aifmd impact survey final results 2014

The impact of AIFMD

Research survey 2014

2 The impact of AIFMD – Research survey 2014

Introduction

In the last two months prior to the expiration of AIFMD’s transition

period IFI Global conducted a wide ranging qualitative research

survey with alternative fund managers, and other key opinion

formers, on the Directive’s anticipated impact on the industry.

The goal of this research is to find out how alternative managers,

and their service providers, expect that they will be affected by

the Directive. Whilst AIFMD’s introduction has been debated

for many years there has been little to no research, prior to this

survey, on what material impact the Directive will have on individual

businesses.

Managers with dedicated alternative assets of $197 billion, and an

overall AUM of approximately $2.5 trillion, took part in this survey.

Interviews were also conducted with London based fund lawyers

as well as a number of fund governance firms and consultancies.

73 organisations participated in the survey of which 71% were

managers.

Overall breakdown by industry category (73 organisations)

Managers

Lawyers

Fund governance firms

Consultancies

71%

11%

11%

7%

Manager catagorybreakdown

(56 organisations)

Private equity & real estate

Multiple (ie long only with hedge etc)

Hedge fund of fund

Hedge fund

19%

41%

17%

23%

Overall breakdown by industry category (73 organisations)

Managers

Lawyers

Fund governance firms

Consultancies

71%

11%

11%

7%

Manager catagorybreakdown

(56 organisations)

Private equity & real estate

Multiple (ie long only with hedge etc)

Hedge fund of fund

Hedge fund

19%

41%

17%

23%

The impact of AIFMD – Research survey 2014 3

Contents

Summary of the overall conclusions 4

Benefits vs drawbacks 6

Forecast AIFMD winners & losers 8

Investors 9

Risk management 11

Reporting & regulatory issues 14

AIFMD platforms & ManCos 15

Conclusion 17


Summary of the overall conclusions

l There was universal agreement amongst interviewees that the European

alternative fund industry is going through a period of substantial structural

change. But the role that AIFMD is playing in this process is more open to

question. A majority of survey respondents believe that the Directive will act

as a catalyst for changes that, in many cases, were already occurring on the

operational side of the business. Others see AIFMD as a profoundly negative

development that, in and of itself, puts the other regulatory measures

introduced since the market crisis into the shade. And a small minority of the

boutique managers that were interviewed for this survey see the harm that

the Directive will do to their businesses in almost existential terms.

l Despite the fact that it took many years to draft, with each new development

followed closely in the press and discussed ad nauseam at industry

seminars, the survey found a surprising degree of uncertainty on how much

AIFMD will really impact interviewees’ businesses. This particularly applies

to alternative fund distribution. It also applies to depositary and particularly

‘depo-lite’ topics. But the area where there is most uncertainty is in risk

management. There is a great deal of doubt as to whether AIFMD’s risk

management provisions are really a compliance matter (some sort of box-

ticking exercise) or something potentially more fundamental – possibly

even bringing about a step-change in the way that portfolio management

decisions are monitored and made.

l Aside from the question raised above, the majority of survey respondents

do not believe that AIFMD’s risk management provisions will be much, or

perhaps even any, benefit to investors. Some respondents even suggested

that there is a real danger that regulated AIFs will lull investors into a false

sense of security which could well be dangerous. The concern is that

investors will do not the same level of due diligence on regulated AIFs as they

do on unregulated offshore alternative funds.


Summary of the overall conclusions

l At the time that the fieldwork for this survey was conducted, in June and July

2014, a number of interviewees were concerned that their applications would

not be approved for some months to come. Those that are in this camp were

worried that their ability to do business might be hindered as a result. The

possibility that investors might delay making allocations to funds because

authorisation has not been granted was raised. There was fierce criticism of

the how the FCA has handled the application process: those most familiar

with it stated that the regulator has not devoted sufficient resources to

AIFMD approvals.

l AIFMD is expected to initiate a period of innovation and creativity in European

fund structuring but it will also help bring about the end of the era of fund

product innovation that the industry was famous for over the last two

decades. How alternative fund strategies are ‘packaged’ to investors as a

result of the Directive will very likely change considerably over the next few

years. But the strategies themselves will be no different than before.

