Asset managers need the help of asset servicers as the Alternative Investment Fund Managers Directive, Ucits V and a whole lot of other regulation hits the industry. The participants of our roundtable in Luxembourg discuss in which areas their clients lag, where the limitations of their help is and how blind dating introducing clients to a corporate network is becoming increasingly popular. Edited by Stefanie Eschenbacher.
Sébastien Danloy, managing director, continental Europe and offshore, RBC Investor & Treasury Services
Steve David, managing director, country head, Northern Trust
Paul Faltz, director, fund services product, Citi Investor Services
Georg Lasch, head of client development, BNP Paribas Securities Services
Barry McGloin, institutional business development, Caceis Bank Investor Services
Olivier Renault, deputy chief executive officer, country manager, Societe Generale Securities Services
Funds Europe: When it comes to the implementation of the Alternative Investment Fund Managers Directive (AIFMD), in which areas have asset managers advanced most over the past year? In which areas do they still lag?
Steve David, Northern Trust: Our own research suggests that the majority of asset managers does not expect investors to have made considerations regarding the AIFMD beyond the end of 2015. Given that the AIFMD was developed to protect investors, these findings come as somewhat of a surprise. Another key finding was that 66% of those surveyed saw the directive primarily as a compliance and cost exercise. And lastly, 62% of those we surveyed felt that it would not have an impact on their long-term product strategy.
Barry McGloin, Caceis Bank Investor Services: Asset managers have been unaware of the full reach of the directive so it is fair to mention the challenges many depositories have had in reviewing existing contractual arrangements with sub-custodians, prime brokers, and with each alternative investment fund, making the necessary amendments to comply with the directive.
The alternative investment fund will also need to review its constitutional documents to ensure that the required provisions are provided for and again to make any necessary amendments. Furthermore, they must create and agree on prime brokerage arrangements, which includes analysis to gain a full understanding of the potential liability and how such risk arising from supervisory and oversight duties can be mitigated.
Paul Faltz, Citi Investor Services: Official data released by the local regulators shows that only about 25% of alternative investment fund managers in Europe have submitted an AIFM authorisation request so far. This is partly explained by the fact that many UK managers have deliberately reduced the registration pace because they do not see a competitive advantage in implementing the directive requirements imminently.
Georg Lasch, BNP Paribas Securities Services: Asset managers have clearly advanced in the areas of supervision, corporate governance, risk management and segregation of duties. They have started thinking about the passporting of some management companies or alternative funds, but only 31 management companies have been authorised as alternative investment funds in Luxembourg, with an additonal 200 in limbo. Asset managers are really behind when it comes to links with depositaries and it is fair to say that not all of them have grasped the impact of the contractual changes.
McGloin: Asset managers have advanced in their understanding of the AIFMD’s requirements regarding supervision, governance, risk management and the segregation of such duties. They should also be at an advanced stage in their decision process to decide on the route taken – either creating a new alternative investment fund manager or utilising an existing third-part. There is a limited number of regulatory approved alternative investment fund managers but are likely to increase. Where asset managers lag is understanding the complex relational structure between nodes of liability, for example the links between the alternative investment fund manager, the alternative investment fund, the depository and the valuation agent. There needs to be a distinction of duties between all parties to conduct the business. New entrants will require contractual, technical and, on occasion, a formal due diligence analysis which may significantly impact timing prior to any launch.
Sébastien Danloy, RBC Investor & Treasury Services: Another issue is the scope of asset managers that are impacted by the AIFMD. It is not only alternative investment fund managers; the directive also catches other traditional, non-Ucits funds. While the Commission de Surveillance du Secteur Financier in Luxembourg has authorised 31 alternative investment funds so far, the Financial Conduct Authority in the UK has authorised 31 in the UK, as has the Autorité des Marchés Financiers in France. Those numbers are still low. Some 20% of alternative investment fund managers may have submitted their applications, but that does not mean all of them are going to be processed in time for the deadline.
David: It may not necessarily be a challenge for Ucits-compliant management companies to switch over to become an alternative investment funds manager. But there could be a tactical element of waiting, learning from the lessons the pioneers have made. If there is no client demand because of distribution purposes, for example, why would asset managers not choose to benefit from the grandfathering provisions and file whenever they are ready?
