Alternative investments are a big part of the Irish asset servicing sector. Our panel hears that fund promoters have a realistic attitude about the regulatory impact on costs. Money market funds are also discussed. Chaired by Nick Fitzpatrick.
Clive Bellows, country head, Northern Trust Ireland
John Bohan, managing director and global head of operations, Apex Fund Services Ireland
Susan Dargan, head of global services, State Street Ireland
Keith Hale, executive vice president, client and business development, Multifonds
Mike Hughes, global head of fund services, Deutsche Bank
Alan Keating, head of operations, UBS Fund Services Ireland
Neil Wise, vice president, investment fund services, Clearstream Banking
Funds Europe: Which has been the strongest growing portion of business in the fund management segment in Ireland in the last three years and why?
Clive Bellows, Northern Trust: We continue to see significant growth in ETF administration. This has been concentrated among existing providers and we haven’t seen many new entrants into the area.
There are many new funds and new fund structures in Ireland across multiple asset classes with, in our case, private equity and property dominating. So far this year, we have launched more funds than we did in 2012.
There are also more and more funds being launched with performance fee calculations, which is particularly interesting when you consider developments in Ucits regulations and the regulators’ views about performance funds. It could be a dominant subject in the coming years.
Susan Dargan, State Street: ETF growth over 12 months has been huge. A year ago European ETF assets were €260 billion and are now around €350 billion. Ireland has 39% of that market and is the largest servicing location for ETF funds.
The ETF industry is starting to see a focus on returns with some of the more high yield product coming through.
There is also a move from synthetic replication ETFs to physical.
It is worth pointing out money market funds, too, which are important to the Irish funds industry. These went through a huge change in 2008 and the segment is about to go through another period of potentially significant change with the policies being considered at present.
John Bohan, Apex: When determining the key areas of growth within the Irish funds industry, it is important to distinguish between the regulatory environment and the economic environment. The strategy and the type of fund is driven more by the economic environment which ensured a greater flow to to the ETF space and the search for low volatility in what has been a very turbulent few years.
Since 2008, there has been an ongoing flight to regulated products with AIFM only increasing that flow.
In 2011 there were more regulated funds launched in Ireland than any other EU states, including Luxembourg, so we’ve turned a corner there in increasing our market share.
Neil Wise, Clearstream: Regulatory change, low yield and the current low interest environment means more pension funds are investing in alternatives and certainly over the last three years there has been a 20% or so increase in the overall size of hedge funds in terms of assets. The distributor base is pushing us now very clearly into the alternatives space to offer our same mutual fund services, but tailored and dedicated to alternative investments.
Keith Hale, Multifonds: Institutional investor allocations are definitely pushing hedge funds to become more regulated, with perhaps daily liquidity and performance fees. Over the past year the number of funds with performance fees on our software platform has doubled. That’s just reflective of long-only funds becoming more like hedge funds in some cases and hedge funds more like long-only funds and being institutionalised.
At the other end of the spectrum is the ETF market, which I think will continue to grow as investors question fees.
Mike Hughes, Deutsche: Many of us are seeing a convergence of open-ended and closed-ended funds. This is where committed capital is invested in liquid assets, but in closed-ended structures.
Ireland has certainly done a good job in trying to build capability based on infrastructure and distribution that allows this kind of hybrid structure to be brought to market.
Alan Keating, UBS: Talking to our asset management colleagues in terms of where they see the future, they see strong growth potential in the passive funds market. Passive funds, some with an element of active management overlay, will be in demand. It’s partly to do with RDR [the UK’s Retail Distribution Review] and a focus on more regulated funds with lower TERs [total expense ratios], which puts pressure on all the fund costs, including the asset servicing fee.
The challenge for asset servicers is to deliver new services for all these new developments while acknowledging the cost pressure.
Bellows: I think in the last 12 months most of our clients have recognised that, given the scale of regulatory change, asking service providers to reduce fees and take on additional work is not an equation that works in anyone’s interest.
Keating: Funds are under cost pressures from investors but need more services due to changing regulations. The challenge is to find a balance.
Bellows: But I’m seeing no indication of clients thinking they are going to get an AIFMD-level of fund service with no incremental cost. I mean, there is an absolute acknowledgement that the directive is going to create a cost in the market.
Hughes: In fact, asset managers are asking us as an industry what our costs will be. There is an expectation that they will have to pay. They just want to understand what that quantum is.
Bohan: There’s been a parallel evolution which centres on the outsourcing of more services, like risk management and reporting. As demand for greater reporting has increased technology has advanced too, meaning that processing, operations and how efficiently we do things, is always improving and continually evolving towards a more fluent STP [straight-through processing].
