November 2013

TALKING HEADS: Alternative thinking

With the AIFMD now exerting its influence on the European funds industry, Funds Europe asked several asset services executives for their thoughts on implementation, jurisdictions and risk management, among other issues.

GEOFF COOK PARTNER, CO-HEAD OF INVESTOR SERVICES EUROPE, MIDDLE EAST AND AFRICA, BROWN BROTHERS HARRIMAN

Has there been consistent implementation of AIFMD across the EU?
The transposition of the AIFMD has been uneven; so far, only thirteen member states have transposed the AIFMD into local law.  However, given that the directive is so new and there have been so few managers authorised as alternative investment fund managers (AIFMs), it’s hard to judge the consistency of the implementation. That said the preliminary feedback is that, at least, the two major cross-border domiciles, Ireland and Luxembourg, are consistent in their implementation of the AIFMD.

Has this helped to project certainty and clarity and made the EU as a whole a more attractive destination for alternative investors?  
I have some doubts that the AIFMD will become a destination for non-EU alternative investors other than where required, for distribution within the EU.  The AIFMD introduces a number of measures and requirements for a fund manager.  All of these requirements come at a cost, which will likely be borne by the investor.  Given the choice, non-EU investors may opt not to pay for the AIFMD infrastructure.   In fact, we have already seen asset managers reconsider their product plans in light of the new AIFMD requirements.

Will the traditional Ucits market reclaim the Ucits label for vanilla investment funds?
The divide between AIFMD and Ucits may become more clear as one sees whether alternative investment funds (AIFs) manage to develop a parallel  "branch" or positioning beside, but distinct from, Ucits. That may permit a more distinct bifurcation of product sets, but it's a little early to tell at this point.

PIERRE CIMINO MANAGING DIRECTOR, CACEIS BANK LUXEMBOURG

Will we see the appearance of centres of excellence for AIFMD-branded products and where will they be?
We believe Ireland and Luxembourg - currently the leading fund centres for Ucits - will become the centres of excellence for AIFMD-branded products as well.  However, a certain asset class specialisation is likely to develop in the two centres, with Irish AIFMD funds leaning towards hedge fund assets and Luxembourg AIFMD funds seeing greater inflows of private equity and real estate assets.

Has there been consistent implementation of AIFMD across the EU? Has this helped to project certainty and clarity and made the EU as a whole a more attractive destination for alternative investors? 
Esma, the European Securities and Markets Authority, has been proactive, publishing guidelines to ensure the harmonised application of the directive to prevent regulatory arbitrage and make the EU an attractive destination for investors. Due to the inherent complexity of the directive and national financial authorities’ own implementation guidelines, there will be consistency issues.

Will the use of prime brokers change under AIFMD and, if so, how do you think changes in this area might evolve?
There are two models. The first, which is the norm, is where the depositary accommodates a fund’s prime broker; the second is where the depositary appoints the prime broker. We believe the second model is likely to prevail mainly due to the greater transparency afforded to the depositary in carrying out its duties
with respect to sub-custody monitoring and rehypothecation of assets. 

LAURENT VANDERWEYEN CEO, ALTER DOMUS

Has there been consistent implementation of AIFMD across the EU? Has this helped to project certainty and clarity and made the EU as a whole a more attractive destination for alternative investors?
The main players within the fund industry including UK, France and Luxembourg, have transposed the AIFMD. In addition some key European markets such as Germany and France are gold-plating the requirements by adding additional procedures over and above those required by the directive.

While we do not think the AIFMD will drastically increase the attractiveness of the EU for the alternative fund industry, regulatory harmonisation is always positive and clarifies the rules of the game around Europe Furthermore, as Ucits has become a trademark for non-alternative funds, the AIFMD is likely to have the same outcome.

Is there a business opportunity for new specialists? Can we expect fierce competition between specialists and new service providers?
The AIFMD allows non-bank entities to provide depositary services to AIFs investing mainly in non-financial assets with an initial five-year lock up. This will permit specialist service providers op-erating in this industry to offer fully integrated solutions to their clients. The AIFMD provides a pragmatic answer to the particularities of the private equity and real estate industries, allowing fund managers to work with specialists through the chain and to decrease the number of third parties.