Lasch: We see a different level of interaction depending on the type of clients. Wherever they have a strong governance and a sensitivity for legal and regulatory topics, they have focused on the AIFMD and its operational and legal impacts a long time ahead of the deadline. Today our interaction with these clients is limited to renegotiating contracts and agreeing on best practices. A large part of asset managers are traditionally more focused on product development and have not finalised their AIFMD approach and they depend much more on us as providers to guide them in their approach. To deal with such large, complex regulatory or legal compliance matters.
Olivier Renault, Societe Generale Securities Services: The most significant challenges are around the relationship between depositary banks and asset managers. And even large players are not used to being asked for more information or to provide data.
Asset managers will have no choice but to become compliant with the AIFMD. While larger players tend to be better prepared, smaller ones can get help from specialised service providers. The AIFMD will fundamentally change the relationship between asset managers and depositary banks because they will have to control each other, carrying out due diligence and disclosing internal procedures. The main consequence is that some small asset managers might disappear and/or use the services of a bigger asset manager.
Danloy: Many market participants underestimate the amount of work that has to be done on all levels with regards to some of the requirements they need to fulfill as many details are still being finalised.
The most challenging ones include additional and more detailed regulatory reporting and tighter risk management. We are only a few months away from the first reports having to be produced, and the majority of asset managers are still undecided over who they are going to work with in terms of the regulatory reporting requirements amidst the uncertainty of what is required and who can best provide it.
Lasch: When we recall the first days of Ucits IV, most management companies were ready on the last day, just, if not some days after the last day. I expect it to be similar for the AIFMD.
Faltz: One of the reasons the industry is behind is that it is still trying to determine what will be categorised as an alternative investment fund manager.
This is not because the industry is unorganised, it is because it is a complex decision to make. We have an entire team set up to help clients deal with the consequences of the AIFMD, including reporting.
Several providers will look after reports and file them on behalf of clients, but that does not mean they will have the data to produce these reports. This data will come from a number of different sources and only to clarify the ownership of the data, let alone to analyse the nature of the data, is monstrous work. This is definitely underestimated.
Danloy: We have been working with clients on formats they require for certain providers of AIFMD reporting services they have chosen.We will look to use these across the board going forward with other providers.
Funds Europe: What are the strategies for reaching full compliance?
Faltz: The investment managers that have a significant exposure to the AIFMD have put overarching project management teams in place, working together with the vendors – a systematic, cross-functional approach. Ucits managers and specialised investment funds who have solid corporate governance and risk management in place are marginally impacted; they work on an incremental basis, analysing which additional features they need to develop.
Renault: The big players are setting up their own risk and compliance departments. Some smaller firms will try to outsource some activities, which will result in costs. While larger players will be able to absorb the requirements of being fully compliant, smaller players might have difficulties to reach the target.
Faltz: Non-European Union managers, typically US, Japanese or managers from emerging Asia, are in a wait-and-see mode. They have a grace period, and will be looking at compliance cost versus opportunities, asking if they have the critical mass to justify the incremental cost. Some managers, both onshore and offshore, have been caught by this directive and have underestimated the consequences. They will not necessarily be able to leverage existing processes and infrastructure and will need support from fund service providers to be compliant.
Renault: We have one client that decided to change its own organisation and centralise all the management companies in Luxembourg, instead of adding different small asset management firms in different countries. This client has centralised all means and resources in one location.
Danloy: There are some that see regulation as an opportunity and others that see it as a burden.
McGloin: Given the complexity of the processes involved in attaining full compliance with the directive, it is not uncommon for investment managers to push back against the directive, exploring alternative routes in order to avoid or reduce the impact of certain elements of the directive. This is particularly evident in the alternative investment fund manager selection process where there is sometimes the perception that the investment manager is relinquishing control and responsibility. However, for investment managers not wishing to build a full internal solution, the appointment of a third-party alternative investment fund manager is an attractive option as control is maintained but liability is shifted away in a transparent manner from the investment manager to the alternative investment fund manager.