l The Directive means a very considerable increase in managers’ costs and

time spent on ‘unproductive matters’, as one interviewee put it. And a

significant number of survey respondents said AIFMD’s carrot, the passport,

is of little to no interest to them. (These are interviewees from what one of

this group described as the ‘real’ alternative management houses, more

commonly known as the boutiques, as opposed to the large mutual fund

complexes with their alternative ‘lite’ funds.)

l The results of this survey suggest that the AIFMD winners are managers

that have UCITS fund ranges and/or multi-billion organisations that have the

resources and structure to take AIFMD’s regulatory burden in their stride. The

losers are the boutiques. More than one of those that was interviewed from

this category think that the ultimate goal of the Directive is to severely curtail

their development; it is believed that the powers that be in Brussels have

never been comfortable with relatively small, and previously lightly regulated,

specialist alternative fund houses that have sprung up in London over the last

10 to 15 years.


Benefits vs drawbacks

Following are the main benefits and drawbacks of AIFMD mentioned by survey

participants:

Benefits

l AIFMD provides managers with the opportunity of having their funds

passported across the EU.

l The Directive will encourage potentially significant numbers of investors to

allocate to alternative strategies for the first time. And many existing investors

will likely allocate more. This combination will result in a sizeable growth in

alternative fund managers’ AUM in Europe.

l Alternative fund fragmentation will end. AIFMD will require those running

alternative funds in future to have strong and stable infrastructure, real

economies of scale with well-resourced service providers. The Directive will

therefore result in industry consolidation – including service providers as well

as managers. In future the vast majority of European alternative funds will be

run by fund management houses with deep pockets.

l The Directive has already unleashed a wave of fund structuring creativity

that is expected grow strongly over the coming years. In particular third

party AIFM compliant ManCo platforms are in the vanguard of this trend. A

number of different outsourced AIFM compliance opportunities are also being

presented to managers at the moment, and it is expected that there will be

more of these in future. Managers said that they are receiving a lot of offers

from providers of outsourced services at the moment.

l AIFMD will encourage managers to place greater emphasis on risk

management, especially at board level. The evolution of risk management

into a broad and holistic discipline in investment management (with various

elements in addition to market risk) maybe one of the most beneficial

outcomes of AIFMD.

(NB: not one respondent said a benefit of AIFMD would be investor protection.)



Negatives

l There is much concern that AIFMD will lead to a very considerable increase

in costs with little to no compensating rewards. This view was most forcefully

expressed by the managers interviewed with AUMs of less than $1 bn.

Managers interviewed with AUMs below $1 bn say that AIFMD has increased

their cost base from between 33% to 50%. Hardly anyone in this category

sees any compensating benefits from this increased expenditure.

l The cost imposition imposed by AIFMD is forecast by all to be especially

harmful to the start-up manager market. Some of those interviewed fear

that it might effectively disappear. Should this occur it will have a knock-on

effect on alternative fund product creativity in Europe. “London has been a

centre of hedge fund innovation; that will no longer be the case”, said one

interviewee.

l Investors will be lulled into a false sense of security because they will regard

regulated AIFs as being safer than offshore unregulated funds. Despite the

fact that AIFMD has been enacted as an investor protection measure not

one manager interviewed for this survey, when asked to list AIFMD’s benefits,

mentioned investor protection. Given that this is main purpose of the

Directive this is a surprising finding.

l Non-EEA resident alternative managers will be discouraged from

accessing the EU market. This will mean that there will be fewer investment

opportunities for EU investors from overseas managers. There is a danger

that a ‘Fortress Europe’ protectionist mentality could develop in the EU’s

alternative fund industry as a result of AIFMD. ‘Fortress Europe’ might be

welcomed by EU based fund management complexes but it will be of little

benefit to the region’s investors.



