Convergence and the impact of AIFMD survey.

Transcription

1 Convergence and the impact of AIFMD survey

2 Executive summary $16 trn total AUA, 51 survey participants The survey was carried out in June 2012 and primarily fund administrators and asset managers were invited to respond. We received 51 responses and the findings represent the views of 15 respondents from third party administrators, 23 from global custodians/fund administrators and 7 from asset managers, servicing a total of $16trn assets under administration (AUA). 50% of the responses were from Multifonds clients and 50% from non Multifonds clients. Respondents service a mix of both traditional and alternative funds including hedge funds, commodities, private equity, real estate, long only/mutual funds and unit trusts. Type of investment funds managed/administered Long only/ mutural funds Private equity funds Hedge funds Real estate funds Unit trusts Other Commodity funds 41.2% 39.2% 47.1% 56.9% 27% of respondents were from organizations with AUA between $20 and $100bn, 20% from $100bn to $500bn and 27% from over $500bn. The survey findings present a global view with respondents located in Channel Islands, Finland, France, Germany, Hong Kong, India, Ireland, Luxembourg, South Africa, Sweden, UK and US. This white paper contains the final survey results and conclusions and seeks to highlight the key drivers and industry trends surrounding the convergence between mutual funds and hedge funds and the regulatory Alternative Investment Fund Managers Directive (AIFMD). CONVERGENCE OF ALTERNATIVE AND LONG ONLY FUNDS For well over a decade now, convergence between traditional mutual funds and hedge funds has been a frequent topic of discussion for the investment funds industry. However, convergence has yet to have a systematic and broad impact across the industry. This is now changing, and over the course of the next few years, convergence will be front and centre for fund managers and their service providers, perpetuated by a perfect storm of an increasingly institutional investor base, evolving regulation and the increasing competition for capital. This change is supported by the survey findings where 86% agreed that convergence will continue. 70.6% 70.6% 66.7% CATALYSTS FOR CONVERGENCE Fund types will continue to converge in their characteristics both as a result of increased institutional investment into alternatives and retail investor demand for absolute return funds. Institutional investors, including pension funds, are having to continually consider increasing their hedge fund allocations. They expect good performance, but increased levels of risk management, transparency and liquidity far more akin to a traditional fund, forcing alternative funds to become more like traditional funds in their service model. Equally, retail investors are increasingly interested in absolute return funds and this will continue, with mutual funds taking on hedge fund characteristics such as performance fees and associated investor equalization. In addition, adherence to regulatory initiatives, such as AIFMD, are also driving convergence. In the survey, 43% believed that the combination of these three factors, namely retail investors looking for absolute returns, institutional investors increasing allocations to hedge funds and regulatory requirements such as AIFMD, are all significant catalysts for convergence. Alternative Investment Fund Managers Directive (AIFMD) Convergence Institutional investor investment into hedge funds Retail investment into absolute return funds 1

3 OPPORTUNITIES AND CHALLENGES PRESENTED BY CONVERGENCE Efficiency is critical to the ongoing profitability and indeed survival of administrators. The spoils will go to the fund administrators who can execute and marry the level of institutional control from the mutual fund world, with the level of flexibility required in the alternatives sector. We are already seeing evidence of consolidation of players in the administration market through service provider mergers and acquisitions and the blurring of boundaries between traditional and hedge fund administrators. Convergence will present both opportunities and challenges, with those that can handle both efficiently, positioned well to gain market share. THE IMPACT OF REGULATION ON CONVERGENCE The industry continues to face a growing set of regulatory and tax requirements post financial crisis. This survey focused on AIFMD with a view to understanding the impact of this regulatory initiative on administrators and asset managers and the role it plays in the move towards convergence. When AIFMD comes into effect in Europe, a fund will not be able to market to any European investors unless it conforms to all of that Directive s rules, including independent administration and evaluation of the underlying assets. This will only accelerate convergence, bringing UCITS-like requirements to European hedge funds. This was a view shared by 69% of respondents who agreed that AIFMD will be a catalyst for convergence. THE CHALLENGES AND OPPORTUNITIES OF AIFMD The Directive timeline moves forward and despite external criticism still looks likely to become law next year. The implementation date and deadline for the Directive to be transposed into national law is set for 22 July 2013 and passports will be made available to EU AIFMs. There will be one year s transitional period to apply for authorization for EU AIFMs operating before 22 July % of our respondents indicated that they would be ready within 12 months for the Directive also revealing on the flip side that 20% do not expect to be ready, indicating it will take them longer than a year. Elements of AIFMD which will have the most significant impact Depository liability Risk and liquidity management Operational requirements Valuation rules Third country provisions Leverage limits Investor disclosure Competent authorities 7.8% 13.7% 19.6% 31.4% 31.4% 45.1% 45.1% 56.9% Elements of the AIFM Directive present real challenges to our survey respondents. 57% of respondents viewed depositary liability as the most challenging aspect followed by operational requirements with 45% and risk and liquidity management also with 45%. Valuation rules and third country provisions also featured high on the list of challenges for service providers. 86% of respondents agreed that convergence of traditional and alternative funds will continue. 2