David: It is getting more and more important to all of us to really understand what the needs of our clients are.
Danloy: Some in the industry have positioned themselves to act as a third-party management company for alternative investment funds because the asset managers themselves are not looking to comply at present. Third-party Ucits management companies do not necessarily want to take on the liability of being an alternative fund manager for each and every fund they work with.
Lasch: Institutional investors are increasing their market share of non-traditional investments and we will need to have structures that accommodate those. While we expect growth in the alternative investment space over the next few years it is also important to look at Ucits funds. Together with the Association for Luxembourg Investment Funds we continue to work on getting approval for new markets to distribute Ucits funds.
Danloy: Clients are definitely still more interested in Ucits funds, but nonetheless assets under management in alternative funds are growing at a faster rate.
Lasch: One of the important factors is how pensions will be regulated since those are one of the largest investors.
McGloin: AIFMD-compliant products will not attract a new base of investors that would avoid anthing other than traditional mainstream products. Pension fund asset allocators tend to be conservative and so are less inclined to invest in investment products with non-traditional strategies. It remains to be seen what changes Ucits V and Ucits VI will bring, but pension funds and other similar institutional investors are likely to make their allocation selections based on the investment policy and legal structure.
Faltz: Our clients keep going back to Ucits funds because they want to build a global distribution capability and Ucits can be moulded if the service providers get the paramaters right: accepting subscriptions and trade cut-offs late in the day, offering Eastern Standard Time closing prices and publishing the net asset value in time for Asia the next morning. One can imagine that the EU passport is going to become more important for alternative investment funds.
David: We support several alternative investment funds that could be structured as Ucits funds. It just happened that the client wanted these structured as specialist investment funds.
Renault: There is more velocity for new investment strategies, including loan funds and securitisation funds. With only Ucits V there will be definitely increased regulation on reporting and risk management.
Danloy: We see more and more opportunities from real estate and private equity. Looking at the number of new funds being established in Luxembourg, there is an emerging preference for those asset classes over traditional Ucits. When it comes to regulation, be it on over-the-counter derivatives or collateral management – we look at it as an opportunity to build a new offering.
Faltz: The traditional separation between alternative investment and long-only funds is blurred: similar regulations are being applied across alternative investment funds and Ucits and hybrid structures, requiring elements of both worlds. The asset managers and service providers have to adapt their operation models to service specific asset classes, such as over-the-counter and loans. Credit or debt asset classes are now behind most new fund launches. Regulation is increasingly driving innovations when it comes to products and services. The European Market Infrastructure Regulation has favoured approaches to optimise over-the-counter derivatives and collateral management so that is a big area of focus for clients and their providers.
The AIFMD and the European Market and Infrastructure Regulation are European standard-setters for regulatory reporting as well asleverage and exposure calculation.
Lasch: One of the effects of tighter regulation is that asset managers, especially smaller ones, are already enquiring whether they can outsource or delegate part of their activities, most notably depositary services.
Renault: Others want to outsource part of their business or use external providers for certain middle office services, risk management, structuration, substance and domiciliation or reporting. It is a good opportunity for service providers to bring some added value.
McGloin: For some investment managers, the need to appoint a depositary is a new concept. Consequently, the decision to appoint a depository may be combined with an outsourcing opportunity, driven by regulatory or internal cost pressures. In simple terms, investment managers do not want to pay for duplication of functions already performed today. With investor focus on fund expenses and pressure on performance, the issue of cost-effectiveness is key.
Custodian banks are interconnected and, by consequence, able to offer superior cash management, payment and supervisory services. Furthermore, as a data repository, the depository can also provide a suite of risk reports for investor or regulatory compliance, offering a competitive outsourcing solution.
Funds Europe: Do you see new competitors coming to the market?
Faltz: The depositary lite banks are new market entrants. Some providers may exit the depo bank business in the light of increased responsibilities and liabilities. We also expect more players to come to the market to offer specialised services for non-custody assets, covering risk management, data vendors and reporting.
Danloy: Those new depositary lite providers are not targeting the same type of businesses we are. Most of our clients would not feel comfortable appointing a depositary entity without the financial backing we have.
