Delaware structure and you would like to market to investors in Europe, you could domicile the fund in Dublin, Luxembourg or perhaps even the UK, and then distribute that same fund to any of the AIFMD participating countries. So for example, you can sell in Germany, even if the funds are domiciled in another country. This is likely to be a big draw for offshore managers coming onshore to set themselves up as an alternative investment fund.
Eighty-two percent of respondents to our survey said that non-EU managers will set up operations in Europe to take advantage of AIFMD. It will be interesting to see how much take-up actually happens. In the near-term, I suspect most of the activity will come from the existing funds transposing into alternative investment funds so that they can immediately be distributed around Europe.
AIFMD has been live for a year—has Multifonds been coping?
The impact of AIFMD for us is purely one of data delivery—all the functionality and processing is already in place. We’ve worked with a couple of reporting vendors and with our clients to help them get the required data out of our system and into the aggregated reports. Other aspects, such as depository liability, don’t have a direct impact.
The Foreign Account Tax Compliance Act (FATCA) had a much bigger functional impact on us in terms of what we need to deliver to our transfer agency clients, as it directly affects the way you do anti-money laundering checking on clients, to see if they are a US resident or not and should be included for US tax purposes. We have worked with our clients and built a lot of functionality into the system to make it as easy as possible for them to categorise, scan and flag up any US residents invested in funds.
On top of FATCA, are there any other regulations you’ve had to incorporate into your software?
We have to keep an eye on the constantly evolving regulations along with our clients. Our client base is composed mainly of the global fund administrators and a large part of what they have had to deal with over the last six to seven years is the impact of regulatory change on behalf of their clients. When we know changes require extensive modifications, such as FATCA and German tax, we’ve hosted client focus groups and employed specialist consultant firms to help us understand the specificities of what needs to be done to make our software compliant.
In terms of our development, regulatory change is always top of the list—we focus around 14,000 man-hours on development and approximately a third goes on regulatory updates. With all the recent changes, we think our platform is now well positioned with the major regulatory-driven initiatives.
Aside from ongoing regulation, do you think there are any challenges coming up for AIFMD?
Reporting is the biggest challenge for AIFMD. It will be interesting to see the take up of AIFMD and how many choose to go down the directive route or stay with private placement structures. A fund manager could look at the strategy its running and think: “I can make my fund into a UCITS fund instead, which has more controls and more restricted assets, but get access to a bigger market and a wider distribution network.” This would have a detrimental effect on AIFMD. But in practical terms in the coming years for alternative investment funds, I expect good, relatively low cost and light regulation for the alternative industry will continue.
Investors will see this as a positive step and so AIFMD could potentially grow in the same way as UCITS and become a new global standard like UCITS did for mutual funds. The challenge is making sure the regulation and the costs are not too high to make it unattractive. In our research last year, industry participants estimated depository costs would be between 5 and 25 basis points. This year, we’ve uncovered that depository costs are much nearer 2.5 basis points, which means tapping into this market is seen as worthwhile investment.
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