There is also a steady stream of business coming down the line with the opportunity to make more fees in some areas, like Fatca, OPERA reporting, AIFM additional reporting requirements.
Funds Europe: What trends are developing in fund management product development as a result of regulatory change and/or investor pressure, and how are asset servicers responding?
Dargan: A real challenge on the money market side is the low interest rate environment. Fund promoters and service providers have had to react to that.
Some good solutions – such as fee waivers and share redemptions – have come out of working with the regulator to see how promoters can manage those challenges whilst still making the product itself viable.
Bellows: And I think there’s still a big question mark around money market funds. Some regulations are certainly causing some clients to review how they invest their short-term cash and I believe the industry is being forced to innovate and develop new products in line with these regulations.
Dargan: I think there will be potential for various forms of money market funds. You will have some larger players who, depending on the capital buffer levels required, will continue to provide constant NAV [net asset value] structures. However, I do not believe that capital buffers are an appropriate tool to mitigate the risk of CNAV [constant net asset value] money market funds in the wider financial system.
There is also the possibility of managed accounts and variable NAV structures.
Hale: With regard to hedge funds, the challenge created by institutional investors is that most service providers traditionally had separate lines of business for alternatives and long-only investments. Having them both on one platform is not easy – it’s a major challenge.
But if you can get that right, by having a technology platform that does both sides – the long-only daily aspects, the performance fees and all those complexities at the same time – then you can get some real efficiencies and real leverage in terms of TER in the alternative space.
Funds Europe: Are fund managers supporting or resisting automation?
Wise: Over the last three years, we’ve actually seen a lot of transformation here in Ireland, largely driven by the investment banks that are producing Ucits-type products for sale for retail investors. The banks are dragging the horse to water, as it were, and traditional alternative fund administrators are adopting automation standards; with the ongoing downward pressure on fees, there’s added motivation to get the operational cost base under control.
Dargan: Our client base is not resisting it because they know from the perspective of their own cost base that they need to be moving forward. You’ve got to have automation to support regulated hedge funds; you can’t operate those funds without a high degree of automation.
Bellows: It’s back to the fee issue. If clients want competitive fees then automation is one way of helping keep their cost base under control.
But I think there’s also another increasingly important element: data security. Particularly as data is sent in so many ways and to mobile devices for example, regulators are putting pressure on providers and clients to make sure that data is sent in secure formats. The only way to do that is using automated means. So I think that the push towards automation is coming from all sides and all parts of the industry are embracing that.
Hale: Statistics show that automation in the long-only world is pretty good. There are STP rates north of 75%. In the alternatives world, there is a lot of scope for improvement, which is happening on a number of fronts, but it is starting from almost zero.
But, equally, STP rates across both are definitely ticking upwards. Across our platform they went from about 70% two years ago to about 78% at the end of last year.
Bohan: But rates are still very disjointed regionally. You can take the EU as one region and the UK as a separate market. Northern Europe is very much a retail market, it’s a savings market but that’s not in conjunction with the rest of the EU. The UK has stronger automation than the likes of some other EU states.
Funds Europe: How could product development under the Central Bank of Ireland’s proposal for a Retail Alternative Investment Fund structure evolve? Will fund managers be comfortable with it – or is this a step too far for the retail market, increasing the chance of a fund ‘blow-up’?
Hale: My understanding of the proposal is that the fund is somewhere between a Ucits structure and sophisticated investor structure. It allows a larger range of eligible assets in the fund and more short selling capabilities. Ultimately this can potentially result in higher risk than Ucits strategies. That said, Maddoff’s LuxAlpha was a Ucits fund.
Whether it will actually get any critical mass or growth via available retail distribution channels is a completely different question. But I think it’s not a bad idea to have a middle ground for retail investors who only have a certain amount of money and would not normally be considered worthy to buy a hedge fund.
Keating: The key will be the brand. If you look at what’s happening within Ucits, then there’s definitely a market there for a type of product which will give retail investors a higher risk product with potentially higher returns. But, as I said, it will ultimately come back to brand.
Bellows: But there appear to be so many of these strategies already wrapped into Ucits funds that I’m not sure what’s going to go in this new product.
Dargan: I think the view is that this non-Ucits retail regime has always been there, from an Irish perspective. So I think what is happening, along with AIFMD, is the regulator is taking the opportunity to revise the existing framework.
Bohan: With AIFMD coming in I think managers will leave that on the fence for now. There certainly will be take up once the dust has settled and managers have some time to swallow the requirements of AIFMD with global macro liquid strategies that will fit well into it. I think it will be at least three plus years until the AIFMD settles down before RAIF structures build any real traction.
