Pension funds are asking fund managers to explain their plans under the Alternative Investment Fund Managers Directive. Nick Fitzpatrick looks at how they might respond.
“A typical large, well-known hedge fund isn’t going to sit around and fill out 200 pages of an RFP document for a pension scheme.”
This is the view of one investment chief at a pension fund with over €1.2 billion.
Pension funds are known to access hedge funds mainly through fund of hedge fund (FoHF) platforms. FoHF providers effectively carry out a single RFP – or request for proposal – process for dozens of pension fund clients.
Direct access to single managers by pension funds has been tipped as a major trend in European hedge fund investing for quite a while now.
Could it happen soon – especially when the new regulatory regime for alternative investment managers takes hold this year?
“I’m not convinced about that,” says Simon Oxley, at Paamco, a FoHF provider in London. “Regulation on its own does not ensure a sound or value-added investment proposition; although having regulated onshore European funds and managers may provide some investors with more comfort.”
Either way, the Alternative Investment Fund Managers Directive (AIFMD) is set to change alternative investing and may well attract more pension funds to the various alternative strategies.
Recently, the Irish Funds Industry Association reported that some European pension funds putting out RFPs were asking investment managers to state their plans under the directive.
So how might fund managers answer an RFP?
The directive is effective from July 22 and on that date the fund service industry in Luxembourg, a major European fund servicing hub, can at last stop eating, drinking, and sleeping the AIFMD. Not for at least two decades has a set of regulations occupied so much time for fund service providers.
The arrival of the directive brings with it a happy ending to the first chapter of the story. The directive has seen a remarkable turnaround in perceptions since it was proposed in April 2009. At first it was read like a Doomsday proclamation for hedge funds; now it is promoted like a gilt-edged certificate. It has a brand potential that is almost immeasurable – at least, this is what Luxembourg anticipates, as does Ireland, the other major centre for cross-border fund servicing.
Ireland’s enthusiasm is seen in its fanfare for the AIF Handbook. The Irish industry boasts that its regulator, the Central Bank of Ireland, is the first European regulator to publish this level of detailed guidance.
Luxembourg has been less showy.
But despite the nearness of the implementation date there is still room for some uncertainty as national regulators now implement the directive.
These last remnants of uncertainty are not helpful if a fund manager is asked by a pension fund to state how they are adapting to the AIFMD environment.
So how, with four months to go, could they answer a pension fund’s RFP?
One of the most urgent tasks, say many in the Luxembourg fund servicing industry, is to identify the entity in a business that has to comply with the AIFMD. This might be the official management company, as recognised by the directive and referred to widely as the “manco”. The danger is that non-AIFMD regulated activities may accidentally become covered by the new regulation.
Brian McMahon, head of alternatives at BNY Mellon Luxembourg, says: “An investment manager that aggregates all its funds into a so-called super manco may find it has included some activities that are not in scope as far as AIFMD is concerned.”
Ian Barnes, head of trust and fiduciary at JP Morgan Bank Luxembourg, says: “Fund managers must decide who the AIFM [Alternative Investment Fund Manager] is. It’s important to know that the official AIFM will not affect the rest of the business.”
Regulatory ambiguity could result for a manco that is both an AIFMD and Ucits manco.
“For example, local regulations in a particular country might prevent distribution,” says Barnes.
Barnes also says a fund manager might need to state how prepared its depositary bank is for the AIFMD environment. Although it looks to be a difficult topic, a useful question for a fund management company to ask its depositary is how it treats prime broker relationships.
The depositary banks have been at the centre of the AIFMD debate. The directive expects them to take a greater responsibility for assets that are lost while in their safekeeping.
This happened in the Bernard Madoff fraud, but a more pressing concern is with prime brokers who might re-use – or rehypothecate – assets used as collateral from a depositary’s client. If the broker loses the assets, which might result from one of its counterparties failing, as happened in 2008, it leaves the depositary banks liable.
Jean-Michel Loehr, chief of industry and government relations at RBC Investor Services, says: “We know that certain prime broker business models still need to change. Depositaries will be liable for assets even if they are lost by a prime broker and this effectively makes a prime broker a sub-custodian of ours. To do business with us, they will have to comply with delegation requirements.”
He says RBC Investor Services is likely to seek privileged relationships with “three or four” prime brokers.
Barnes also says a shortlist of prime brokers will be used at JP Morgan, and he adds: “There are hedge funds using prime brokers that we do not currently use which will fall under the directive. In future, we will use all the prime brokers that we currently work with, and a few that we do not work with at present.”
The AIFMD is bringing real estate and private equity firms into contact with depositary banks in many cases for the first time.
Laurent Vanderweyen, Luxembourg CEO of Alter Domus, a third-party fund administration business, says: “Depending on their structure, real estate and private equity managers will not be familiar with the role of a depositary.”
This is not the case in Luxembourg, he says, where structures such as the specialist investment fund – a preferred private equity and real estate structure - must appoint a depositary.
Alter Domus intends to obtain a depositary licence for AIFMD work to provide the service to its target market of private equity and real estate managers.
Crooked Wall Street hedge fund owners aside, providing services to private equity firms that invest in frontier markets is about as extreme a risk as a depositary could take. Vanderweyen says vagaries around proof of ownership of assetsarethe reason. Providing this is the fundamental role of the depositary.
Alternative investments like private equity are exactly the sector that Luxembourg wants to build with the help of AIFMD, but even Luxembourg may want to turn away from this sharp end of the private equity market.
The country hopes to build a Luxembourg AIFMD brand to equal its Ucits brand, and like with Ucits, from July 22 Luxembourg will have a major responsibility in protecting it.
Meanwhile, fund managers have a fast-approaching deadline and none can yet claim to be an AIFMD-certified investment manager.
©2013 funds europe