One key characteristic of a fund manager is that they are able to make difficult choices. What structure to invest in? Which investors to target? But the overriding decision they now have to face is taking the form of regulation and how it could impact the very shape and character of their fund operations.
Regulation comes in all shapes and sizes with the biggest, certainly in terms of its potential impact, being the Alternative Investment Fund Managers Directive (AIFMD). This is fast becoming the main catalyst for hedge fund managers and private equity managers to re-evaluate their current business architectures. The AIFMD presents a significant challenge to firms because it potentially prevents them from marketing to European investors unless the jurisdiction they are based in comply with the Directive’s key conditions. Regulation is often associated with onerous form filling and expensive costs, but a regulation like the AIFMD will be a complete game changer as it results in firms making changes that reach to the core of how they run their business. This pivotal piece of legislation is coming into force in July 2013 so time is running out for fund managers to decide which route they want to take.
But which two routes does the AIFMD offer?
First, full compliance with the Directive offers up a European passport, yet only to European managers with European funds. So if you are a European manager with a European fund, you will be able to benefit from a passport which means once you are authorised with your home member state, you can market across the continent with that one authorisation. However, this level of compliance impacts nearly every aspect of a business model from, the establishment of a dedicated risk management function to imposing restrictions on the payment of remuneration – a complete sea change of proposals are imminent for the industry.
The second option, for non-European structures, is to access Europe through the traditional private placement route. This essentially comes down to going through Europe, member state by member state, in search of investment with no singular passport allowance and will likely involve some form of registration with each member state where marketing occurs.
These are two very different routes that can affect different fund setups with a plethora of matters to take under consideration. For one, the AIFMD has the potential to be significantly costly to funds with one of the most costly requirements being the necessity of having a depositary. AIMA’s preliminary research indicated that the price of this for hedge funds could end up anywhere between 100 and 150 basis points. There are a whole range of expensive measures to account for, but ( due to strict liability provisions) the issue of a depositary will end up carrying the heaviest bill.
On the other hand, while the private placement route could be more time consuming (depending on the number of member states involved), as far as the Directive is concerned, the transparency provisions would be the only operational factors to take under consideration. Regardless of whether you are subject to the private placement provisions or full compliance, the transparency provisions are the same.
At PwC, we work with a range of fund managers with different strategies and diverse investor bases so we are seeing a mixture of responses depending on their priorities. In part, this really comes down to the strategic reasoning behind the fund manager’s final decision with a re-examination of their choice of jurisdiction potentially being involved. This can be heavily influenced by the end investor. For instance, it may be that you have certain institutional investors that want the AIFMD seal of approval, whereas other investors may not want to have to cover the additional compliance costs through higher fees, preferring the private placement route in today’s economically challenging times. There are investors in both camps so fund managers have to be ready to respond to whatever option their investors prefer, this could mean offering parallel options to investors.
At PwC we aim to be ready for any decision that is made. For instance, if we look at a traditional hedge fund model, say a Cayman hedge fund with a UK manager/adviser, then essentially the manager would have to comply with the Directive. This mixture of European and non-European exposure means they would only be able to market on a private placement basis while having to be fully compliant with the Directive; essentially a worst case compliance scenario potentially involving a complete restructuring of the operating model in-line with the AIFMD as well as time consuming private placement considerations. In this position, we can help them not only find the right solution for them, but also help them implement it.
For those managers that need or elect to be fully AIFMD compliant, we can provide a breadth of services ranging from discussions on the requirements of AIFMD to performing gap analysis and health checks through to implementation of the changes required. The gap analysis will determine how the current operating model compares to that required under the Directive and is supported by clear guidance about what is needed to become compliant.. Alternatively, we can also help with the complex yet sometimes necessary restructuring of a hedge fund operation - this may include assistance with redomiciliation. The Directive does not allow ‘letter box entities’ to act as AIFMs. Under the private placement regime, the route many funds will choose to take until 2018, self managed funds will have to demonstrate their ‘substance’. Here, the funds can be ‘internally managed’, effectively being classified as the manager, but will have to be more than a ‘letterbox entity’. Boards of directors will need to be able to control all delegated functions. This could provide an opportunity for Jersey which has a history of providing appropriate substance. Jersey offers the expertise to deliver whatever level of governance is needed to meet investor and regulator standards according to each fund’s requirements.
Under the AIFMD, Jersey is seen as a third country, the same as any other non EU country. The AIFMD is all about regulating and authorising managers, something that Jersey already does. While Jersey intends to have a fully compliant regime in place by 2015 when the AIFMD’s passporting aspect will be operational for third countries, it is also committed to retaining existing ‘private placement’ regimes for asset managers that don’t want to access EU institutional capital under an AIFMD passport. Jersey already has an appropriate regulatory regime in place and existing managers working under the national private placement (NPP) regime will, subject to compliance with the third country provisions, be able to continue operating until at least 2018. Chief of these third country provisions is the requirement for Jersey to enter into exchange-of-information agreements with EU member states. Jersey is on track with preparations to sign up to these agreements when they come online later this year Additionally, Jersey leads the way in anti-money laundering procedures, being more compliant with FATF recommendations than many larger onshore asset management jurisdictions.
But it doesn’t end there. Dodd Frank is the other key regulation that hedge funds and alternative products need to take into consideration. Under Dodd Frank, any adviser using US means to conduct business must comply with certain rules and regulations in the Advisers Act, even if the adviser is exempt from all registration and filing requirements in the US. Most of our clients in Jersey are not full registrants under Dodd Frank but instead file as exempt reporting advisers (ERA’s), and still subject to reporting, recordkeeping and other obligations. In addition, ERAs, as an example, are required to have in place policies and procedures to prevent the misuse of material non-public information, comply with the Advisers Act “pay to play” rule, and may be subject to additional specific recordkeeping requirements. ERA’s also become subject to US insider trading rules as the SEC expects to see compliance frameworks and governance structures consistently implemented and enforced throughout the entire structure.
Time is running out for fund managers and significant changes will inevitably need to be made. PwC is in the right place to help out these funds; literally as well as figuratively. With a Jersey presence, we understand that a location here on the island can work out to be best possible outcome for a fund facing such drastic changes taking shape in the form of the AIFMD and Dodd Frank.