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. 

A packed audience of NCI members and others heard Tilman Lueder – in charge of the asset management division at the European Commission in Brussels – give an insight into the EC’s thinking on Wednesday 17 September. In an engaging speech, Mr Lueder emphasised that the EC is not about “regulation for the sake of regulation”, but is keen to see the creation of much bigger cross-border investment flows, and the “conquering of new markets” such as China.

Mr Lueder, a lawyer by training who formerly represented the EC in the World Intellectual property Organisation (WIPO), spoke for almost an hour and then took a series of probing questions on the whole gamut of investment management issues, including the somewhat opaque nature of ‘passporting’ funds across Europe. He said on this matter that “we need regulatory cooperation and...a joint rulebook, and the EC needs to ensure that there is a common interpretation of the rulebook.”

Mr Lueder spent the day visiting several NCI member firms in London, exchanging views with them on the prospects for this industry and discovering the major concerns of small-to-medium boutique asset managers. He said that in his view the attractions of smaller niche operators were considerable, and that the “EC is interested in learning what kind of strategy niche funds might be able to offer.”

From the perspective of NCI members it is tremendously useful to have opened this key channel of communication with the European Commission. Dominic Johnson, NCI Chairman, said: “It’s terrifically heartening to hear from Tilman Lueder that his part of the European Commission is focused on fostering true European capital markets integration, assisting our members – and firms like them – to compete better globally.”

Nine young men and women this week started a two-week summer internship programme organised and funded by New City Initiative (NCI), the association of 45 asset and wealth managers based in the City of London and Paris. The paid internships are supported by some of NCI’s leading member firms, who collectively account for some £400 billion in assets under management.

The nine undergraduates kicked off with a day of seminars by senior figures from NCI member firms, including Somerset Capital, Stanhope Capital, Oldfield Partners, and Mayfair Capital. The students, all academic high-achievers, are studying at the Universities of Central Lancashire, Leeds, Warwick, and York. Their final day is on 11 July, when they will receive coaching advice on how to build their City careers from  Panda Morgan Thomas, a leading City executive recruitment specialist, the founder and Managing Partner of 33 St James.

The nine students are: Louise Hatem; Justyn Lawson; Nikita Jevtechov; Annabelle May Purchase; Mohamed Mohamed; Ronak Shah; Michael Smith; Kavita Vaja; and Matthew Wong. The intern places are being provided by Dalton Strategic Partnership, Oldifled Partners, Stanhope Capital, 2CG Senhouse, Stonehage Investment Partners, and Troy Asset Management.

Gary Mead, Executive Director of NCI, said: “This is a great and potentially life-changing opportunity for the interns. For NCI member firms it’s a chance to talent-spot future asset management stars. It’s also a demonstration that small-to-medium boutique owner-managed firms are intent on putting something back. The NCI espouses old-fashioned City values – supporting young people to gain a rung on the ladder is the right thing to do, and I hope we are able to expand the intern programme further.”

Capital Wars

By Daniel Pinto, Bloomsbury, £25 hardback

'Daniel Pinto has written a remarkable book.  He begins with an informed and merciless analysis of how the West has strayed; and then goes on to propose a practical programme for change that makes instinctive and inspiring sense: all in admirable English.  If our leaders are wise enough to read, digest and apply, the West will be entitled to fear less and hope for more than current opinion holds.' Sir Martin Sorrell, CEO, WPP

For more infomation, please click here