AIFMD & UCITS
Authored by: Synechron Business Consulting Group
‘Better the devil you know than the devil you don't know’ seems to be the attitude many commercial institutions take when faced with the choice between UCITS or AIFMD. With the AIFMD coming into force, funds established or marketed in Europe will be covered by one of the two directives. This means that certain players have had to or will have to make important considerations. Considerations, given the recent commencement of UCITS V, are again raising a few more questions. This is because, although the choice for UCITS seemed like a logical one for many of these players, it might turn out to be less beneficial when UCITS V and VI come into force.
Managers of alternative funds which were not regulated under the Act on Financial Supervision, however, have little choice as they had until July 22, 2014 at the latest to file an application for an AIFMD license to avoid being paid a visit by the regulator in the near future. A date which makes it important to start taking large steps in the process of getting to know this new regulatory 'devil'; steps which many appear not yet to have taken, given that two months ahead of the deadline, AFM has only issued three licenses.
Synechron has carried out an investigation into the impact of the AIFMD and the possible interaction between UCITS and the AIFMD, including holding a number of interviews with a range of players that will have to deal with these directives. For instance, commercial institutions, a depositary, the regulator and industry organizations. The insights that were gained from these interviews are essential in setting up services which will make it possible for the different financial institutions affected by this regulation to implement the directive as effectively as they can.
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UCITS: A short introduction
The process of regulating collective investment sector has been ongoing for more than 26 years, i.e., since the publication of the UCITS I Directive on December 31, 1985. The original aim of this directive was to set up a clear framework for investment funds in Europe in order to facilitate their distribution and offer European citizens equal protection. Meanwhile, the latest amendment to this regulation goes under the name of UCITS IV which was implemented in July 2011. The aim of this was to make the internal market for the collective investment sector more efﬁcient by, for example, introducing a European passport for managers of UCITS funds and easing international mergers.
This wag UCITS has, over the years, developed into a quality label within the investment sector, seen internationally as an investment fund's hallmark. This quality stamp is not the only benefit to the fund manager. There are also economies of scale and the relatively easy distribution of the fund throughout Europe, not to mention the beneﬁts to the investor. Thanks to the requirements with regard to risk management and transparency, UCITS is seen as a product that people can trust. The popularity of UCITS is illustrated by the fact that the so-called Newcits or alternative UCITS funds with relatively complex investment structures 'voluntarily' opt to join the UCITS regime. Besides, various Dutch asset managers moved the majority of their funds to the UCITS regime when they were faced with the choice between the AIFMD and UCITS.
The success that was achieved up to and including UCITS IV, is mainly due to the fact that each time the amendments were aimed at efﬁciency and an expansion of the framework. With this change to the framework and extending the possibilities for the UCITS funds, including permitting complex investment strategies, it emerged that stronger requirements were necessary for the avoidance of conﬂicts of interest, regulation and transparency.
The lack of this is what led to scandals such as the Madoff fraud. In addition, the crisis revealed that unlimited bonuses and variable remuneration were undesirable within the context of risk management. This is what led to UCITS V on which an agreement was reached in April 2014. Here, the focus is mainly on the details of the depository function and remuneration policy. In 2016, the directive must be implemented in national legislation.
However, the consultation round of new amendments to the UCITS directive, UCITS VI was already launched in 2012. Possible, new provisions are likely to relate to limitations to investments in OTC derivatives, the creation of a framework for long-term investments for retail investors, stricter requirements for liquidity management and the introduction of a European passport for the depositary.
AIFMD: A short introduction
The aim of AIFMD is to realize a harmonized legislative and regulatory framework which establishes common requirements for the authorization and supervision of alternative investment funds. Moreover, the Directive will enable the risks and their consequences for the investor to be addressed coherently. In other words, on the one hand the focus is on protecting investors and on the other, what is important is the management of (systemic) risks resulting in increased trust and stability on the financial market.
However, the UCITS has been able to build up support for more than 25 years, the adjustment period for managers of alternative funds has been considerably shorter. Within a few years this sector will be going from a situation in which it had more or less free rein to far-reaching rules relating to matters, such as risk management, liquidity management, remuneration, reporting and the appointment of a depositary. The last of these is so far-reaching that it will also influence the entire landscape for fund managers, prime brokers and custodians. It is therefore logical that so far there isn't any wide support within the sector for this regulation.
What isn't helping either is that the AIFMD was, in essence, set up for the regulation of hedge funds. Whereas, it now covers all alternative funds that are above the specified threshold. A one-size-fits-all approach for sectors which, in terms of business operations which are vastly different, is not always appropriate. After all, why should a private equity house pay the depositary a fee, often based on assets under management when the depositary is unable to carry out one of its core duties, safekeeping? After all, inherent to the business operations within this sector, there is quite simply nothing to be 'safe kept'. It seems as, though Europe sometimes takes rather rash and hasty decisions, which has been shown not to be unique over recent years.
As with any new regulation, the AIFMD will certainly come with a number of challenges: the costs for compliance will increase, certain business processes will need to be altered and a suitable depositary will have to be appointed. On the other hand, the regulation will offer certain opportunities. For instance, it will, in some cases, become easier to enter the whole European market, border barriers will generally be removed and there will be opportunities to restructure certain organizational processes.