The long and winding road

Written by: Dave Waller Posted: 21/11/2014

With the transition period over and reporting deadlines looming, Dave Waller examines the state of play with AIFMD, and finds there are still hoops for managers to jump through

When the EU introduced its Alternative Investment Fund Managers Directive (AIFMD) in July 2013, it caused its share of consternation - almost as if the four horsemen had saddled up on the shores of the Channel Islands, followed by thunder and lightning and an ominous train of red tape. But with the dust now settling on AIFMD"s year-long transitional period, it seems the impact on the Channel Islands hasn"t been all bad.

The Directive"s aims are sensible enough. It was designed to prevent instability in the provision of alternative funds, improving investor protection through new standards and enhanced transparency, and it introduced extra reporting requirements and a stronger focus on risk management. In essence, if non-EU-based fund managers wanted to market into Europe, they"d have to jump through a whole load of new hoops.

Which is where the dark clouds come in. With the first reporting deadlines for many approaching this December, some fund administrators have been frantically looking at existing client structures to ensure they"re fit for purpose. This extra reporting, not only to investors but to regulators, presents a daunting challenge for many fund managers, who need to pull information from disparate sources and report it, often in unfamiliar XML formats, within the given time constraints. Then there"s additional training, and obligatory new custodial requirements like depositaries [see box].

“We"re seeing fund administrators thinking about the reporting that"s required and getting ready for that in advance of the reporting dates,” says Kirsty Mackay, Executive Director in Advisory and Assurance Business Services at EY. “People are working out whether they paid sufficient attention to adapting to the new regulations and whether they"ve put the resources in place to deal with it. We"re still speaking to some who haven"t fully identified the impact on their clients - they obviously underestimated the requirements.”

Balancing the costs

As you"d imagine, these added requirements mean extra costs. And there are further complications. While AIFMD has been adopted across the EU, with each country obliged to introduce it as legislation, the likes of France have added their own additional requirements and fees. So managers who are complying with everything required by AIFMD may still have additional hoops to jump through for each different country.

“It"s meant to work like a passport giving access to the EU,” says Justin Partington, Commercial Director at Ipes in Guernsey. “But instead of just waving your documents at the border guard and driving straight through, you have to stop the car, sign 80 pages of papers and wait for a month before you can get out of the country.”

As such, even if this isn"t exactly a Book of Revelations-scale disaster, it still represents quite a pain. In July, research by Preqin showed that only 16 per cent of real estate and investment fund managers thought AIFMD would have a positive impact on the industry (with 47 per cent predicting a negative impact, and 37 per cent saying it wouldn"t have any). For many, the costs outweigh the benefits.

“At the outset it was seen principally as a downside aspect that just had to be covered off - the same as other tax reporting or standards-related regulations,” says Tim Morgan, a Partner at Ogier in Jersey. “These can seem to be the result of a potentially flawed policy-making process, which is in fact used for political purposes, to give certain European centres an advantage over the UK and offshore world.”

Yet rays of light are breaking through the clouds. The Channel Islands occupy a peculiar position on AIFMD - as they lie outside the EU, neither Jersey or Guernsey are required to comply with the Directive, but any funds that are domiciled in the EU and marketed there are. Both islands have responded intelligently, putting in place a dual regime that gives managers the opportunity to opt in to AIFMD-compliant rules if needed.

One regime, fully compliant with the Directive, is for fund managers who are marketing to the EU. This can be done under the EU"s private placement provision, allowing for an agreement with each particular jurisdiction on a case-by-case basis. The other is the regulatory framework that existed before AIFMD - for those funds that don"t need to be, or choose not to be, regulatory compliant.

“It enables Jersey to continue to do what a well-balanced jurisdiction would have done prior to AIFMD,” says Morgan. “Non-EU clients raising non-EU money can continue with the full approach, which is of course something an EU jurisdiction can no longer offer. And if those non-EU clients want to target EU money, but don"t know how much of their business that will represent, they can dip in without having to take the whole lot. Jersey has been able to reflect AIFMD in its own regulations on its own terms, and that"s been a real strength. It gives additional credibility compared to less regulated jurisdictions like those in the Caribbean.”

Silver lining

Indeed, get beyond the administrative scramble and uncertainty, and a positive marketing picture has emerged for the Channel Islands. As the one-size-fits-all model doesn"t work for every fund promoter, they may be turned off by any EU jurisdiction that imposes added costs because they"re straitjacketed by the regulations. Suddenly the appeal of the Channel Islands, with their proven resilient, substantive and now more flexible regimes, increases.

“Jersey is now the low-cost, flexible way into Europe,” says Charles Le Cornu, a Director at Elian Fund Services in Jersey. “Many non-EU fund managers will go offshore to Jersey, as a third country, where they can benefit from the light-touch Directive legislation.” According to the Jersey Financial Services Commission, 164 funds had opted to use Jersey"s private placement option as a route into Europe as of 22 July.

There"s also the fact that such regulations soon become a standard that the majority of managers need to have. As the alternatives sector becomes more mainstream, regulation and reporting standards may be the next logical step, rather than something to be feared.

“The more the regulators know about the industry, the more they"re likely to trust it,” says Tim Andrews, Ipes" Guernsey AIFMD Depositary Director. “And the less of a bad reputation the alternative sectors might actually have. As AIFMD beds down between national legislators, it becomes business as usual and much less scary than it was.”

Indeed, it"s important to remember that not only is AIFMD more than a single set of rules with a single blanket application, but its implementation hasn"t been a single event. It"s a process, and one with further significant stages of implementation to come. From its initial implementation in July 2013, non-EU managers could market funds offshore into the EU via private placement schemes. In July 2015, the passport is set to come in, alongside the existing private placement provision. Then in 2019, ESMA will make a call on whether both will continue as they stand. The impact of these future changes remains, at this stage, a guessing game.

This is all obviously hugely relevant to the Channel Islands, as it will affect its role in the way fund managers access Europe. The private placement model is familiar and popular, yet further changes of course remain absolutely possible.

“Administrators are hoping they"ve gone through the significant change and that the next one, the passport, won"t be so significant,” says EY"s Mackay. “We"re waiting on the regulators" lead to know the implications of the next phase. People are keen to make this - and to protect their business.”  

Depositaries: a must-have?

Among the requirements introduced with AIFMD was a more robust form of custodian service for alternative assets - depositaries. These would monitor and verify the ownership of assets, and provide oversight on cash and transactions.

The majority of depositaries established in the wake of AIFMD in July last year are via existing fund administrators, who are already blessed with the necessary custodial expertise and client base. The only snag? A depositary isn"t exactly a money-spinner, and the liabilities are significant - if the depositary makes any mistakes, it"s going to pay.

As such, it"s seen as a cost burden more than anything, but for many fund administrators it"s a necessary move. Many establish a depositary to prevent their clients seeking the obligatory service from another provider, which may lead them to seek other services elsewhere too.

Depositaries have thus proven to be more about holding on to existing business than generating anything new. And thanks to the intricacies of AIFMD they tend to be based onshore. While the UK and EU have seen them spring up in droves, the Channel Islands have only about half a dozen. Yet, as with many facets of AIFMD, this may well change in the future. The EU introduces its AIFMD passport in 2015, and the number of depositaries setting up offshore may increase. And the Channel Islands certainly have the custodial experience and expertise to benefit.


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