4 Respondent profile The survey was carried out in June 2012 and primarily fund administrators and asset managers were invited to respond. We received 51 responses and the findings represent the views of 15 respondents from third party administrators, 23 from global custodians/fund administrators, 7 from asset managers and 3 each from vendors/consultants/lawyers/suppliers and other. The 51 respondents to the survey service a total of $16trn AUA. 50% of the responses were from Multifonds clients and 50% from non Multifonds clients. Type of organization % of respondents were from organizations with AUA between $20 and $100bn, 20% from $100bn to $500bn and 27% from over $500bn. The remaining 26% were from smaller organizations or unclassified. Value of funds administered (AUA) 7.8% 3.9% 13.7% 23 Asset Manager Third Party Fund Administrator (not a Custodian) Global Custodian/Fund Administrator Vendor/Consultant/Lawyer/Supplier Other Respondents service a mix of both traditional and alternative funds including hedge funds, commodities, private equity, real estate, long only/mutual funds and unit trusts. 27.5% 19.6% Less than $1bn Between $1bn and $20bn Between $20bn and $100bn Between $100bn and $500bn More than $500bn Not applicable 27.5% Respondents gave a global view with respondents based in Channel Islands, Finland, France, Germany, Hong Kong, India, Ireland, Luxembourg, South Africa, Sweden, UK and US. 3

5 Survey findings - convergence THE REALITY OF CONVERGENCE Over the course of the next few years, convergence will need to be a key focus for fund managers and their service providers. Our respondents were asked if they agreed or disagreed as to whether they believe that convergence will continue and 86% agreed that it would. CATALYSTS FOR CONVERGENCE Institutional investors, including pension funds, are having to continually consider increasing their hedge fund allocations. This is because many global institutional investors are now facing underfunded obligations and need access to the increased returns from alternative funds in order to catch up. They expect good performance, but increased levels of risk management, transparency and liquidity far more akin to a traditional fund, which is forcing alternative funds to become more like traditional funds in their characteristics. In other words, there is a convergence between long only and alternative funds. A recent survey by Citi Prime Finance predicted more than doubling of the global hedge fund assets from approximately $2.1 trillion to over $5 trillion in the next 5 years, with another $1 trillion from institutional investors alone. Equally retail investors are increasingly interested in absolute return funds hence the growth in alternative UCITS and registered hedge funds in the US. This will continue to cause mutual funds to take on hedge fund characteristics such as performance fees and associated investor equalization. We asked our survey respondents which of these factors: retail investors looking for absolute returns, institutional investors increasing allocations to hedge funds or regulatory requirements such as AIFMD, were the main catalysts for convergence. 43% believed that all three were significant catalysts for convergence. Additionally, a sizeable 35% felt that regulatory requirements such as AIFMD were the most significant and we explore this finding later in this paper. Catalyst for convergence 43.1% 9.8% 11.8% 35.3% Retail investors looking for absolute returns Institutional investors increasing allocations to hedge funds Regulatory requirements such as AIFMD All of the above 4