Winners

l Large managers with well-known brand names and substantial resources

l Managers with UCITS fund ranges and established distribution channels

across Europe

l Technology providers with AIFMD solutions, particularly in risk and

reporting

l The EU’s two leading fund domiciles of Dublin and Luxembourg (the

emerging ‘Dub-Lux duopoly’)

l The risk management industry and those with risk experience that want to

be NEDs

l Law firms

l Consulting firms offering AIFMD solutions

Losers

l Boutique managers

l Alternative UCITS funds

l The start-up manager market including service providers that focus on this

market sector

l Smaller fund domiciles catering for European start-up managers

l Investors (approximately 20% of those interviewed believe that investors

will be net losers)

Forecast AIFMD winners & losers


Survey respondents were asked what views their investors

have of AIFMD. Replies to this question were largely equivocal.

The majority of interviewees say that there is very little investor

demand for regulated AIFs, to date. However others say the

disclosure provisions in AIFMD are welcomed particularly by

northern European institutions.

A variable level of understanding on AIFMD was reported by

managers of their investors. Many experienced alternative

institutional allocators are said to be knowledgeable (but many

intend to continue using existing offshore structures if they

can). Less experienced alternative investors have little to no

knowledge of the Directive as yet.

Just 30% said that the Directive has broadly been welcomed

by investors. Those that are in this category suggested that

institutional investors will increasingly require funds to be

compliant with the Directive before considering an allocation.

One interviewee said that pension funds are known to have

a ‘herd mentality’ and that once some of the market leaders

demand AIFMD compliance others will follow.

But those that are in this are camp are also largely sceptical

about the potential of the Directive to expand the market for

alternatives to new investor groups, at least in the short term. A

small number of interviewees, however, said that AIFMD should

help in Germany. One of the reasons why German institutions

have been slow to allocate to alternative strategies (relative to

those in The Netherlands and the Nordic region, for example) is

because most of these funds have been unregulated offshore

entities, to date. Lightly regulated offshore funds have not been

popular with German institutions.

The survey came across many managers who said the extra

costs that have been imposed on them by the Directive will be

passed on to their investors. Therefore AIFMD will prove to be

unpopular with them. Hedge fund boutiques and private equity

Investors

“AIFMD has raised

the administration

costs in our funds by

approximately 50%,

but I do not expect

any investor will ever

be able to identify a

single benefit they

have derived from

the expenditure they

have been forced to

undertake” – $800 million

long-short equity manager

“The number one

priority for investors is

return. By adding to

costs the increase in

regulation takes away

from returns. This will

deter investors; it will

not encourage them”

– quant macro manager


Investors

managers interviewed focussed on how increased costs will take

away from their funds’ net returns.

However not all managers said that their extra costs will be

passed on. (It seems that boutiques will be required to pass

on these costs in order to remain profitable but the largest

managers surveyed will not be required to do this.) Interviewees

were therefore split on whether the increased regulatory costs

will be passed on to investors. Approximately 35% of managers

surveyed believe that investors will not allocate to those that

attempt to pass on increases in their regulatory costs.

There is a widespread concern expressed by interviewees that

investors will perceive regulated AIFs as being safer than offshore

funds and will not do the requisite level of due diligence. For

example through its extensive reporting requirements AIFMD

allows risk management respectability to be bestowed on a

number of manager organisations that does not appear to be

justified. Many investors may not understand this.

“We have experienced

the full spectrum of

interest from ‘not at all

interested’ to ‘if you are

not AIFMD compliant

we won’t invest’”

– large PE manager


Investors

Interviewees were asked how their risk management practices

might be impacted by the Directive. Responses show that the

approach that is being taken by the larger fund groups to risk

management, those with AUMs in excess of $1 bn, is in many

cases significantly different from those of the boutiques. This

difference was evident prior to the introduction of AIFMD but the

Directive seems to be acerbating these disparities.

Boutique managers interviewed are being forced into multi-

tasking risk management with various other functions as a result

of AIFMD. Boutiques surveyed see AIFMD’s risk management

provisions primarily as a compliance function. On the other hand

large managers interviewed stated that risk management needed

to go through a re-appraisal following the market crisis. Their

view is that the market crisis occurred because it was assumed

the worst case scenario was based on what had happened

in the past rather than a set of circumstances that hadn’t yet

evolved.

As a result there is a widespread view amongst the larger firms

surveyed that risk management has evolved into something

that is a great deal broader and more complex than risk

measurement. They believe that much of the real skill lies in

making sensible judgements about the future. Scenario stress

testing has become standard at large fund management houses.

