Striking a balance

Mary Bruen, appeared in the JEP Investment Review  June 2012

The AIFM Directive has presented new challenges and new opportunities for all key stakeholders in the alternatives industry.  It may require significant modifications to the structure, strategies and operations of fund managers and alternative investment funds (‘AIFs’) to secure continued access to Europe.  Those who are most prepared to react and flex their business models will emerge ahead of the competition.

Where we are in the process
After much lobbying and frequently acrimonious debates, the EU Parliament adopted the AIFMD November 2010, with the rules to take effect by 23 July 2013.  In November 2011, the European Securities and Markets Authority (ESMA) published its final advice to the European Commission ('the Commission') on possible implementing measures (also known as the Level 2 measures) under the AIFMD.  The Commission is currently reviewing the advice and seems close to issuing its response.  Preliminary leaked documents indicate a severe and conservative approach in some areas.  The Level 2 rules that finally emerge will, unless the Commission retrenches their position, impose a very strict regime on managers managing or selling product into Europe. 

One of the key concerns is the extension of the scope of the almost strict liability provisions of the Directive to include assets held as collateral.  So, industry must continue engaging with the Commission right up until the final measures are adopted in summer 2012.

Who and how will it impact?
It will affect any alternative asset manager; wherever in the world it is based, seeking to raise institutional capital in Europe.  It will affect managers at both the business and the operational level and will permeate all aspects of the organisation where managers are subject to full compliance. And the impacts will continue to unfold throughout 2012, as Member States across Europe, progress with their domestic implementation and, as the EU Commission prepares to release the final implementing measures to the EU Parliament for their approval and adoption.

Jersey’s response
Jersey is looking at the global market and ensuring it is open for business to all investor markets. It is working to deliver a fully AIFMD compliant regime and to also retain existing complementary regimes for asset managers that don’t want to access EU institutional capital under an AIFMD passport.  Additionally, 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 in to cooperation and 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.

So, for Jersey it can be business as usual whilst the programme  to shape and develop Jersey’s future AIFMD compliant regime runs, including work to participate in the passport due to come into effect in 2015.  

At the same time, Jersey continues to explore enhancement of existing options for those asset managers whose main source of institutional capital is outside the EU, thereby ensuring that Jersey has a flexible and appropriately regulated offering that provides the right balance between investor protection and returns for all managers, globally.

When should one act?
When new regulation is under development, judging the right time to start preparing for it and how much effort to devote to anticipating the eventual detail that will follow, can be difficult.  The old adage, ‘fail to plan, plan to fail’, will too often prove true, particularly for organisations operating in multiple jurisdictions who face additional challenges.

Service providers and administrators will be the first port of call for many asset managers seeking solutions and so should have started planning their responses already. 

While waiting for the final adoption of the advice may be an option for smaller managers with less complex business models and product ranges, larger managers should already be in the process of completing impact and/or gap analysis so that they can appropriately flex their business models to match their future marketing strategy (private placement vs passport vs marketing outside of EU).  

I was involved first hand in the final negotiations of the Directive during a 1 year secondment to FSA where I worked alongside ESMA in drafting and negotiating the level 2. My practical understanding of the Directive and appreciation of how complex and challenging its interpretation, is gained from experiencing hours of discussions at both UK and EU level. We know this complexity presents a challenge to businesses, but whilst a ‘watch and wait’ approach has been right up until now, the time for action has come.

How to act?
Managers will need to map affected AIFs and determine which entity or entities may be considered the AIFM and, as a result the likely routes to marketing in Europe post 2013.  Future investment focus is an important part of the decision process: Depending on whether Managers elect or are required to be fully AIFMD compliant, or decide that private placement remains their preferred access to Europe, significant restructuring may be needed.

Where continued access to Europe is to be secured through private placement Managers will have to look at transparency provisions of the Directive and on the substance requirements of the AIFM(s) to avoid it (them) being deemed a “letter box entity”. 

Additionally, they’ll need to rectify any data or systems gaps that will impact their ability to comply with the extensive transparency requirements, including quarterly reporting to regulators, and administrators’ role in this process. Certainly by summer 2012 all managers should be starting to assess if / how their business and operating models need to change in response to the Directive.  

AIFMD, as it stands, also looks likely to deliver significant unintended consequences.  Groups at risk include those providing custodian services for assets. With the potential for unlimited liability, firms will likely either raise the fee that they charge or stop providing custody services altogether, causing a reduction of choice and another system-endangering concentration of assets on the balance sheet of several institutions.

The final analysis
In a fast changing political, economic and regulatory landscape getting the full picture, as far as possible, is vital if you want to effectively navigate and plan your responses. If you’re not already doing it, you need to be determining your strategic response to the Directive and reviewing existing compliance and operating systems against those soon required.  We’ve been working closely with our clients to ensure they are on track.

The Directive brings with it new challenges and opportunities for all key stakeholders in the alternative industry’s value chain.  Effectively navigating those challenges and opportunities will be key to success.