By Roger Ganpatsingh, Director, Throgmorton
The 22nd July looms large in the eyes of the hedge fund community with implementation of the Alternative Investment Fund Managers’ Directive (AIFMD) almost upon us. With the drop-dead- date less than two months away, large swathes of the Directive’s requirements and consequences remain clouded by the mists of detail and the seemingly endless pontificating by political and regulatory authorities. Given that it is almost five years since the Directive was first mooted by European politicians, the fact that so much detail remains unclear with less than two months to go seems astonishing but is also to be expected.
For UK managers, as many as 70-80% of the ‘in scope’ firms are looking to make use of the one year deferral to push back the ramifications of AIFMD. There appears to be little, if any, ‘first mover advantage’ to be gained from early adoption. UK managers with pre-existing FCA authorisations will be able to utilise the extension. For the 180-200 UK managers intending to adopt in 2013, almost all will be doing so to ensure they will be able to market to EU investors once the Directive takes effect.
For those looking for early adoption, the rush is on! The FCA has committed to having application forms available by the end of May and to turn around applications within one month. For those managers marketing purely to UK investors, the FCA’s intention to require only a notification rather than full authorisation means that the pressure is off – for now.
At the smaller end of the market, managers with assets under management below €500m (ungeared) or €100m (geared) will be able to take advantage of size exemptions which will remove many of the Directive’s requirements.
Whether going for early adoption, utilising the one year extension or utilising the size exemptions, our clients tell us that their primary concerns in dealing with the requirements of the Directive centre on depositories, remuneration and changes to regulatory capital requirements.
The depository requirements of the Directive present an operational headache that is by no means insignificant. Whilst it can be said that it will be up to the relevant service providers to ensure that they are able to meet the AIFMD requirements, fund managers find themselves in the unenviable position of conducting due diligence on service providers that have yet to finalise the details of their product offering. It is becoming clear that the larger, more diversified financial institutions offering depository services are likely to take pole position in the march to win business. Stronger balance sheets, economies of scale and more integrated service lines are highly likely to enable the larger firms to offer a more complete and better ‘value for money’ proposition than the smaller and more specialist operators. For prospective depositories, there clearly is a first mover advantage in demonstrating the strength of their offering.
Perhaps the biggest unknown for fund managers surrounds remuneration planning. The FCA has yet to issue its third consultation paper on the remuneration guidelines. It is likely to be July at the very earliest that we see more colour on the remuneration consultation.
Given the prevalence of Limited Liability Partnerships (LLPs) within the structures of UK Hedge Fund groups, the consequences of remuneration deferral and compulsory investment in the underlying fund present significant challenges to managers, primarily due to tax timing differences and consequent funding mismatches. Unsurprisingly, our clients are asking for our assistance in addressing these timing differences. As yet, there is little indication of how proportional the remuneration requirements will be when applied to managers at the smaller end of the scale.
AIFMD will impose increased capital requirements on firms caught by the Directive. For larger firms, the increases are likely to be minimal but at the smaller end of the market, firms are likely to feel a considerable impact. Minimum requirements will rise to the greater of i) €125,000 plus 0.02% of gross AUM in excess of €250m, or ii) one quarter of annual expenditure. A further capital sum of, or professional indemnity insurance equivalent to, 0.01% of AUM will also be required. Clearly this represents a material increase for some firms with capital requirements as low as €50,000 or even €5,000.
The increased requirements will require owners of such firms to bolster their balance sheets through retained earnings or additional capital contributions. Our clients are seeking our assistance in planning for these increased capital requirements. We are assisting firms in understanding the consequences of the new regulations for their firms and in planning their capital structuring through financial reforecasting, scenario analysis and balance sheet stress testing.
Wider concerns of regulatory overload
Whilst the direct impacts of these various strands of AIFMD occupy the minds of managers, there are also wider concerns regarding the increased costs incurred, both to the manager and the fund, from the increased administrative and regulatory burden. At a time when investment returns and management fee structures are also under pressure, the resultant “squeeze” will be a significant challenge for a lot of managers.
For a directive that has taken five years to draft, it does not seem right that managers are still in the dark about some of its more controversial implications. The goalposts are likely to continue moving for some time yet. Our clients accept that increased regulation is the order of the day, but their acceptance does not equate to approval. Any industry on the receiving end of more regulation is unlikely to be happy about it, but given the political motivations driving much of the Directive, the scepticism within the UK financial services industry is not surprising.
Few would argue with the over-arching principles that underpin the recent raft of new financial regulation, namely increasing consumer protection and market stability. With new financial scandals rearing their heads on a seemingly continuous basis, the pace of regulatory change is unlikely to abate. As ever, the danger is that the pendulum swings too far. There exists a growing consensus that the regulatory agenda is killing our financial markets. Add in the political agenda that can all too often drive domestic, continental and global regulation and we may find ourselves in danger of ignoring those high level principles.