6 THE OPPORTUNITIES AND CHALLENGES OF CONVERGENCE The administrators For fund administrators in particular, they face both opportunities and challenges. If they can handle both sides of the convergence, they will gain market share from those that focus on specializing on one or the other. Convergence will drive significantly higher revenue potential, but along with the equally significant challenge of aligning both technology and operating models to take full advantage. The administrators have an opportunity to gain from increasing their share of the hedge fund wallet. Fund administration has always been seen as a sticky business, but this is particularly true for hedge fund administrators. Not only are they providing a fund administration service, but they are invariably offering more middle-office services, such as independent valuation and collateral management, in addition to helping their clients penetrate new international markets. However, in order for them to compete for the largest and most successful hedge funds, they will need to ensure that their people, processes and technology can efficiently and effectively incorporate the retail aspects that will be required. This will involve supporting not just the regulatory and portfolio transparency that will be enforced upon them, but also the institutional controls and processes that institutional investors now expect including depth of controls, full auditability with audit trails, readily accessible backup documentation and four-eyes processing. We are starting to see the impact of convergence on the administration players in the market, with the consolidation of firms through service provider mergers and acquisitions and blurring of boundaries between the traditional administrators and hedge fund administrators (HFA). Most recently, we have seen State Street acquire Goldman Sachs hedge fund administration unit and SS&C acquire GlobeOp to become one of the market s leading fund service providers. Today while CITCO remains the top HFA by far based on assets under administration, five of the top ten HFAs now come from the tier one mutual fund administrators: State Street, BNY Mellon, Citi, Northern Trust and HSBC. However, operationally they have mainly operated with separate teams, processes and technology for mutual fund versus hedge fund administration. Their challenge in the need to reduce fees and administration costs will be to align their people, operations and systems in a more cost effective and scalable structure, and without compromising on controls. The investors Investors will benefit from diversification in asset class, reduced exposure to market volatility and access to a wide range of products, perhaps with some better return characteristics. This can also enable them to diversify their portfolios and better hedge against unforeseen circumstances. The fund managers It is also good news for hedge fund managers because their assets are growing. Hedge funds could more than double their assets under management according to the Citi research. And let s not forget the traditional institutional fund managers, who will increasingly move into alternatives, offering types of absolute return products to attract new assets and claim a share of the pie. 43% believed that the combination of three factors, namely retail investors looking for absolute returns, institutional investors increasing allocations to hedge funds and regulatory requirements such as AIFMD, are all significant catalysts for convergence. 5

7 Survey findings - AIFMD IMPACT OF AIFMD This survey focused on understanding the key areas of impact of AIFMD on administrators and asset managers, the opportunities it presents and the role it plays in the move towards convergence. When AIFMD comes into effect in Europe, a fund will not be able to market to any European investors unless it conforms to all of that Directive s rules, including independent administration and evaluation of the underlining assets. This sort of new regulation will accelerate convergence, bringing some UCITS-like requirements to European hedge funds. 69% of survey respondents agreed, either strongly or partly, that AIFMD will be a catalyst for convergence. AIFMD as the catalyst for convergence 9.8% 9.8% READINESS FOR AIFMD In May 2012, the third and final draft of the AIFM Directive was published and unsurprisingly, against a backdrop of extreme Eurozone turbulence, they have re-introduced many of the more prohibitive requirements that were first seen in the original draft but had been successfully lobbied down in the second version. Therefore even with external criticism, the Directive still looks likely to become law next year. 80% of our survey respondents indicated that they would be ready within 12 months for the Directive also revealing on the flip side that 20% do not expect to be ready, indicating it will take them longer than a year. Within the custodian category, 74% said that they expected to be ready within 0-6 months, compared 46% and 28% with respectively in the third party fund administrator and asset manager categories, suggesting that the custodians/fund administrators are furthest ahead with their preparation in readiness for compliance. 7.8% 13.7% Strongly agree Partly agree Partly disagree Strongly disagree Don t know 58.8% 69% of respondents agreed, either strongly or partly, that AIFMD will be a catalyst for convergence. AIFMD will bring offshore hedge funds into the regulatory scope in a meaningful way, requiring any alternative funds marketing to European investors to establish many of the same mechanisms that protect retail investors in the cross border, UCITS funds today, including the use of a custodian, independent fund administration, independent asset valuation and a minimum level of portfolio transparency, among others. 6

