The alternative investment fund management directive proposes that managers of all open and closed-ended collective investment undertakings (subject to a size limit) which are not currently subject to EU Ucits regulation should be authorised and subject to standardised rules.
This means managers of all funds that are not Ucits funds (including UK non-Ucits retail schemes) will be caught as well as managers of investment trusts. This alone has drawn much criticism. Can one set of rules be produced to sensibly regulate such a broad range of funds – from venture capital to property, commodity hedge and infrastructure funds?
In return, it proposes that managers will have a right to passport such funds to professional investors across the EU (currently, private placement rules vary from country to country). However, where the funds are based outside the EU, this will only be possible after a period of three years, provided the fund’s country of domicile meets OECD standards in relation to tax reporting. Non-EU-domiciled managers of funds must, in addition, meet equivalent standards of conduct of business and information-sharing agreements.
Most of the proposed rules seem reasonable in principle. Rules to ensure the safekeeping of fund assets, their correct valuation, appropriate oversight of delegated activities and proper risk management all appear rational. But it is at the level of detail where many of the issues arise.
An AIFM can only delegate investment management to another AIFM so how does this work with existing arrangements to use non-EU managers? Depositories must be EU credit institutions but how does this work with hedge funds, prime brokerage models or “real” property funds? And depositories are to be liable for funds’ assets when they use a sub-custodian abroad, even where they have carried out all appropriate due diligence and acted in good faith. Will depositories want to take on such liability and, if so, at what cost?
For mainstream advisers offering clients traditional retail funds, there may be little to be concerned about. But if the proposals stay as they are, many of the standards are likely to find their way into the Ucits directive as, logically, retail clients should have at least the same protection as that available to professional ones.
The Commission has already stated that the rules relating to depositories will mean changes to Ucits. So the consequences of the proposed depositary liability rules may well result in depositories of Ucits funds either seeking much greater fees for providing custody in emerging market regions or pulling out of providing such custody altogether. The result could be much higher costs of invest-ment in these markets or it could become impractical.
For advisers servicing more wealthy clients, perhaps another implication will be that many alternative fund managers may decide to move their operations outside the EU. This might mean a restriction on advisers to access such managers and funds.
A compromise proposal is expected after the summer and some form of agreement may be reached at the end of the year and any formal adoption is likely to occur until in 2010.
Simon Vernon is head of fund regulatory strategy at Schroders