And larger managers interviewed are increasingly using the term

‘enterprise risk’ to cover operational risk, linked to strategic

risk within their businesses, including governance as well as

traditional market risk.

The results of this research suggest that the larger the

organisation interviewed the greater the emphasis that there

is on risk management; but this has had little to do with

AIFMD. AIFMD might end up being a net negative for real risk

management. The degree of multi-tasking envisaged by a

number of the smaller managers surveyed might not be healthy

for real overall risk reduction.

Risk management

“I am not sure that

those came up with

these requirements (re

risk management) really

understood what they

were doing”

– fixed income manager


Hardly any managers surveyed plan to hire additional risk officers

as a result of the arrival of AIFMD. Larger managers interviewed

stated that they already have well-resourced and sophisticated

risk management departments. As a result they can largely take

AIFMD in their stride. Many of the smaller managers are not able

increase their risk management resources as a result of AIFMD

reporting and other regulatory expenditure.

The results of this research suggest that fund boards are not

ready for AIFMD’s risk management requirements. No one

interviewed thinks that there are enough people with risk

management experience available to serve on the boards

of hedge funds (private equity and real estate are a different

matter). Risk management is often being confused with risk

measurement by fund boards.

Managers say that it is very difficult if not impossible to

find people with real risk management (as opposed to risk

measurement) experience to serve on boards in the locations

where these funds are domiciled. This is because, historically,

risk management has never been embedded in fund governance

practices.

Governance has traditionally focused on due diligence and

operational functions. Interviewees said that those that sit on

boards in fund jurisdictions come from a legal, auditing or fund

administration background. Fund boards have always had a

risk oversight role but those that fall under AIFMD now bear

additional responsibilities that are codified by the Directive.

Written rules have now taken the place of general principles.

Survey respondents from private equity and real estate fund

backgrounds gave very different answers to those from the

hedge fund sector, quoted above.

Risk management

“Most of what we are

being asked to do we

were already doing

anyway”

– large alternative and long

only manager


Particularly those respondents from the Channel Islands, where

many of these funds are domiciled, are less concerned about

the risk management board stipulations of AIFMD. Respondents

from Guernsey and Jersey said that board risk supervision skills

are sufficient for private equity and real estate funds.

Risk management

“It will take some time

to sort the board

requirements out”

– fund governance firm


Reporting and regulatory issues

Many respondents, especially boutiques, made the point that

AIFMD should be seen as a part of a general unwelcome trend

to regulation that is fundamentally changing their business. The

Directive has arrived at a time when managers have had to digest

numerous other regulations.

One manager who uses a lot derivative instruments said that his

firm has to follow approximately one million pages of rules, some

of which are overlapping. He added that his firm can be required

to report certain trades 11 different times.

The overall regulatory Tsunami will prevent start-ups from being

launched. The consensus is that a London base hedge fund

manager needs a minimum of $250 million in AUM to get to break

even in even in the simplest strategies.

Regulations are also criticised for been overlapping. This overlap

occurs between regulators in the major capital markets (for

example Dodd-Frank and Sarbanes-Oxley in the US with AIFMD)

and between the FCA and the regulator in the jurisdiction where

the fund is domiciled. Managers interviewed, both large and

small, said that regulators should more coordinated. The lack of

coordination adds to cost, time and frustration.

The difficulties expected by Annex IV reporting requirements were

raised by some respondents whilst others admitted that they had

yet to get on top of this. Those that did raise the topic said that

they were surprised by just how much Annex IV covers, and the

fact that it includes reporting on qualitative as well as quantitative

data. Annex IV appears to be a whole new world for many

boutique managers surveyed – most have not been required to

provide information like this before. It is likely to be the most painful

aspect of AIFMD for many survey respondents. Many interviewees

were still finalising their rregulatory reporting templates for AIFMD

when surveyed.

For start-ups ‘$1 bn is

the new $100 million’

– long-short manager with

$1.5 bn AUM

“We are concerned

about how certain

measures are being

interpreted and applied

by different countries”

– lawyer

“From now on I will only be coming to Europe for

vacations” – large US west coast fixed income manager

“What will they do with

all the information that

they will be getting?