MELVIN JAYAWARDANA EUROPEAN MARKET MANAGER, CONFLUENCE

Will IT and compliance costs be absorbed or passed on to end investors? How much of an issue is this and will it reduce the benefits of the AIFMD brand?
AIFMD is a mammoth task that will require substantial spending to ensure compliance. As a brand, it will start off with mixed sentiments across the industry. However, the promise of enhanced investor protection and the trend we are seeing in terms of asset diversification should enhance brand equity. Passing along high compliance costs to end investors is certainly not the intention. Sensitive to investor concerns, the industry is exploring creative ways to gain cost efficiencies, such as evaluating multiple platforms, disparate information and duplicate processes that are no longer fit for purpose.

AIFMD requires a greater demonstration of risk management. How is this manifesting itself? Is it solely a reporting issue, or are there material changes to risk management practices?
AIFMD goes beyond a reporting issue and will require AIFMs to demonstrate strong risk management processes. It will result in a redrafting of the internal risk policies that will need to be supported by good governance and strong technical risk experience.  In particular, it will require a restructuring of operations to ensure risk management oversight which is independent from other day-to-day fund management operations, including portfolio management.

What consideration should be taken when looking at off-the-shelf solutions for AIFMD transparency reporting?
The challenges and the cost implications facing many AIFMs and administrators who need to file will lie in the approach taken to address this issue. I recommend asking the following questions as you research and select the best possible solution. Is the vendor experienced in the industry and a proven provider of fund-related regulatory solutions globally? Do they offer a hosted and SaaS-enabled solution with workflow and collaboration enabling easy access and task management? Does the solution automate and provide the majority of the calculations? Is a filing mechanism included that will file reports with any European regulator and provide confirmations with additional notifications to your local exchange where required? Has an audit of the solution been conducted by an external consultant to validate the calculations and ensure the platform is fit for purpose?

JEAN-DANIEL ZANDONA SALES DIRECTOR, CREDIT SUISSE FUND SERVICES

Will we see the appearance of centres of excellence for AIFMD-branded products and where will they be?
One of the most important benefits from the AIFMD is the ability for AIFMs to distribute their alternative products across borders. There are still a number of question marks around tax issues and local registration procedures between regulators, but once cleared, fund domiciles like Luxembourg and Dublin will be able to leverage on their solid track record of exporting regulated investment products.

Beyond this, the two domiciles propose sound expertise in terms of advising, structuring and administering alternative funds and both already operate in an environment where working with a professional depositary is nothing new.

Outsiders such as Malta or Gibraltar also aim to play a more important role in manufacturing AIFs, and to take market share from the leading domiciles, while UK, Jersey/Guerney will probably keep playing an important role.

AIFMD requires a greater demonstration of risk management. How is this manifesting itself? Is it solely a reporting issue, or are there material changes to risk management practices?
Going back to the origins of this directive, we find a crisis, bankruptcies, and a Ponzi scheme - so risk management has clearly been a strong driver for our policymakers. While in most cases the risk function was already organised at the level of the asset manager, potentially supported by external providers, the directive is now setting this in stone, imposing more documented risk management processes and more segregation between risk and portfolio managers. In other words, managers need to clearly understand, document, and mitigate their risks, and make sure investment decisions are ratified by independent risk managers. The depositary is also impacted. As an example, the depositary will be liable for loss of assets even if these assets are held at the prime broker and re-hypothecated. First, this is about redesigning the organisation, for managers and depositaries amongst others, and their contractual relationships with third parties to cope with these enhanced risk requirements.

Thereafter comes the reporting issue: to properly monitor risk, a manager needs reports, on limits, liquidity, counterparties, and do on, meaning sound system capabilities. Some managers might be tempted to delegate this production of risk management or regulatory reports, maybe even to delegate the entire risk function.

©2013 funds europe