The Alternative Investment Fund Managers Directive will inevitably lead to higher compliance burdens and cost. Dealing with it will be uncomfortable, write Guy Rainbird of The Association of Investment Companies
The last 18 months has seen a sea change in attitudes towards financial services. Banking failures, turmoil on stock markets and the effect of these events on the global economy have resulted in demands for tighter regulation of markets and the institutions that operate within them. The Alternative Investment Fund Managers Directive exemplifies this situation. It is ambitious and comprehensive, covering all non-Ucits structures which want to sell into the EU, regardless of where they are based. Unfortunately, the desire for action, without a full understanding of the funds the directive was to regulate, meant the original proposals included features which were unworkable and unnecessarily damaging to the funds they sought to govern. It has required a strong, coordinated and effective industry response to try and set this right. Despite an unpromising starting point, discussions over the rules have been constructive and should result in a broadly acceptable outcome.
For example, the original proposals would have severely damaged investment companies – or even stopped them functioning altogether – as they did not recognise the unique governance structure of the industry and would have prevented any new share issuance. These issues, largely unique to our sector, should be resolved when the proposals are finalised. Other concerns, such as rules which would have prevented funds delegating to managers outside Europe and hard leverage caps, have also been moderated to reduce the negative consequences of the new rules. Many problems have therefore been resolved or, at least, had their negative impact reduced. However, two unresolved areas remain subject to fierce debate.
The rules require fund managers to appoint a depositary to ensure various functions are carried out, including custody, receipt of client money, verification of assets, and aspects of legal oversight of fund activities. While this has a legitimate regulatory purpose, it is concerning that the manager is not free to appoint more than one provider to undertake these roles. Bundling activities have traditionally meant poor value for consumers and compromised service quality. It is therefore difficult to see why the rules should encourage such an approach. Also, the standard of liability applied to depositaries is strict, without a reasonableness test. This will lead to high costs as service providers seek to manage risks which cannot be offset by customary risk management processes. Policymakers should allow multiple depositaries and create a reasonable standard of liability. This will secure their regulatory goals within a proportionate framework and allow lower costs and, ultimately, better outcomes for consumers.
Access for third-country funds to European markets is also subject to intense discussion. The risk is that the rules will set standards of entry which will prevent investors buying funds from outside the EU. This will reduce their ability to diversify their portfolios and secure returns. It also threatens to disrupt capital flows into Europe with serious implications for businesses seeking finance. Avoiding these outcomes should be a priority for policymakers. The best means to achieve this is likely to involve allowing individual member states to set their own rules for market access. This will enable them to satisfy their preferences for consumer protection, but avoid cutting Europe off from essential financial flows.
Progress should be made on both these issues before the rules are finalised. Where regulation supports orderly and fair markets, provides investor confidence and prevents market failure it has an important role. However, lawmakers must be wary of restricting the legitimate operation of capital markets, which has the potential to harm businesses and consumers alike. Discussions over the directive suggest that many of the most harmful aspects of the original proposals will be removed. If good will on all sides can be maintained, hopefully further progress can be made.
The directive will inevitably lead to higher compliance burdens and cost. Dealing with it will be uncomfortable. While it does feel like swimming against the tide at times, we are committed to making the case for sensible regulation and hope we will be joined in this by our colleagues across the financial services sector. There is still scope for policymakers to take notice of the legitimate concerns of industry stakeholders if the case is made clearly, compellingly and constructively.
• Guy Rainbird is public affairs director at The Association of Investment Companies
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