The FCA’s systems

might be able to do

something with the

quantitative data points

but what about the

qualitative data?”

– global macro manager


AIFMD platforms & ManCos

AIFMD is anticipated to lead to a large growth of various third

party platforms and sub-advisory relationships. The structure of

these is expected to evolve significantly in the years ahead. The

results of this research show that they are being used by larger

managers as well as the boutiques.

The third party ManCo option, in particular, is welcome by

many interviewees. They are likely to be used by many larger

managers surveyed as well as smaller ones – and by European

based managers as well as US ones. Interviewees say one of

the chief selling points is their ability to do the risk management,

as stipulated by AIFMD, in the jurisdiction where the fund is

domiciled.

Fiduciary firms interviewed say that their ManCo platforms offer

managers in the US an opportunity to get into the European

market without having commit large amounts of capital and

resources. And taking away a lot of the headache of AIFMD’s risk

management requirements is also a big selling point.

Some managers surveyed raised questions about the

relationship between ManCos and the funds on their platform

from both a branding and governance perspective.

For example one respondent said that he is concerned that

ManCos can get in the way of the relationship between the

fund’s directors and the investment manager. He said he is

concerned that ManCos are dictating what information the

board can see but it is the fund’s directors that will bear the

responsibility if something goes wrong.

“We have joined a

ManCo platform in

Dublin; this is a good

option for us”

– long-short manager with

$1.5 bn AUM

“Our business is

growing rapidly; we are

seeing interest from

both the US and the

UK”

– fund governance firm

with offices in Dublin and

Luxembourg


Domiciliation

Most comments received on domiciliation came from the

lawyers and consultants surveyed; managers had little to say on

domiciliation other than expressing a general view that they did

not think AIFMD would require them to change the domiciliation

of their funds. This included those whose funds domiciled in

jurisdictions outside the EU. For example many of those surveyed

with funds based in Guernsey and Jersey are taking advantage

of the opportunity to use private placement rules put in place in

the Channel Islands to meet their AIFMD requirements.

A clear majority of lawyers and consultants surveyed, however,

said that there is a general and growing trend by alternative

managers to domicile in Dublin and Luxembourg. But this is not

necessarily a result of AIFMD. Hedge fund managers have been

using Dublin as a domicile, where many have had their funds

administered, for a number of years now. Equally private equity

managers have been using Luxembourg for some time too. It

is expected that AIFMD will increase this trend but when the

fieldwork for this survey was conducted it was too early to tell.

The popularity of alternative UCITS funds, which does require EU

domiciliation, was mentioned by a number of interviewees. One

manager interviewed had just returned from a trip to Switzerland

where some of the people he visited, despite being outside the

EU, had asked him if he would consider putting a UCITS wrapper

on his funds.

On the other hand many of the hedge fund boutiques surveyed

said that they are very happy with Cayman and had no plans to

make any changes.

“We would never

re-domicile, we are

happy where we are,

but we might decide

to launch future funds

for European investors

from within the EU”

– private equity manager

“We always advise our

clients to domicile their

funds in the jurisdiction

that is going to be most

acceptable to their

investors, at the end of

the day it is that simple”

– lawyer


Conclusion

l Most boutique managers cannot see any real advantages to AIFMD; a few

say that they might move offices to centres outside Europe

l The emphasis on risk management in the Directive will be of little real benefit

to most investors and in some situations, paradoxically, could conceivably be

dangerous

l The European alternative fund industry will become yet more institutionalised

than it is today; on present trends there will few independent alternative

managers left in the EU with AUMs below $1 billion by 2020 (but the EU

might not include the UK by then)

l Nobody surveyed said that one of the benefits of AIFMD will be investor

protection

l There will be a considerable growth in manager alliances, third party

platforms and related activity to obtain distribution; for the passport to be

worthwhile accessing well established distribution channels will be essential.

aifmd impact survey final results 2014

Business

impact of aifmdresearch

alternative fund managers

alternative managers

alternative fund strategies

hedge fund of fundmultipleie

overall conclusionsl

number of interviewees

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