Complying to the hedge fund industry

Nicola Smith, CEO of Gibraltar-based fund administrator, Helvetic

During 2008, the financial sector witnessed the collapse of Lehman Brothers and the discovery of the Madoff scandal which resulted in the financial markets being brought to their knees as the global economy moved towards meltdown. The blame was quickly leveled against participators in the financial markets, who allegedly took advantage of the light regulation, allowing them to engage in highly speculative transactions through opaque structures. These factors provided a strong catalyst for change in the hedge fund industry with the landscape of the financial industry moving dramatically away from rating funds based on their performance alone, towards the requirement of greater levels of transparency and corporate governance prior to deciding whether to invest in a fund.

The campaign for funds to comply with enhanced regulation intensified as investors began demanding more stringent checks to be conducted on the operations of hedge funds. These issues were stressed by European Governments and resulted in the move towards a hedge fund and private equity sector whose regulation has advanced to a high standard and key amongst this progression has been the implementation of the Alternative Investment Fund Managers (AIFM) directive.

The AIFMD was published on 1 July 2011, with the aim of regulating the management and marketing of alternative investment funds (funds). It also provided a harmonised regulatory framework for alternative investment fund managers, (fund managers) based inside and outside of the EU, which manage these funds allowing greater transparency, as well as combating malpractice in the fund industry. Each EU Member State is required to implement the AIFM directive nationally prior to July 2013 and are required to supervise fund managers at a national level once the AIFM directive comes into force, reporting to the European Securities and Markets Authority (ESMA).
All alternative investment fund managers are working towards ensuring compliance with the AIFM directive, however, the AIFM has been met with apprehension as to whether deadlines for implementation of the directive are likely to be met by fund managers and regulatory authorities. In January 2012, the discussion paper distributed by the UK FSA highlighted concerns that the AIFM directive could result in over-regulation of the industry and fund managers had a lack of implementation time to comply with the AIFM directive. These issues had not been the intention of the Directive during the consultation process but have emerged in consequence of adopting the Directive prior to an appropriate implementation timeframe being provided to fund managers. It has been considered that the AIFMD must avoid the risk of simply combining politically motivated single goals to give the perception that Europe is regulating an industry that has seen high profile public scrutiny and which may result in the directive not standing the test of time.

Since 2008, institutions have closely scrutinised the management of investor monies by fund managers to ensure that fund reporting is carried out to a high standard, which in turn has led to an increase in the need for the support and assistance actively provided by independent third party fund administrators. Fund managers may find the increase in reporting and disclosure requirements difficult to manage whilst continuing to concentrate on the supervision of the underlying funds, which is where third party fund administrators can assist. One important function of a fund administrator is to update their clients on reporting requirements and this provides fund managers with some comfort that compliance activities will be kept to the required standard required under the AIFM directive.

Investors and auditors both recognise the support made available by independent third party administrators who are able to provide impartial reporting, greater transparency and risk migration, conducting these independently from the fund manager, and as such, these services cannot generally be matched by an in-house fund administrator. The obligation for fund managers to ensure valuations are conducted independently and in accordance with the laws of their home Member State, which the AIFM has instigated, has resulted in recommendations that valuations should generally be delegated to a third party to ensure the requirements under the AIFM directive are met.

It is anticipated that the foreseeable future will continue to be a challenging time for fund managers inevitably leading to a drain on resources, as they will be required to register or request authorisation from their home Member State, gather information required under the AIFM directive and provide large volumes of reporting in order to ensure compliance prior to the AIFM directive taking effect. Investors will demand assurances that each fund manager is meeting standards and that all the necessary information is available for them to make informed decisions when investing into alternative investment funds. This will result in fund managers having to adhere to requirements in order to ensure investment monies continue to be received. Statements of a more general nature in the offering documentation of funds without limitation or restrictions will no longer be accepted.

To enable fund managers to preserve investor confidence, they are encouraged to work alongside third party administrators to ensure that all objectives of the AIFM directive are conducted, through close monitoring of funds and providing disclosures to investors. The expert counsel and oversight provided for by fund administrators will allow fund managers to focus on their core activities.