The AIFM directive is set to introduce sweeping changes for alternative managers and their administrators. Nicholas Pratt looks at what these changes may be and how administrators are aiming to help both their clients and themselves
The Alternative Investment Fund Management (AIFM) directive is comfortably the most controversial piece of legislation ever produced by the European Union. It has received over 1,500 submissions already – far more than the Lisbon Treaty ever inspired, regardless of how many letters were written to daily newspapers by irate conservatives.
The number of submissions should be no surprise given the uniquely politicised nature of the directive and the backdrop to its formulation – that is, the deepest financial crisis since the 1930s. Rightly or wrongly, the alternative investment community has been blamed for the escalation of the crisis and international governments have been desperate to act. After all, there are no protestors in the street over the roll-out of Ucits IV, but there are over the public’s perception of the roles of hedge funds.
The directive is also the first ever attempt to establish a standardised set of supranational regulations for the alternative investment industry which has been left unregulated to a degree. And, unlike, say, with Ucits regulations, the directive is applied to both management companies and their investment products. It will also have far-reaching implications for managers’ service providers, particularly their administrators and depositary banks.
Despite, or perhaps because of, the political urgency behind the directive, there still remains a lack of clarity in certain areas. The first of these concerns the need for alternative funds to appoint a depositary bank, a process which is already required in some European markets but not in others. For the managers, it means integrating entirely new functions and expertise in the funds processing chain. For the service providers, typically those that offer both administration and depositary services, the directive significantly increases the scope and potential magnitude of their liability in respect to a fund and particularly in relation to its sub-custodians. This additional liability would also increase the depositary’s costs, which would then be passed onto the managers and, ultimately, the investors.
“The main challenge for all of us is that we are still looking for clarity,” says Tim Gandy, head of trust & fiduciary services at JP Morgan. “On the depositary side, there has been a lot of dialogue around the liability issue and it is still unclear as to what the final position will be. We are facing strict liability measures and an inversion of the burden of proof where an event is foreseeable but no-one is sure about what the definition of ‘unforeseeable’ is and I can anticipate lots of debate around this definition.”
Offshore domiciles
The second main area of concern is around the ‘third country’ issue and what the directive means for any domicile outside of the EU and the managers and service providers operating in those domiciles. For off-shore jurisdictions within Europe, the concern is particularly acute. Jersey, for example, has approximately £180bn (€215bn) of assets under management and a mixture of fund administrators from the global companies to more home-grown operators.
Currently everyone in Jersey’s funds industry is keenly eyeing the directive and its conditions on third countries. “It is all up in the air and it is impossible to work out what the best strategy will be for fund promoters operating in Jersey and wanting to do business with or in Europe,” says Richard Thomas, chairman of the Jersey Funds Association.
Thomas recognises that the EU wants to establish a framework that manages the potential for systemic risk. “This is a common goal for everyone, but we do not want a protectionist approach where we and other offshore jurisdictions are left outside of the European market.”
This apprehension is shared by Ian Moore, chairman of Jersey-based administrator Moore Group. “The directive hints at protectionism and is yet another attack without foundation on offshore domiciles. The implication is that it puts these jurisdictions at a disadvantage and could have an effect on the business conducted here.”
The uncertainty around the directive is already creating a sense of paralysis across Europe and not just within offshore jurisdictions like Jersey, says Moore. “Unless there is a pressing investor demand, no-one is particularly keen to set up new funds.
But the advice we have had is that managers should carry on doing whatever they are doing.”
Although Moore says that he is in the wait-and-see camp like everyone else, he is fairly confident that Jersey and other offshore jurisdictions will not be fatally wounded by the directive, even if it does limit the opportunities available within Europe. “There is plenty of business out there for offshore jurisdictions – we have a lot of interest in Asia right now and also in private equity. The directive does not mean the end for us; it is just opening up other opportunities.”
But while the likes of Jersey may well have to look beyond Europe and the alternatives market for its future prospects, other domiciles where there is already a strong depositary industry could well profit handsomely from the directive. “Administrators and depositaries in Luxembourg and Dublin have a competitive advantage because they already have the necessary experience as well as the agreements in place with prime brokers,” says Sandrine Leclerq, general counsel of France-based administrator Caceis. “This could attract promoters to relocate their products to such jurisdictions capable of offering the combined benefits of efficient product regulation and the required expertise.”
Furthermore, as a result of the directive, small and mid-sized investment managers may face expensive restructuring. “This is where large administrators can step in and offer additional services designed to assist managers in complying with the directive’s governance requirements, such as risk management support, the provision of varied reports, the monitoring of investment decisions or even logistical support for rationalising distribution networks,” says Leclerq.
These opportunities for administrators are only likely to further support a growing trend for managers to look to large players rather than smaller specialists, even in the alternatives world. For example, Chris Adams, head of product for alternative funds at BNP Paribas Securities Services, believes that managers have been looking to reduce the number of service providers they use for some time and the events of recent years have brought this into focus.
“The way that various fund administrators can react to regulatory changes and convince their clients of their ability to do so may well become a decisive factor in the selection process as managers look to whittle down the number of service providers that they work with,” says Adams. “Therefore it is really important that we demonstrate a full and complete understanding of not only the directive but its implications for our clients.”
Greater convergence
The ability for administrators to have a single platform to service both Ucits and alternative funds as well as those in between will also become more important, says Adams. Hedge funds and funds of hedge funds are already becoming more institutional and the directive could lead to more alternative funds seeking a Ucits structure given the current trend for investors to seek greater and more transparent regulation and given the potential overlap between the draft directive and the Ucits model.
It is a view shared by Mark Schoen, head of product development Emea at Northern Trust, who adds that such a development could mean yet more business for administrators working in Luxembourg and Ireland. “We are already seeing alternative managers hedging their bets and setting up products in EU domiciles in the wake of the proposed legislation. Quite rightly there has been a lot of focus on the product range which can be accommodated within a Ucits III wrapper – which also takes the fund out of the AIFM directive – but we are also advising clients on non-Ucits products available…
“In general I think greater convergence will be good for the market in terms of relative comfort for investors but I think it will also restrict returns to a degree. Long/short funds and event-driven investments and convertible arbitrage can all fit into a Ucits structure. But there will still be those strategies and asset classes that do not fit into a Ucits structure and require a lot of leverage. So that is a challenge for the regulators and the market – to accommodate both ends of the alternative funds spectrum.”
©2010 funds europe
