Alternative fund managers are beginning to see the directive as an opportunity rather than a threat says Guillaume Fiastre, CEO, Taliance
Since the banking crisis, most regulations and directives have been accepted as inevitable by the industry. The Alternative Investment Fund Managers’ Directive (AIFMD), however, has been controversial from the outset.
The directive, designed to transform how alternative fund managers deal with risk and sell funds, came into force at the end of July 2013. But opposition to it began long before. For example, passions ran so high that, while the AIFMD was still in draft form around four years ago, the UK’s Daily Telegraph newspaper ran a ‘Ditch the Directive’ campaign. Since then, the AIFMD has begun to divide opinion. In a study of asset managers carried out by Deloitte in 2012, 72% said they viewed the directive as a “business threat”.
However, now a more positive view is emerging with a growing recognition that the directive may, after all, be a good thing – and far from putting the alternative investment sector at risk, it should be seen, instead, as a major opportunity.
Are these new optimists simply wearing rose-coloured spectacles – or being expedient, seeing that the directive is here and in force despite everything? At the heart of this more encouraging view is the concept of the European passport which allows alternative investment fund managers who fall within the new regulations to market to professional investors in EU member states. It is noticeable that in the Deloitte study, despite the majority seeing AIFMD in a negative light, 41% said they intended to use the passport to extend fund distribution.
The idea of a harmonised regime without the need to comply with the complex rules of each different nation is an attractive one. However, this freedom comes with heavy demands for transparency and accountability in managing risk. The directive is impacting several areas of business processes including investment, asset and risk management, fund structure, marketing and sales strategy, depositary and capital requirements. And up-to-date reporting based on a firm foundation of credible data is becoming a real necessity.
So how can alternative investment fund managers make the transformation needed to turn these demands to their advantage?
First they must identify the key areas of their business model which need changing and do this as quickly as possible. Looking at the AIFMD, there are four key areas that need attention: risk management practices; transparency; capital requirements and ratio calculations and investment strategies:
Risk management: Fund managers will need to reshape the way they currently manage their risk. The traditional way is to calculate rather than anticipate risk. Instead of basing investment on past performance they need to be able to anticipate the consequences of risk in their portfolios, forecast future trends and move from descriptive tools towards more predictive analytical tools.
Transparency: The AIFMD demands better control over data and more frequent, deeper and responsive reporting. This reflects investors’ needs for more complete accurate and appropriate information. Fund managers will need systems capable of handling more information faster and present it in an easy to understand format.
Capital requirements and ratios calculation: Alternative investment fund managers are required to maintain certain capital levels depending on the value of Assets Under Management (AUM). They will also need a system in place capable of running calculations of several ratios (leverage, solvency, liquidity, for example) to attract major investors.
Fund managers also need to develop ways of running multiple and complex calculations of capital ratios through internal or tailored models, ideally testing worst case scenarios to help them maintain adequate capital ratios. These calculations must reflect degrees of volatility in order to secure greater leverage and assure solvency and liquidity in case of future downfalls.
Investment strategies: Besides assessing business processes, fund managers should also consider the different investment vehicles introduced to the European market over the past years. All these vehicles vary in asset composition, capital requirements, liquidity levels, valuation requirements and so on – and for this reason, assessing current investment strategies and selecting the right investment vehicles will be a crucial element of the compliance process.
These are only a few of the areas that alternative investment fund managers need to consider. It’s not surprising that PwC hedge fund leader, Rob Mellor, has said that the AIFMD will bring an “avalanche of change”. One of the causes of disquiet about the directive is that it will put larger fund managers at an advantage as small firms have fewer internal resources to deal with the initial and ongoing responsibilities.
However, software platforms which enable fund managers to replace spreadsheets with a central database and allows business data modelling and forecasting to help anticipate risk, is now becoming widely available. This can enable companies to comply with regulation with the least amount of disruption.
These platforms will help fund managers comply with AIFMD terms – but they will do more than this in business terms. They will enable fund managers demonstrate to clients that they are totally in control of their investments – that there’s ‘a pilot in the plane’ and it’s going in the right direction.
What better reassurance to potential clients accustomed to old-style fund manager still using paper and spread sheets?
It may be that EU fund managers have only a short window to act to gain competitive advantage. It’s possible that those from outside the region may be able to apply for authorisation under the passport system after 2015. For those who wish to explore the potential of the EU passport, the pessimism has to stop and the action must begin. Only those who adopt the changes and implement the right systems to enable the process will be the winners.