This INDOS Financial article was first published by HFM Week and can also be read here (subscription required).
After more than five years of regulatory onslaught from the EU and US, a period of relative calm has descended for some in the UK alternative fund management industry. Implementation of the EU’s Alternative Investment Fund Managers Directive (AIFMD) appears, on the whole, to have been smoother than expected with most managers getting to grips with its requirements. Now firms are starting to familiarise themselves with the Markets in Financial Instruments Directive II (MiFID II) which comes into effect in January 2017.
In the interim before the impact of MiFID II is fully felt, a number of managers are taking stock of the operational side of their businesses. Particular focus areas include reviewing their AIFMD implementation strategies so far, data management and service provider oversight, all of which are somewhat inter-related.
Following the introduction of AIFMD, managers are performing health checks to ensure that they are complying with the full range of new regulatory obligations. Marketing continues to be a focus area particularly for those managers running non-EU funds that initially sought to rely on reverse solicitation but now realise this is not a sustainable marketing strategy. As such, more managers are looking to comply with national private placement regimes albeit predominantly in the UK and a limited number of other EU member states.
Firms are also reviewing how they comply with new regulatory reporting requirements such as derivative trade reporting under the European Market Infrastructure Regulation (EMIR) and the AIFMD’s Annex IV. A lot of man-hours are consumed on reporting regardless of whether it is carried out in-house or outsourced. Strategic thinking is required around data management particularly as reporting obligations will increase further under MiFID II. Some managers are reportedly bringing reporting back in-house having originally outsourced the task.
Good service provider management is becoming an increasingly important component of a firm’s risk management and internal governance. This is not only in terms of understanding a service provider’s strategy and commitment to your business but also monitoring and overseeing their performance. Beyond the more traditional administrator relationship, focus is turning to the role of the depositary introduced by AIFMD for any non-EU funds managed by EU managers and being marketed in the EU.
We are aware of several managers re-evaluating their depositary relationships. Some managers are noticeably disappointed by the performance of their depositaries so far, and are looking to port business elsewhere. Indeed, a number of larger funds are known to have already switched providers notably to firms that are independent from their administrator. Operational due diligence professionals and consultants are increasing their understanding and focus on the depositary service and their opinions will matter in future depositary selections by managers.
There is an increasing recognition of the benefits an independent depositary solution can bring as it provides an additional level of oversight over the fund administrator’s processes. As such, the small number of administrators that only allow an affiliated entity to act as depositary will come under increasing pressure to justify this stance.
The introduction of UCITS V, due to take effect in March 2016, is also going to result in major changes for depositaries. UCITS V aligns depositary rules with that of AIFMD. However, unlike AIFMD, UCITS V does not permit depositaries to discharge liability for lost financial instruments to their sub-custodians. The enhanced operational requirements could put significant resource pressure on depositary banks servicing UCITS funds and this may have knock on effects on their services to AIFM clients. This could mean these depositaries do not have the capacity to fully service AIFMs, particularly smaller managers. We could see depositaries exit some AIFM business. It might also result in AIFMs themselves moving to other providers if they feel they are not getting the correct level of service and attention.
Beyond depositaries we expect to see a number of administrators perform their usual pre-year-end client cull, and more changes are starting to be seen in the prime broker space, where terminating or re-pricing relationships with clients is starting to become more common place because of increased capital requirements. This all demonstrates how important it is for firms to focus on service provider management. This is a key element of risk management for any business and will only continue to grow in importance.