Lasch: We see much more of a flight to quality and actual concentration on ever stronger competitors in terms of balance sheets. Even though there are new players entering the market, larger players increase their market share and new entrants focus on marginal business
Renault: It is odd to see that regulation allows some of these new players entering the depositary bank business while, at the same time, the AIFMD increases the liabilities of the depositary bank. Today there are more than 60 depositary banks in Luxembourg, and with regulations such as the AIFMD and Ucits V, the number of the overall depositary banks will likely decrease.
McGloin: Investment managers have the decision to appoint a full depositary with a strong balance sheet, or opt for a lite solution under the Article 36 requirements. A number of market entrants have announced they intend to launch AIFMD depositary lite operations. However, the lite solution is a temporary one, which will end in 2018 with the private placement regime. After that, all funds managed or marketed into the European Union will require a full depositary service.
Lasch: There is also an increase in outsourcing of dealing services, a demand that comes mainly from small and mid-sized asset managers, but also private banks. In general, there is a trend of getting closer and closer to the front office. We will see more competition from data vendors and specialist service providers.
Faltz: When it comes to middle office operations, fund accounting, fund administration and others are increasingly interconnected. This is one service we have started to offer clients.
Funds Europe: A recent Citi/Cerulli survey, Ucits at 26, found that beyond registration and fund administration the two most sought-after services among investment managers are distribution needs and understanding emerging markets. Do you agree?
Faltz: The overlap of the AFIMD and Ucits V adds to an increasingly complex regulatory environment. Our clients need help to navigate the regulatory agenda and this trend is only going to increase further.
Service providers can share past experiences and give generic feedback on industry trends and good practice, but asset managers will increasingly need legal advisers and tax providers. While asset services play an important role, they cannot overreach.
Lasch: There are many new entrants in the market from Asia and Latin America, even from the US. Their first question is always about what kind of product they need to set up to tackle what market in terms of distribution. Thereafter, come questions about what markets they could target and other aspects of distribution. Then come questions around auditing and other legal aspects where we can share our experience. While we can provide some pointers, we leave the rest up to the specialists.
David: Asset managers seek add-on services, like distribution support, but that means different things to different people.
McGloin: Distribution support can be summarised in three parts, as technical connectivity, market intelligence and raising capital. We can provide support to the first two, but must remain independent in terms of asset gathering. Consequently, we provide information on distribution channels and platforms within and outside our group, making introductions, but the ultimate pitch is for the manager.
Renault: We can help with information, some guidance and we can open the doors for our clients. When it comes to distribution, it becomes more difficult because it usually requires a significant investment in a sales effort at least at a regional level or by country.
Lasch: Technology is no longer much of a differentiator because the world is so interlinked and standards are becoming more common. What we can do is introduce asset managers with no distribution channels to institutions like asset owners, fund of fund houses, creating a sort of market place for asset management. This is something they value and creates a strong relationship with clients.
Danloy: Wherever possible, we need to leverage the experience gained from new products, strategies and distribution channels of our most innovative clients, those that are consistently ahead of the game, and use that experience to benefit our clients.
Faltz: The largest custodians can offer services to support investments in emerging markets, including the renminbi qualified foreign institutional investor scheme in China.
Lasch: Sharing our experience is what clients want. In terms of distribution, we have most of the markets and products covered.
Faltz: We leverage our large distribution network to provide access, insight and expertise to our clients. On a selective basis, we can introduce clients to our contacts from our corporate network, our custody network, and elsewhere in the industry.
Danloy: We are no different in terms of introductions, mainly there are governance reasons as to why we offer that service but no more than that. What we have done is established a global fund platform to bring new asset managers on to. It allows them to advertise their funds for sale and gives them access to hundreds of underlying distributors. Beyond that, they start marketing their funds independently.
Lasch: We are distributor-agnostic and work with a panel of distributors. While we can talk to clients and arrange introductions, we do not promise distribution.
Renault: Internally, we are looking for synergies. Though, increasingly, we make business with large institutions, and those looking for reciprocity. Asset managers ask us for advice to distribute their funds worldwide and penetrate markets where we are present.
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