Andrew Rubio of Throgmorton asks if the EU’s Alternative Investment Fund Managers directive is smart regulation or political shambles?
The EU’s Alternative Investment Fund Managers directive (AIFMd) is not a popular piece of draft legislation among the alternative investment management industry in London. The battle to curb its worst excesses continues in Brussels. However, when you actually speak with most managers you realise there is a certain professional resignation to the changes being imposed and that alternative investment fund managers are getting on with the business of managing their clients’ capital. Many are taking a ‘wait-and-see’ attitude to developments and are optimistic about the future, at least until the directive comes into force sometime between late 2012 and 2015.
Enhanced regulation is in many ways a noble cause deserving everyone’s labour and ultimate acceptance. Yet the collective desire to deal with systemic risk, financial stability, transparency and investor protection after a major financial crisis can lead to some politicians determining not to ‘waste a good crisis’.
Blame
Following last week’s vote in Brussels, it is important to ask whether the collective thrust of both the currently worded AIFMd documents actually deals with the problems the directive set out to solve. For starters, it has pretty much been agreed in all quarters the main culprits in the financial crisis were the banks and not the alternative investment community. Alternative investment funds (AIFs) do not pose systemic risk to the markets, the experts agree, and yet this lesson has not taken hold. This legislation will impose onerous regulations, restrictions and outright prohibitions on the wrong market participants.
Andrew Wall, chief operating officer at Belay Partners sums up the industry concerns: “We understand the directive as currently drafted could increase our costs and limit our distribution channels.”
Some may think such concerns are irrelevant because the main aims of the directive, as currently drafted, are largely politically driven. The EU wants to teach the AIFs a lesson because they were getting too big for their boots.
Additionally, there is a sense in continental Europe the UK has prospered far too much by being receptive to hosting AIF managers and needs its wings clipped. Some might say this is just out and out envy. And while London will remain Europe’s financial capital and while talk of a stampede of managers toward the exit is exaggerated, could this be the first painful stumble in a long decline?
The first aspect of the directive that will hit hedge funds, private equity firms and investors is the matter of the use of depositories. The rules are highly onerous and restrictive with respect to the ability of such depositories to delegate tasks and their geographic location. But the most problematic issue is the depositary would be liable to the AIFMd and investors of the AIF for losses suffered due to the depository’s failure to perform their duties even in situations beyond control. This will simply lead to increased costs and the potential systemic risk arising from there being fewer players in the market.
The legislation seeks to tackle leverage and yet the wording in both versions of the AIFMd is ambiguous at best. A workable solution to the leverage issue demands further dialogue between legislators and industry.
Misunderstandings
With remuneration, the AIF managers will have to submit to the constraints applicable to credit institutions. This is a clear misunderstanding by politicians and officials of how AIF managers work. It is a clear attempt to reign in the free market forces integral to the alternative space. AIFMs are not banks.
The Third Country Provisions place a de facto ban on non-EU funds marketing to EU investors. Perversely, this will have a much greater impact on sophisticated investors than the AIFMs themselves. The Alternative Investment Manager Association (AIMA) has said “non-EU managers from America, Switzerland and Asia, and even EU funds domiciled in places like the Cayman Islands will be affected”. In a joint letter to MEPs dated 14 May, the National Association of Pension Funds, the IMA and AIMA declared such a ban would “reduce choice and drive down returns for pension funds and other investors”.
Managers seem exasperated by this in particular. Andre Visser, executive chairman and CIO of La Fayette Investment Management said: “The spell cast on hedge funds is politically successful, but objectively unfair.
“One simply cannot understand how the law could forbid European qualified investors to invest in non-EU funds. If this very protectionist move should happen, at least a grandfathering clause and a long adaptation period should be set up to avoid an additional disruption in the market if people have to redeem from existing offshore funds.”
All of this is not yet law. The most optimistic estimate for implementation is Q3 of 2012. There may be a further three-year transition period after the directive becomes law before the third country provisions kick in. But the bulk of the wording will be agreed by 6 July. There is to be a “trilogue” between council, commission and Parliament to thrash out details and we can only hope this horse trading will result in more realism.
And yet despite the negative impact the directive will have on the industry, hedge fund managers are relatively sanguine about the upcoming negotiations and are determined to continue as best they can and adapt to changes when needed. Gary Link, CEO of Stoneworks Asset Management, commented he would “continue to support industry efforts to get the best possible result. No doubt the outcome will result in higher compliance costs for managers, but as things stand, I do not see any show stoppers for UK managers.”
Paul Feldman, chief financial officer, BlueGold Capital Management, warned about embarking on any drastic structural changes before the AIFMd is implemented: “As SEC Lite registration showed a few years ago, acting early was not the smart thing to do and just ended up costing the industry a lot of money and effort.”
Adaptability
Christophe Reech, chairman, Reech AiM Group, takes a similar logical approach: “With new reforms, two reactions and consequences are to be expected. The first is to decide to operate outside the framework of the new reform, which in this case would have implications on geographical as well as investor base. The second is to adapt to the new framework, become a proper asset manager, and deploy strategies inside the new rules.
“It is not the first time the industry needs to adapt. The balance between the two options will depend on the impact of the directive on the actual viability of the industry under the new template.”
We must accept the alternative space has been earmarked for a dressing down. However, the AIFMd will reduce investor choice, produce less-than-optimal performance by funds, increase costs, introduce draconian rules on compensation, create ambiguity and cause increased risks from having fewer depositories.
Despite the determination of most managers to carry on doing what they do best, at least until the AIFMd is implemented, I would argue this was never the original intention of the directive. Let us hope the long-term negative and unforeseen consequences can be kept to an absolute minimum.
Andrew Rubio is chief executive of Throgmorton UK
