As the July 2013 deadline for the AIFMD’s implementation approaches, its far-reaching implications are becoming clearer. What might initially have appeared to be a testing exercise in regulatory compliance and reporting will evidently have a significant effect on the alternative investment sector. While the Directive will undoubtedly open up new possibilities for raising capital in Europe, it may also change the shape of the alternative investment sector.
Intended to protect investors, AIFMD impacts managers in a variety of ways – some intended and some probably not. Due for introduction in July 2013, it will make firms reinforce their reporting and control infrastructures, adding significantly to costs. But it will also affect marketing strategies, portfolio manager remuneration and, possibly, even investment strategy.
From a positive perspective, the AIFMD might well prove to be the alternative investment world’s equivalent of the UCITS passport for traditional asset managers, opening up a far wider marketplace and providing a badge of quality. Yet in order to take advantage of this opportunity, alternative investment managers will have to overcome a range of strategic and operational challenges. Potentially, these not only curtail alternative managers’ investment freedom but also impact their ability to recruit the most talented investment professionals.
At PwC’s annual European Alternative Investment seminar, held in early February, attendees speculated that unintended consequences would include handing competitive advantage to large managers with sufficient scale to absorb AIFMD’s extra costs, and pushing the sector towards plain-vanilla investment strategies.
Below we highlight three critical issues arising out of AIFMD. In all of these areas, managers need to understand not only the immediate compliance requirements – but also the possible strategic implications.
The AIFMD adds a new service provider, the depositary, which bears responsibility for safekeeping a fund’s assets and monitoring its cashflows. But only a limited number of organisations will become depositaries and they will have limited capacity. So some managers might find that they cannot access depositaries at all. This would leave them with no option but to market via the private placement route, which they can do until 2018.
During our February seminar, delegates’ consensus opinion was that depositary fees would range from 10-25 basis points per annum. Yet we believe that the range might be even greater. Conceivably, managers with investment strategies involving plain-vanilla assets could pay as little as a few basis points, while some smaller managers with exotic investment strategies might not be able to find a depositary willing to take their business at any price.
When selecting a depositary, a manager must check not only the fees that it would charge but also whether the depositary is willing both to work with its prime broker and facilitate its investment strategy. The danger is that smaller managers with less bargaining power might find themselves paying higher fees than larger managers, and suffering greater investment restrictions.
While the AIFMD theoretically opens a single market across all 27 EU member states for alternative managers, and gives greater access to less sophisticated institutional investors, some managers might conclude that having an AIF passport to the single market isn’t their best option.
For example, some smaller hedge fund managers with exotic strategies that can’t find a depositary willing to service their funds at an acceptable price might choose to base their funds in an offshore, non-EU location. As the natural investor base for these funds is probably sophisticated institutions, doing so shouldn’t restrict marketing opportunities. Similarly, some private equity and real estate managers might choose to continue marketing through private placements, so avoiding the full burden of regulatory compliance.
Yet opting to retain the private placement route to market brings its own difficulties. The advent of AIFMD is giving national regulators a reason for rewriting their rule books. Germany, for example, has proposed scrapping marketing via private placements within its borders. Even Ireland, a favoured EU hedge fund domicile, is making changes to its rule book.
So alternatives managers marketing through private placements will have to monitor private placement rules country by country.
The European Securities & Markets Authority’s final February guidance for rules on remuneration specifically states that they’re designed to discourage excessive risk taking. While the rules are subject to the legal principle of ‘proportionality’, meaning that national regulators can decide whether they’re necessary to achieve their underlying aim, if imposed they will reinforce a shift in hedge fund remuneration practice that has already started. Hedge fund managers are moving away from basing variable remuneration on a share of performance fees, which was common practice in the hedge fund sector.
AIFMD requires alternatives managers to defer 40%-60% of the variable remuneration of ‘identified staff’ such as the management company’s directors, senior management, members of control functions and risk takers. While it’s common practice for some hedge fund portfolio managers to roll up some variable remuneration voluntarily into their funds, AIFMD makes the practice compulsory. What’s more, AIFMD proposes that variable pay in support functions, such as risk management and compliance, be benchmarked against staff’s performance in their specific roles. They shouldn’t be rewarded directly according to fund performance or firm profitability.
Beyond these measures, AIFMD requires managers to set up remuneration committees, although again national regulators have the option to decide whether doing so is appropriate for all managers. Smaller alternatives managers, for example, might be exempted.
In the UK, Europe’s largest alternative investment centre, the Financial Services Authority applied the principle of proportionality to the CRD III banking regulation’s remuneration rules, suggesting that it’s also likely to do so for AIFMD’s. So many managers probably won’t have to comply with all of the ESMA guidance. Yet managers would be wise to look into ESMA’s guidelines and make contingency plans – particularly as these rules could affect competitiveness when bidding for talented staff against rivals based outside Europe.
These three critical areas illustrate AIFMD’s potentially momentous consequences. If alternative managers haven’t already done so, they need to recognise that the Directive is more than a matter for compliance departments. Senior management needs to look into its impact on all areas of business strategies, investment strategies and operations. AIFMD’s impact is complex and will differ from one manager to the next. For some, AIFMD will open up opportunities; for others it might present formidable challenges.
In the fullness of time, AIFMD might prove to be the start of a new period of growth for alternative managers. At PwC, we can give you the benefit of our experience and expertise to chart your course through its opportunities and challenges. After July 2013, the alternative investment world will change dramatically, and you need to be prepared.