8 KEY CHALLENGES OF AIFMD Respondents were asked to indicate which elements of the AIFM Directive they thought would present the most challenges: depository liability, valuation rules, operational requirements, investor disclosure, competent authorities, leverage limits, risk and liquidity management and third country provisions. Respondents were able to select multiple items from the list above. 57% of respondents selected depositary liability as the most challenging aspect followed by operational requirements with 45% and risk and liquidity management also with 45%. Valuation rules and third country provisions also featured high on the list of challenges for service providers. Elements of AIFMD which will have the most significant impact Depository liability Risk and liquidity management Operational requirements 45.1% 45.1% 56.9% OPERATIONAL REQUIREMENTS Operational requirements were the single largest concern within the asset manager group with 71% specifying this. This is not particularly surprising, as the raft of regulatory reporting, constraints on leverage, and requirements for liquidity and risk management controls will mean significant additional demands across each fund s operating model and stakeholders, with the AIFM ultimately retaining all responsibility for compliance. As an example, there will be a new standard for pre-investment investor disclosure that will be much like the Key Investor Information Document (KIID), with an additional requirement for periodic disclosure, including the need to disclose sensitive information such as side letters and remuneration details. Moreover, AIFMs will be required to report on their portfolios across a number of dimensions including levels of liquidity, asset types, leverage, counterparty concentration, etc. All of these will entail a much more granular level of transparency along with the necessary, structured processes both at AIFMs as well as at the various stakeholders including the fund administrators in order to be able to comply with the Directive. Valuation rules Third country provisions 31.4% 31.4% Leverage limits Investor disclosure 13.7% 19.6% Competent authorities 7.8% DEPOSITORY LIABILITY The Directive requires a single depositary to be appointed to each Alternative Investment Fund (AIF) even if the AIF was established before the Directive entered into force. This represents significant changes to the current model. Alternative Investment Fund Managers (AIFMs) will not be able to act as depositories and depositories must be authorized credit institutions in the EU. 57% of respondents thought that depository liability was the most challenging aspect of AIFMD. The survey revealed that depositary liability is a particular area for concern for custodians/administrators and third party administrators with 65% and 60% respectively citing this. The depository liabilities and responsibilities are especially pertinent to those with custodian services as the new standard of strict liability requires assets held in custody in the event of loss to be replaced without undue loss or delay. Depositories are also potentially liable for sub custodian actions but are not regulated by the Directive. This area represents a great deal of uncertainty which explains its dominance as challenging factor particularly for the custodians/administrators. The definition of what constitutes reasonable control is still to be clarified and the service providers do not yet appear to have a clear view of the impact and changes to their business model. 7

9 RISK AND LIQUIDITY MANAGEMENT Risk and liquidity management was consistently viewed as a significant challenge across all groups, with a combined percentage of 45%. Many existing managers today already have some risk management processes and systems in place, which explains the relatively lower proportion of stakeholders who viewed this as a significant challenge. However, this has previously been driven primarily by the fund managers themselves as well as their investors. AIFMD will now require all private funds marketing to European investors to comply with and report against the Directive s terms on risk management. This includes the separation of risk management from portfolio management, that the risk profile doesn t diverge significantly from the offering and investor disclosure documents, resulting in an overall more formal set of processes and reports for risk management. This will no doubt result in additional costs, as well as additional restrictions on the managers investment style (or style drift). VALUATION RULES For each AIF, an AIFM will be required to have procedures for proper and independent valuations of the AIF s assets and to ensure that the NAV of the AIF is calculated and issued to the investors. They retain responsibility for proper valuation and the calculation of the NAV. This responsibility is unaffected by the appointment of an external valuer. The concept of the external valuer is key to the valuation provisions as defined by the European Securities and Markets Authority (ESMA). The external valuer is liable to the AIFM for the losses suffered as a result of the external valuer s negligence, shifting the risk from the current role to the valuer. There appears to be some uncertainty as to who will fulfill the role of external valuer. As a result, 44% of fund administrators/custodians cited this as a significant challenge within the AIFMD initiative, reflecting the current uncertainty. DELEGATION TO COMPLY WITH AIFMD If the AIFM is from a third country or has delegated the activities to a third country, there must be relevant agreements in place with the third country s competent authority to comply with the Directive. For delegation, the AIFM must be able to justify the delegation, they must carefully select who they delegate to and must then monitor the delegated activity. Delegation encompasses portfolio or risk management functions and valuations administration. In order to understand better what is likely to be delegated, we asked our survey respondents what they expected to delegate. The large percentage (43%) did not expect to delegate but a considerable number also remained undecided or did not know at this stage (35%). Only 12% expected to delegate valuations administration or portfolio risk management currently. Delegation to comply with AIFMD 35.3% 9.8% 9.8% 2.0% 43.1% Delegate valuations administration Delegate portfolio risk management No delegation Already delegated Don t know 63% of respondents agreed, either strongly or partially, that AIFMD will make Europe a more attractive jurisdiction for alternative fund investors. 8