Hughes: Investors in the institutional space, and certainly in the alternative segment, have not demanded these regulatory changes, like AIFMD, Dodd-Frank, Fatca, etc. These changes have been given to them without their request.
Aren’t we at risk of creating essentially a two-tier alternatives market, one that is retail-driven and then a ‘super alternatives’ market, which caters to institutional investors that have always been in hedge, private equity and real estate funds? This could have a fundamental impact on the industry by creating a new segment, a new tier, a new set of structures that may not necessarily be regulated structures.
Hale: But a retail investor may well want a bit of high risk in their portfolio too. I think it’s right that a retail investor or a private investor should have the opportunity to have a higher alpha based on higher risk.
In Liar’s Poker, one of Michael Lewis’s books, he says if you don’t know who the mug in the market is, it’s you. Sometimes it feels like that as a retail investor because hedge funds basically are finding the pricing arbitrage via whatever strategy there is out there and I don’t see why a retail investor, through whatever distribution channel, should not have access to that any more than a professional investor.
Hughes: But another point is whether asset managers actually want retail investors in their structures. Certainly the larger hedge and private equity managers would probably not.
Bellows: I agree, I don’t think your traditional hedge fund manager wants the retail investor in any way, shape or form. But I think there are a lot of big global asset managers who run some alternate strategies who would be delighted to get access to some retail flow, particularly if it comes via a distributor, though I don’t think they want to be going out and pulling flows in directly.
Funds Europe: Can it be conceived that rules for depositary liability under AIFMD and Ucits IV may differ between Ireland and other jurisdictions - notably Luxembourg, The Netherlands and Germany – despite the drive for harmonisation?
Bellows: I personally think it will be consistent across jurisdictions and that dramatic differences are inconceivable. Slight differences of interpretation are possible around the edges, though. For example, the issue of prime brokers who, in certain cases, effectively act as sub-custodians and therefore create liability risk for depositary banks.
For those of us that run depositaries in other domiciles, we’re going to run them to the same standard. It doesn’t make sense as an organisation to do them differently.
Keating: In the last 12-18 months ESMA has issued a number of guidelines, standards and clarifications, which the industry has taken on board and adopted. This suggests a uniform approach across jurisdictions is possible. And at the end of the day, ESMA has the power to force regulators to move in the same direction.
Dargan: ESMA is creating a level playing field through its technical standards.
But there are elements, such as the interpretation around prime brokers, which could differ. The question is to what extent they will differ and it’s possible we would not know that until there was a blow-up.
But, generally, I think we will see a level playing field.
Bohan: And the greater focus is the degree to which jurisdictions and managers outside of Europe will have to adhere to the AIFMD and how prepared they are to the concept of depositary and liability.
Hale: Could AIFMD cause some managers with hedge funds to domicile outside of Europe to avoid the costs of the regulation?
Hughes: It depends where their investors are.
Bellows: If they want to invest in Europe, they’re not going to have a choice. But a fund not targeting European distribution wouldn’t come here anyway and they’d already be in Cayman or Bermuda.
I do think, though, that if you’ve got a European-domiciled fund with no European distribution, you’re not going to stay in Europe, though I’m not sure how many funds actually fit that description.
Hughes: The spirit of the directive is that the depositary has liability. But if you look at things like consequential losses, there will be pieces of legislation in each jurisdiction that might be different. That’s a very local issue and not something that we as an industry would be able to control.
Wise: The spirit of the regulation is important. Again, with the Bernard Madoff Lux Alpha fund, if you look at the difference of interpretation between France and Luxembourg, the French regulator said banks were liable for immediate restitution under the Ucits IV banner, whereas Luxembourg under the same regulation said depositary banks were not immediately liable.
It will be a long, long time before any recourse is done there. ESMA and the regulators will learn from that and they will enforce the spirit of the regulation. I don’t see there being any arbitrage at all between jurisdictions.
Funds Europe: It was mentioned that fund promoters have a realistic attitude about increased costs. But what about the increase in depositary fees under AIFMD caused by the increase in the depositary’s liability?
Bellows: Some funds that did not need a depositary before, will do under the AIFMD. So we need to be careful when we talk about increased depositary fees, because in some cases it’s a case of charging a fee for something that didn’t exist in the first place.
I do not really expect to see a wholesale rise of depositary fees, personally.
Dargan: It needs to be looked at on a case-by-case basis in terms of the level of risk service providers are taking on.
Hughes: We look at it as a risk premium on a fund-by-fund basis and what it will cost us to essentially discharge the risk we take on a particular alternative fund, taking into account its structure, where it’s holding the assets, the agent network and how we offset that pure principle of liability.
