The European Union’s (EU) Alternative Investment Fund Managers Directive (AIFMD) is an all-embracing piece of legislation that will have an enormous impact on the operations, business practices and cost overheads of New City Initiative members.
It imposes many onerous restrictions on EU investment fund managers, and non-EU firms marketing to institutional investors in the region. For example, it requires them to appoint a depositary bank; to implement restrictions on remuneration packages; and to submit to stringent regulatory and investor reporting obligations. The appointment of a depositary bank to provide safekeeping of assets, cash-flow monitoring and oversight has proved less burdensome than many predicted, but it is not without its challenges. Remuneration provisions – such as deferred bonuses – have been broadly accepted, although a handful of US fund managers baulk at the idea of changing and publishing details of their compensation structure. The biggest trial surrounds reporting to regulators through the laborious Annex IV document, which will come into effect for the majority of AIFMs on January 31, 2015.
Who and what is affected?
Annex IV has enormous reach. It applies to any AIFM within the EU or European Economic Area (EEA), as well as any non-EEA AIFMs marketing AIF products to European investors via the national private placement regimes. Firms not marketing or without a presence inside the EU, and those managing UCITS, are exempt from the reporting obligations. Non-EU firms are hardly enthused about attaining AIFMD compliance. In 2013 Deutsche Bank Markets Prime Finance found 90 percent of US hedge fund managers surveyed were either undecided or uninterested in AIFMD compliance, even if the pan-EU marketing passport was extended to non-EU managers. 44 percent of US respondents not actively marketing into the EU said the Annex IV reporting was the biggest factor behind this decision.
This reluctance is perfectly rational. Annex IV has some 301 data fields and requires AIFMs to supply information on instruments traded, borrowings, exposures, stress test results and leverage, at both a fund and manager level. The former could potentially run into hundreds or even thousands of pages. Unlike the data supplied to the Securities and Exchange Commission (SEC) and the National Futures Association (NFA) through Form PF and Form CPO-PQR respectively, Annex IV is highly prescriptive and granular in its methodologies and calculations. In other words, simply copying and pasting data provided to US regulators is unacceptable for the most part. Lawyers acknowledge there is overlap between all of these regulatory documents, but point out approximately one third can actually be replicated in Annex IV.
Reporting frequency for Annex IV is determined by assets under management (AUM). Firms running between €500 million and €1 billion are expected to file Annex IV on a semi-annual basis, while managers in excess of €1 billion must submit the report quarterly. Those managing between €100 million and €500 million must file annually. Even hedge and private equity funds managing sums below these thresholds and marketing in Europe must also supply some detail to regulators in those jurisdictions where they are marketing. Full-scope AIFMs are only required to provide Annex IV to their home regulator.
How does Annex IV impact your operations?
Anecdotally, this has resulted in non-EU AIFMs exiting jurisdictions where they have few investors. Frustratingly for managers, there is no single platform by which to supply Annex IV, although regulators have made clear it is acceptable to provide the document in English across the EU. One issue that may arise would be if regulators start tinkering with or altering Annex IV. AIFMD is a directive and not regulation, and member states are therefore entitled to have some leeway in its implementation. There is token evidence that one or two jurisdictions are throwing up barriers, most notably Austria, which is reportedly requiring managers to fill in the “voluntary” sections of Annex IV.
The reporting frequency and scope is also subject to leverage calculations. A firm managing €500 million that is leveraged is expected to file Annex IV reports semi-annually or even quarterly, rather than annually, as regulators incorporate leverage into the AUM calculation. Unleveraged private equity funds must provide Annex IV annually irrespective of AUM. Regulators are also entitled to arbitrarily demand AIFMs to increase their reporting frequency. Firms are expected to submit Annex IV 30 days after the end of each quarter, although funds of hedge funds and funds of private equity funds can provide the report 45 days after the quarter end. This can cause a mismatch with valuation cycles.
The challenges for Annex IV filers
The biggest challenge for managers is collecting the data and ensuring it is consistent with other regulatory filings such as Form PF, CPO-PQR or even the Open Protocol Enabling Risk Aggregation (Open Protocol), the risk reporting toolkit developed by alternative investment consultancy Albourne Partners. Obtaining data from multiple service providers is not without its difficulties. Most fund managers have elected to outsource the work to fund administrators, technology vendors or regulatory reporting platforms. Providers have urged managers to focus on obtaining static, unchanging data primarily before collecting the time sensitive information as the deadline approaches. This is sound advice and will save time, and hopefully prevent a mad rush come the end of January.
Ensuring consistency across these regulatory reports is less clear-cut, purely because there is no uniformity in the methodologies prescribed by the US and EU. Regulatory Assets under Management (RAUM) is a prime example of this inconsistency. The EU calculates RAUM using the gross method, whereby leverage and the notional value of outstanding derivatives contracts are incorporated into the RAUM. The US, by comparison, simply focuses on gross assets on an audited balance sheet when calculating RAUM. Unless regulators come up with a standardised methodology for completing these regulatory reports, there will be significant divergences in terms of data collected. Given these inflated RAUM figures, there is also a significant risk regulators could identify some AIFMs as being systemically important financial institutions (SIFIs) and potentially subject them to bank-style liquidity, leverage and capital requirements.
Stony paths ahead
The costs of Annex IV, and indeed all regulation, are substantial. Quarterly filers of Annex IV will most likely pay service providers approximately $100,000 per year to do the work. Annex IV and AIFMD as a whole is proving to be yet another regulatory barrier to entry for smaller managers, at a time when operational costs continue to rise, and returns show little sign of improving. Reporting requirements, of which Annex IV is just one of many, will inevitably be thrust upon NCI members over the coming years. Policymakers are already hypothesising about the contents of an AIFMD II and UCITS VI. As one senior European Commission policymaker put it, speaking on a panel in 2012 on shadow banking regulation, “the fat lady has not even begun to sing!” NCI members have been warned.Read more…