HEDGE FUNDS: The tide comes in

Cover imageIreland is where the worlds of onshore and offshore hedge funds meet. Nicholas Pratt looks at how the worlds collide as Europe brings in a regulatory system for alternative investments. Ireland is widely recognised as the international centre for hedge fund operations, servicing almost half the globe’s assets. And despite the challenges that the hedge fund industry has faced in the five years since the financial crisis, the figures continue to reflect positively on Ireland. Total alternative assets under management are back almost to Ireland’s all-time high: €1,188 billion at the end of March 2013 compared to €1,192 billion at the end of September 2012. This figure includes funds structured as Qualified Investor Funds (QIFs) which account for €224.50 billion, with non-domiciled alternative assets accounting for the remaining €963 billion. To maintain its success it is vital that Ireland gets the Alternative Investment Fund Managers Directive (AIFMD), and the new, regulated environment for hedge funds that it creates, right. The AIFMD will bring EU-wide regulatory standards for hedge funds and other alternative strategies in Europe and its sponsors anticipate the rise of an “AIFMD brand” that will be as successful as Ucits. Ireland has made a good start. It has become the first EU member state ready to accept and process applications from fund managers that want AIFMD authorisation. This gives Ireland a symbolic victory over Luxembourg, though Luxembourg will not be far behind with its own AIFMD-readiness. Consequently the Central Bank of Ireland, the Irish regulator, has been cheered by its funds servicing industry. Overall, Ireland looks to be positioned well for the new AIFMD era. Industry participants generally praise both the straight-forwardness of the implementation process and the number of options made available to fund managers. The central bank is seen as having done an excellent job in putting Ireland in a position where it can compete not just within the EU, but with the offshore world too. Ireland hopes investors will choose it over the Cayman Islands. The theory is that once investors become familiar with the AIFMD world they will compare onshore funds favourably with offshore funds. In particular, they should see the benefits of passporting a fund between jurisdictions under the directive rather than the private placement regime that many hedge funds are currently used to. The expectation that more hedge fund business will come to Ireland once the AIFMD regime begins in July was seen in Clearstream’s decision to set up an investment fund services branch there in November 2012. Clearstream, a market infrastructure and post-trade services provider, has its main fund service centre in Luxembourg and is strongly associated with that domicile. Bernard Tancré, executive director, head of business solutions at Clearstream, says the arrival of the AIFMD and the greater interest that institutional investors are showing in alternative funds are key drivers in the decision to open a Dublin office. Another fund services provider, Multifonds, says that the AIFMD has been a catalyst for convergence between long-only and alternative funds in that it puts hedge funds into a more regulated context and makes it easier to distribute them across Europe. In the longer term, the AIFMD may even replicate the global success of Ucits funds and become a popular investment vehicle for Asian investors. Should this be the case, says Keith Hale, executive vice president of client and business development at Multifonds, Ireland will be one of the main beneficiaries. John Bohan, managing director for Europe and the Middle East at Apex Fund Services, does not anticipate a flurry of registrations now that the central bank has declared itself ready to receive AIFMD-related applications, but he has already seen a rise in the number of enquiries from potential alternative investment fund managers asking about the need to bolster risk management systems and what the benefits of AIFMD compliance would bring. “The obvious benefit is the passportability of AIFMD funds throughout Europe, especially for those offshore managers with non-Ucits funds, but they will have to look at their distribution channels and whether the cost benefit will be worthwhile.” They may also reconsider whether there is any need to redomicile from the offshore world given the ability for many offshore managers to add an AIFMD layer of compliance to their current model, says Bohan. “Traditionally there have been a number of alternatives managers that have not met the regulatory requirements of many onshore jurisdictions in Europe and saw the offshore world as the easy route.” But now they can work with quasi-providers of AIFMD services to tick the boxes and market those funds throughout Europe. DEPOSITARY PASSPORTS
While the transitioning of Qualified Investor Funds (QIFs) and the standardisation of distribution channels are going to be areas of interest once the AIFMD regime begins, the elephant in the room is the depositary, says Bohan. “The EU Commission is looking at passporting the depositary status from one jurisdiction to the next and this is likely to get a lot of focus in the coming months.” It is still unclear what pricing strategies depositaries will adopt under AIFMD. The directive increases a depositary’s business risk by tightening the burden of liability for any client assets that are lost. This passportability of depositaries may also influence the stance that depositaries take on pricing and how much cost they pass onto fund managers and investors, says Bohan. “They cannot get into a position where their pricing closes the door on all but the largest funds. There are enough providers in the European marketplace that meet depositary status so they do not want to lose market share.” It is not just the depositary aspect that could create cost; there is also extra reporting work entailed in the new regime. After all, the whole AIFMD project started because regulators wanted more oversight of financial activities. Costs will be dependent on the size and complexity of the funds, from the most vanilla equity and bond funds to the most complex hedge funds. Should there be a rush of applications, the central bank has said that it will process as many as it can by July 22 – the date that the AIFMD starts to take hold – and will prioritise the most urgent. Beyond the practicalities of processing applications, there are some other outstanding issues. Remuneration disclosure is still a complex issue and is currently a topic of consultation that lasts until the end of June. The first reporting period now looks like it will be moved out to December 2013. GREAT HERITAGE
One of the main attractions for hedge fund investors will be the enhanced investor protection offered by the AIFMD, says Shane Ralph, senior vice president at State Street International (Ireland). “It is a great opportunity. The AIFMD will give a lot of credibility to these products and make them much more attractive to investors that were reluctant about non-Ucits funds. “If they choose to be based in the EU, then I think they will choose Ireland first. I don’t think that decision will come down to cost. I am not convinced that cost will make or break the adoption of the directive. I think they will look at whether it will be more challenging to be structured outside of the EU or if EU domiciliation makes the fund operation simpler. Luxembourg will try hard to compete for that extra business but I think Ireland will have the first run and has a truly alternative funds heritage and expertise.” ©2013 funds europe

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