10 INVESTOR DISCLOSURE FOR AIFMD For investor disclosure, the Directive will require an AIF to provide information to the investors before they invest and any material changes thereafter as well as periodic disclosures to investors and quarterly reports to the authorities. All of this adds to the reporting burden and growing complexity of reporting for fund managers and administrators. It may result in the disclosure of sensitive information such as side letters and numeration details and major holdings in the portfolio. There is likely to be a significant cost burden in delivering the information required and meeting the various reporting deadlines for investors and authorities. EUROPE AS A CENTRE FOR ALTERNATIVES When AIFMD comes into effect in Europe, a fund will not be able to market to any European investors unless it conforms to all of the Directive s rules. This represents a significant opportunity for Europe. One of the objectives of AIFMD is to achieve a single European market for AIFs, an EU passport. We asked our respondents whether they thought that non-eu managers would setup European operations as a result to take advantage of AIFMD. The majority of respondents, 72%, agreed that this would be the case, with 12% expecting the vast majority to setup European operations and 57% expecting only the minority to setup. Disclosure of AIFMD information to large investors 33.3% 15.7% Will non-eu managers setup European operations to take advantage of AIFMD? 21.6% 11.8% 7.8% 43.1% 9.8% 56.9% Full disclosure Limited disclosure No disclosure Don t know Yes, vast majority Yes, but only minority No Don t know Across all survey respondents, 59% of respondents expect to provide full or partial disclosure to investors and within the asset manager category specifically, this rises to 87% of respondents. Having said that, AIFMD is seen as an opportunity to make Europe a more attractive jurisdiction for alternative fund investors, with 63% agreeing either strongly or partially. Will AIFMD make Europe a more attractive jurisdiction for alternative fund investors? 15.7% 13.7% 3.9% 17.6% Will AIFMD make Europe a more attractive jurisdiction for alternative fund investors? 13.7% 15.7% 3.9% Strongly agree Partly agree Partly disagree Strongly disagree Don t know 49.0% 17.6% 49.0% 9 Strongly agree Partly agree Partly disagree Strongly disagree

11 Conclusion $16 trn total AUA, 51 survey participants The distinct worlds of traditional and alternative funds now look to be finally converging. As the convergence continues and the lines of separation between traditional and alternatives become increasingly blurred, so too will the boundaries between the supporting systems. They will be increasingly required to handle multiple fund types across multiple jurisdictions. In reaction to this, fund administrators will look to consolidate their investor servicing operations. The larger global players have traditionally run separate teams: a team focusing on mutual funds and a completely separate team handling alternative funds, each using different software. With convergence, there is an opportunity to consolidate platforms and capitalize on some of the features, cost savings and efficiencies that are available from moving to the right platform which can handle both. Such a platform will deliver the scalability and control demanded by traditional funds, combined with the complexity and flexibility more characteristic of alternatives. For alternative investment funds, AIFMD seems to be here to stay and the respondents of our survey are on the way to understanding and assessing the impact of the Directive. At Multifonds, we work closely with our clients to assess the impact of regulatory initiatives. For AIFMD, we have been proactive within our user community, running workshops to identify the impact and required changes and sharing the cost of analysis and software changes between our users. The topics arising during the workshops were in line with our survey findings, with discussions focused mainly around depositary liability, valuations and investor and regulatory reporting. Providing efficient global multiple fund type investor servicing and transfer agency processing is key and at Multifonds, we work in partnership with our clients to help them achieve this. Keith Hale is Executive Vice President, Client and Business Development with global responsibility for client management and new business development across all products. Keith has more than 20 years experience in the investment industry, working on more than 50 projects with more than 30 leading buy-side, sell-side and asset servicing clients. T E Sern Tham is Head of Alternatives Product with responsibility across all products for the alternatives sector, including hedge funds, private equity funds and real estate funds. Formerly, he was director for strategy and execution, and head of financial planning and analysis for Omnium (formerly Citadel Solutions). T E 10

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