But I think it’s important to say that if the cost of the risk premium is anything greater than zero, the investor is going to pay some piece of that, detracting from their overall return. I don’t think the investor community has fully understood that just yet, but as more investors start to understand the impact they are being more vocal in their views with managers.
Hale: A survey we are currently running shows that both asset managers and asset services are all expecting there to be additional cost in association with liability.
Bellows: We’re talking to a number of our clients who are in the process of deciding when they are going to adopt AIFMD and clearly part of that process is to understand what additional fees they’re going to incur. Most of the clients we’re talking to are not falling over at the numbers that we’re syndicating with them.
Keating: Another aspect to this is that there’s probably going to be a limit to the number of prime broker relationships that depositary banks will enter into. Potentially, therefore, there may be a restriction in terms of the service offering that certain depositaries will provide.
Bellows: Deciding not to work with a particular prime broker will be a credit decision and a depositary will have to get comfortable communicating that.
Ireland as a domicile is more impacted by this than Luxembourg because most of the funds using prime brokers are domiciled here. So, to some extent, I do think this is an Irish problem more than a Luxembourg problem. We haven’t got years to sort this out; we’ve probably got months.
Funds Europe: Is there a significant place for Ireland in the evolving central counterparty (CCP) regime? Is collateral management expertise mainly to be found elsewhere? Do Irish money market funds provide a useful collateral facility?
Wise: It’s a fantastic opportunity for Irish money market funds. With Emir [European Market Infrastructure Regulation] and the shortfall of available collateral, a large “collateral gap” needs to be filled. Money market funds have a role there, though there are a few issues. There is the view that money market funds are not as liquid as the CCPs would like, but there are some suggestions of potentially using the Irish Stock Exchange to create a secondary market.
But our parent company, Deutsche Boerse, has announced with Eurex that they will be technically able to take money market funds from November this year. That’s a good first step.
It’s good for Ireland because the majority of money funds are domiciled here.
A lot of people are redeeming money market funds for cash and posting that cash as collateral to cover their derivative contracts.
The CCP does not need to be in Ireland and nor does the collateral management.
Hale: Recent EU commission proposals for money market funds themselves could be self-defeating in this case. The question is how much could these funds be used for collateral when they themselves are at risk under the new proposals.
Wise: But they have potential where triple A-rated collateral is needed.
Dargan: The actual structure of the money market industry is changing and this will change the number of funds and the size of them, but I don’t think that stops you using them as collateral.
Wise: Asset managers are heavily pushing this with huge lobbying efforts at government and European levels, as well as with the CCPs.
Bellows: The debate around money market funds is probably as important as AIFMD and Fatca, which we have all been heavily involved in, but it just hasn’t been given the time. However, I think this will change in the next month or so.
Dargan: Yes, it will. My feeling at this stage is that the Commission’s policy coming out towards the end of June or in July will really focus people in terms of where the industry is going and, from an Irish perspective, we need to look at some of the opportunities as well.
Bellows: The custodians that we are speaking with are not suggesting large separate increases for depositary services. There is an overall review of each client relationship and service provider relationship taking place. Strategically with passportability of depositary services on the agenda the banks need to be mindful of how they yield this new shift of power. The new legislation will attract new flow of US and Asian banks looking to provide alternatives to existing players.
Funds Europe: When will the first AIFMD fund be launched? And will Ireland be sooner to market than Luxembourg?
Dargan: I think we will see managers registered on the July 22 deadline both in Ireland and in Luxembourg.
Hale: I think the question should be about who’s going to benefit most, not who’s going to be quickest.
Holland was the first to bring AIFMD into law, but does that mean Holland’s going to be the biggest centre for AIFMD? No, it’s going to be Luxembourg and Dublin. An interesting debate is whether they are going to benefit equally or not.
Wise: Asset managers will go to the jurisdiction where they’ve been before.
Bellows: I think most managers who were planning to launch new products that would need to be compliant with the AIFMD have already done so. This has given them some breathing space to see how things develop.
Hughes: Managers have been given, basically, an extra year to apply, yet depositories have to be ready on July 22. Depositaries have no ability to bring in the change over a reasonable course of time, yet managers have an extra year.
Bohan: Established investment managers aren’t looking for any PR opportunities to be the first to be AIFM compliant. The first AIFM-compliant Manco [management company] will be part of a new breed of increasing Manco providers that look to fill the gap for the thousands of funds or managers that look to outsource the new requirements. Regulators are becoming more accepting of this type of “service management company” assuming sufficient depth and resources.
Hale: The Central Bank of Ireland has published a full suite of AIFMD application forms, and it’ll be interesting to see when applications start being submitted.
But given that none of us seem ready to commit to what the depositary fees are going to be, will anyone actually apply before they definitively know what it’s going to cost them?
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