AIFMD Depositories and the Impact of AIFMD on Fund Managers

Date: March 20, 2014

For the alternate investment fund (AIF) industry, the spotlight is on Alternate fund manager’s directive (AIFMD). 

Aimed to protect investors, monitor systemic risk and establish a harmonized EU framework, it is evident that AIFMD will have far-reaching impact and herald a cultural change in the AIF industry. However, understanding the torrent of this regulatory shift is not an easy task as the scope of AIFMD is enormous.

With July 22, the deadline to comply with the directive fast approaching, fund managers are grappling with the issues of compliance and implementation. For Alternate investment fund managers (AIFMs), realizing the true impact of AIFMD on a firm is key to getting the change right from the start.

At a glance, the directive applies to EU fund managers managing and marketing funds in Europe and non–EU fund managers managing and marketing funds in EU. In the case of non-EU AIFMs, the regulation impacts only to those AIFs that are marketed in EU. Those AIFMs that come under the purview of this rule needs to make provisions to accommodate the new transparency, risk management and reporting obligations.

For an industry that was far less regulated, the AIFMD regulation is heavily onerous. Fund managers at this point are quite aware of the fact that the road to compliance starts by seeking authorization from competent authorities of Member states. Many have either sought authorization or are in the process of seeking authorization. But the big impact is still off the radar.

The real impact

One of the main contentious rules introduced by regulators under AIFMD is that of compulsory depository regime. Post July 22, all authorized AIFs managing and marketing funds in EU will need to appoint a depository. In addition, there are strict rules around where the depository is established, who can be the depository as well as the responsibilities and liabilities of the depository. This will have a serious cost impact on the fund managers as majority of fund managers never had to do this before. Along with the cost factor, operational and practical issues and details accompany the new rule. AIFMs need to think if they have the capabilities to provide relevant information to the depositories on a regular basis. This might indicate the need to redefine data management, integration and sharing capabilities of the firm.

Disclosure norms

A common theme and concern of regulators in a post-crisis scenario has been the need for transparency. In order to achieve transparency in the managing and marketing of AIFs, AIFMD dictates strict disclosure norms to AIFMs, which they have to adhere to. AIFMs will need to focus on defining workflow that can help produce accurate and qualitative information from both internal and external sources in a timely manner.

To investors: While disclosure norms are part of a AIFMs routine, AIFMD emphasis on specific types of information that fund managers should be able to disclose to investors. AIFMs should disclose information about

  • Overall investment, investment strategies and restriction;
  • Valuation, liquidity and leverage;
  • Delegation, remuneration and other expenses and fees
  • Risk profile

To regulators: AIFMs should report to competent authorities about

  • The main instruments in which it is trading, the markets in which it actively trades
  •  The diversification of the AIF’s portfolio including its exposures and most important concentrations.
  • In the case of non-EU AIFMs, they need to report information to the national competent authorities of a Member State regarding only the AIFs marketed in that Member State

Annual report: AIFMD mandates AIFMs to make annual reports available to investors and regulators within six months of year-end. Apart from the necessary accounting information and remuneration policies, AIFMs are also supposed to disclose any changes to funds, managers, and its risk and liquidity profile. AIFMs also have to follow the template ESMA has published as technical guidelines to facilitate reporting.

Read: New Insights for Asset Managers: How Technology Can Drive the Most Effective Middle Offices

Risk Management
Like in any other financial regulation, AIFMD also puts great emphasis on risk management and risk monitoring. This means that unlike earlier, AIFMs can no longer side-line risk management as an ad hoc function and will need to bring it in as a mainstream function. This will create a great impact on the operational side for AIFMs.

So how does it really create the operational and cost impact?

  • AIFMs need to establish functionally and hierarchically independent risk management functions and processes. This should not be mixed with portfolio management.
  • AIFMs should create and document risk management processes.
  • Manage, measure and monitor market risk, counterparty risk, credit risk, liquidity risk and operational risk at regular intervals.
  • Appropriate qualitative internal control mechanisms should be in place to avoid and mitigate operational failures.

Under AIFMD, risk management framework involves all key players involved in the investment management process: Investment manager responsible for investment policies, liquidity risk and geographic concentration of investments; custodian monitoring the impact geographical location of investments and keeping an eye on sub-custody network; Board responsible for defining investment strategy, delegation and fund administrator monitoring market impacts and computing NAV.

While it is sure that AIFMD will impact the administration, operation, governance and marketing activities of AIFMs, the extent of impact will depend on where each AIFM stands in terms of their ability to meet the new rules of transparency, risk management and reporting obligation. Like any regulation, AIFMD also involves a trade-off on costs and needs to be addressed in a holistic and synchronized approach so as to keep control of expenses.

Visit our AIFMD resource page for more articles and information.

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