Europe’s financial industry is amid a compliance shortfall, particularly among alternative investment funds. Only months after the deadline for compliance with the Alternative Investment Fund Managers Directive (AIFMD), a large majority of firms have not yet received significant authorisation for their structure. The news is troubling as it depicts the problems regulators are facing with the enforcement of new financial rules and with Europe’s UCITS V regulation ahead, many fund managers are concerned of the costs and further risk this will present as they struggle to meet requirements in time for the next deadline.
For many firms AIFMD has become the sweeping indicator for how the implementation of cross-border regulation can affect an industry for months on end and incur costs in the billions. With several similar pieces of regulation underway, the lessons revealed by AIFMD compliance, or lack thereof, are a telling indicator of the success of current legislative efforts to regulate financials.
Hedge funds, private equity funds, commodity funds, real estate funds and infrastructure funds, among others, are all covered by the AIFMD. In this respect the regulation is far-reaching and impacts a large majority of the fund management industry in Europe. Fundamentally, the AIFMD was implemented in order to address a number of issues bought to light after the financial crisis, including remuneration practices in financial institutions to tackle incentives for excessive risk-taking.
Managers in a muddle
still need to implement risk and control systems
need to update fund documentation
yet to appoint a depository
With EU regulators maintaining the importance of AIFMD, the lacking compliance post-deadline has come as a surprise. Especially as 82 percent of managers canvassed in a recent BNY Mellon survey confirmed that the required AIFM structure was in place to meet the July 22 deadline. Despite this, almost half still haven’t received authorisation from their local regulator and are therefore not compliant with the new rules.
A lot of this comes down to a lack of resources among local regulators who have been set with the task to enforce financial rules on behalf of the EU. This means interpreting the complicated regulations and ensuring that they are complied with by the local financial industry falls on regulators such as the UK’s Financial Conduct Authority and Prudential Regulation Authority. Both institutions have endured a significant brain drain in recent years as the demand for good financial compliance heads continues to soar.
In particular, a number of European countries have not implemented the AIFMD at all, and if they have, it’s far from complete implementation. According to the Alternative Investment Management Association, this lack of regulatory homogeny in Europe is hindering managers’ ability to do business and means that investors in certain countries may be prevented from accessing alternative investment funds. Furthermore, with many managers facing delays in being authorised by their national regulators firms are unable to conduct marketing campaigns and reach investors in certain countries.
Problematically, the differing adoption of AIFMD across Europe has created uncertainty over how some measures are being interpreted and applied in the different state. This has left certain key relationships between managers and service providers in a state of flux, AIMA told World Finance.
“Unfortunately, like with many pieces of regulatory reform we have seen negotiated and applied in recent past, AIFMD implementation has proven to be more complex than originally expected, not only for the industry but also for the regulatory community. We are heartened to see that European policymakers are starting to recognise that core reform measures need more time to be put in practice and that more generous transposition deadlines are being considered,” said AIMA CEO Jack Inglis.
In this respect, the BNY Mellon survey highlights that a significant proportion of managers will have work left to complete when it comes to key elements of the AIFMD regulations. For example, 31 percent still need to implement risk and control systems, 36 percent have yet to update fund documentation, and 38 percent have yet to appoint a depository. All these elements are crucial for AIFMD compliance and with regulators failing to give timely approval, as well as firms failing to live up to approval requirements, the overall consensus is that alternative fund managers across Europe are falling seriously behind on regulatory compliance.
What’s more, regulatory reporting templates are still being finalised, despite reporting requirements due to take effect in January 2015. This leaves managers with little time to build out their IT systems, while a lack of consistency between reporting requirements in different European countries would push compliance costs higher, especially for non-EU managers seeking to market under the respective private placement regimes. With further, related regulation looming, this is not the time to be lax, yet firms are battling to keep up with costs and finding the resources necessary.
When AIFMFD was finalised by EU regulators, estimates suggested that it would cost every firm between £300,000 and £1m to correspond with the rules and adopt the new regulations. What has become apparent since is that the costs are far outweighing the initial estimates, as well as the benefits of the regulation. In particular, hedge fund managers and other alternative fund firms say that regulatory reporting, followed by risk and compliance reporting have incurred the greatest one-off costs. They will also continue to do so for years to come, as these two areas are expected to account for the majority of on-going costs associated with AIFMD compliance.
“The economic impact assessments produced by the European Commission are notable for their lack of empirical evidence on the impacts of the AIFMD. Deloitte published a survey of UK based asset managers which found that nearly three quarters of respondents viewed the AIFMD as a threat to their business and more than two thirds suggested that the AIFMD will reduce the competitiveness of the industry in Europe and the AIFMD will lead to fewer non-EU managers operating in the EU. The overall asset management industry has an annual impact of €102.6bn and 510,000 jobs across Europe. If Europe lost its competitive advantage in fund management because of the AIFMD, around €21.5bn and 107,100 jobs would be at risk from the regulation,” the New Direction Foundation said in a recent Red Tape Watch report on EU regulation.
The increased costs to fulfil the regulatory requirements around AIFMD in some cases looks set to fall onto individual funds, impacting total expense ratios particularly. Every ninth fund manager even said they now expect costs to be passed on to the fund in full, with a third saying they will pass on some of the costs. Consequently, fund managers are now bracing themselves for higher-than-expected levels of cost and complexity when it comes to meeting requirements around the UCITS V regulation, which essentially aligns the UCITS regulatory framework with certain aspects of AIFMD and is expected to be transposed into local law in 2016.
Benefits and implications
“The continuing challenge for managers will be to attract new inflows of money into their funds – but AIFMD’s impact is significant and causing some funds to question the longer-term feasibility of their business models. We are witnessing a step-change taking place within the industry, which will have far reaching consequences for funds and investors alike,” said Hani Kablawi, Head of Asset Servicing for Europe, Middle East & Africa at BNY Mellon.
Looking forward to the UCITS V Directive, fund managers are now growing increasingly concerned that the UCITS V implementation costs will exceed original expectations, and that compliance will be more complex than anticipated, on the back of AIFMD’s complicated and costly enactment. To this end, AIFMD will also have other implications. Investors will now have less choice between investment products, as a third of fund managers have said that they plan to merge or close funds as the costs of compliance for each individual product becomes too much to bear.
“With UCITS V pending and expected to be even more far-reaching in scope, now is the time for fund managers to start planning and to identify the lessons learned from AIFMD that can then be applied as they look to successfully navigate the changes that will bring around depositary functions, remuneration and administrative sanctions,” said Kablawi.
The BNY Mellon survey revealed that many fund managers are questioning whether AIFMD will even turn out to be beneficial to their organisation. A large part of the industry still maintains that the benefits are hard to gage and that regulators will be the primary group to benefit from the regulation – despite AIFMD being implemented in order to create a more transparent and less risky industry, for fund managers and investors alike. That said, AIFMD is one of the biggest pieces of EU regulation to have been implemented post-crisis and it’s less than impressive enactment, may be a stark indicator of what awaits the finance industry in coming years when the likes of MiFID II, Solvency II and UCITS V roll out.