Custodians in Ireland are enjoying a growth in assets as new regulations like the AIFMD bring business. But Nicholas Pratt discovers there may still be pricing pains along the way.
The last five years have been far kinder to the Irish funds industry than to the rest of the country. Its funds industry will say that the country’s sovereign rating has borne little relation to the stability of the funds sector. And even before Ireland’s exit from the EU/IMF bailout in December 2013, figures showed that service providers in the funds industry were enjoying continued growth.
According to findings from independent research company Monterey Insight, fund assets serviced in Ireland rose 11.9% from end of June 2012 to reach €1,582 billion at June 2013. For custodians, the majority of these assets were under the custody of the North American players, which took the top five positions in terms of total net assets (see table). Regulation – particularly the Alternative Investment Fund Managers Directive (AIFMD) – has been a major contributor to growth, especially as its implementation approaches.
Anne Deegan, managing director of SEI Investments Trustee and Custodial Services (Ireland), says that October 2013 saw a sharp rise in demand as clients started to address their AIFMD applications. At the beginning of 2014, their attention turned to due diligence of service providers, with some needing a depositary.
Buoyed by greater certainty around regulatory change, there are also more managers launching products, says Carin Bryan, managing director, JP Morgan Bank (Ireland). “In particular, we have seen new US alternative managers launching products in Ireland, looking to replicate the success they have seen in accessing US pension fund money through either an alternative or a Ucits fund structure.”
Growth has not been limited to the US providers. Michael Clifford, general manager of Societe Generale’s Dublin branch, says there has been growth in real estate funds investing in Irish property, helped by the rebound in property prices and tax rates.
For depositaries and custodians – there are 23 operating in Ireland – the AIFMD has meant a complete re-engineering of depositary operating models, according to Mark Mannion, head of relationship management in Europe, Middle East and Africa at BNY Mellon. Prior to AIFMD, the depositary was required to provide a limited oversight role to non-Ucits structures, which tended to have very few investment restrictions. But now, the depositary is obliged to provide cash monitoring, safekeeping and oversight services within clearly defined parameters.
This has meant building new interfaces for cash monitoring for identifying significant transactions that require further investigation, and ensuring a more thorough record-keeping facility, especially where special purpose vehicles may be involved.
Costs related to this and any other changes were expected to be offset by the high price that depositaries could charge for new AIFMD-related services. At the outset, prices in the range of 50 basis points were mentioned, say some sources. However, as the regulation has developed, this has not proved to be the case. “AIFMD pricing has been a complex affair,” Mannion says.
The AIFMD introduces the concept of restitution liability for depositaries in the event that financial assets are lost, such as in a fraud. But funds have different risk profiles. Mannion says BNY Mellon has a pricing algorithm, which looks at the capital implications associated with portfolio holdings and generates fee guidelines per market.
Service providers are keen to be fairly compensated for the risks they take on. However, the amount of services that depositaries will provide to their alternative investment client, and the price, may have been overestimated.
“The initial understanding of AIFMD was that there would be significant additional work for service providers, but as further clarity has been provided, the regulation is not as onerous as first thought with the anticipated additional work for service providers not being as great as initially feared,” says Charles Bathurst, adviser to Sumi Trust Global Asset Services.
The three main services required by the AIFMD are safe-keeping of assets, cash-flow monitoring, and oversight. It was thought that these services would be provided independently. Regulators have since said it will be possible for one entity to provide all three, leading to bundled services and at a much reduced price.
Alternative managers that opted for the less onerous “depo-lite” function, notably those based within the EU with offshore funds marketing into the EU, have embraced the split or hybrid service model – though the depo-lite function may be scrapped by 2018. The oversight function – the notable addition in the offshore world to the depositaries’ range of services – is not a fee-generating service. “It is more about assisting with compliance monitoring, reporting and ensuring that the other providers are performing in line with the Directive and fund offering documentation,” says Bathurst. “Any initial estimates at charging around 15- 20 basis points have now shrunk to below 5 basis points.”
Further reduction in the pricing process has resulted from service providers being nervous about losing their client relationships, particularly independent administrators, and are subsequently offering additional servicing requirements almost free of charge just to retain clients.
“Everybody is very secretive about pricing, whether it be 10 basis points, 1 basis point or no basis points; but it is true to say that the original costing and budgeting has been blown out of the water,” says Bathurst.
“When the original fees were proposed, the managers complained and the fees collapsed. The market has brought prices down and that is very good for investors as performance will be largely unaffected. So the regulators will not be concerned about the low fees but they will be concerned about the ability of service providers to reliably fulfil their responsibilities.”
For any downcast service providers, all is not lost. Deegan says that the initial forecasts of 40 basis points for depositary services were an overestimation and we now have more realistic pricing. There is also an upward trend in pricing as the implementation date nears.
And a lot will be learned once the implementation goes live – for example, what happens in the event of a regulatory breach or a case where the regulator voices its concern, particularly where one entity is providing all of the services on a bundled basis.
Another unknown is just how popular the AIFMD will prove to be with underlying investors, says Clifford. While high net worth investors, especially those outside the EU, may continue with private placement, there is a real appetite for regulated products among EU institutional investors that service providers hope will outweigh the reduced pricing model.
“A lot of assets that might have gone into Ucits funds may now go into alternatives instead. So any concerns about the reduction in the pricing model will be offset by the increase in business,” says Clifford.
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