Q&A: RWC’s Peter Harrison On The Pros And Cons Of UCITS Regulation

Feb 25 2010 | 11:41am ET

RWC Partners began life in 2000 as MPC Investors, chiefly a hedge fund house. In 2006, Peter Harrison was named chief executive, the management teams were expanded and today, RWC Partners (owned and controlled by the portfolio managers and management team) manages assets of over $2.5 billion. Of that, over $1.5 billion is in UCITS funds, so we thought Harrison would be a good person to talk to about UCITS III regulations (and the upcoming UCITS IV) and proposed EU regulations for alternative investment fund managers – and we were right.

FINalternatives senior reporter Mary Campbell reached Peter Harrison in London last week.

I have to start with the financial crisis – what has been the fallout for your business, the ‘Madoff effect’ so to speak?

The really interesting thing, to my mind, is that we are [only] now seeing the full impact of it...We went through a whole series of emotions, obviously the first one was shock and then it was anger, and then what happened is that people started to think about how their businesses had to reshape themselves for it. And I would say that the average due diligence process that we go through has now doubled – either in length or depth or [laughs] any measure one cares to look at. But effectively what’s happened is that many of the people who were affected by it (and obviously people who weren’t, but particularly the people who were) have basically gone and hired senior due diligence people and they’ve now completed putting into place their teams...so the bar has gone up a notch. But it’s taken this long for it to happen...it’s really interesting how long it’s taken to work through the pipe, but it’s very clear now.

And how has this affected your business?

Basically, we have always set out to be more transparent. We take the view of more transparency and more openness on risk reporting, etc – or not so much risk reporting but actually thinking about what is in the best interests of our clients, so if someone wants to follow a trade all the way through, we’ve always got our doors open. That, plus, the second impact of Madoff has been the rise of UCITS and we’ve always put a great deal of store by UCITS. So I would say…first, we’ve seen better flow than we probably would otherwise have seen, and second we’ve seen more flow in UCITS than Cayman.

The EU has proposed new regulations for alternative investment fund managers [Only managers established in Europe would be able to provide their services in the EU; rules allowing the marketing of third-country funds would come into force three years after the rest of the directive.] What impact do you think they would have, if adopted?

Clearly, we’ve put a lot of emphasis on UCITS and particularly sophisticated UCITS management, so, in a sense, insofar as many of our competitive funds wouldn’t be available to our clients, perversely, it would help our relative position. I have to say, I think it would be very bad for the industry. I mean, my own perspective is I think that absolute return portfolios have a place in people’s portfolios. I think there’s a huge amount of misunderstanding still about what constitutes an absolute return portfolio and the risks inherent in it, but I think the returns over the last couple of years have illustrated that people in hedge funds have been considerably better off than people in long-only funds. And...if you make that more difficult for people, I do worry that in the long term a much broader populace will suffer. So, in the first instance, it will be funds from outside the EU, but in reality the pain will be felt by many people who would be better off owning [absolute value funds] rather than worse off.

Do you think the regulations, if adopted as proposed, would see more managers establishing UCITS-compliant funds?

I think it would, absolutely. Well, it would do two things. What’s quite clear is that the Americans have looked at UCITS and rejected it as being, generally speaking, too complicated, you know they’re just not used to daily liquidity, etc, etc, so I think you would see far less US-based product sold in Europe.

Second is that people who are in Europe and currently have their management outside Europe in the Caymans would try and move onshore to UCITS. But I mean, whilst I think this is what would happen, UCITS is difficult. UCITS is operationally very demanding and UCITS cannot accommodate all strategies. And so, I do think there will be a lot of people who just have a massive problem. So, yes, it will benefit UCITS but you know, if you’re an event manager or a credit manager who does need longer-term liquidity – maybe you need 90 days – my really big fear is that, out of business necessity, these guys will persuade themselves they can run daily or weekly priced funds, and they haven’t really got the liquidity to do it, and then all that will do is transfer the problem into the UCITS world. And what happens if we start seeing UCITS funds being gated because of non-liquid strategies being offered?

So I think [UCITS] is not a panacea for all ills. And who’s going to control, properly, the genuine liquidity in those strategies to make sure they can be priced daily? My sense is that there’s a real onus on the management company to do that. Now, at the moment, we’ve all got a choice, we do UCITS or Cayman, and if there’s not enough liquidity you must do Cayman. But the reality is, if you take the Cayman option away from people, they’ll all do UCITS and then we’ll just have a blow-up in UCITS because the regulatory structure isn’t strong enough to ensure the liquidity...I mean, if we had another 2008, it would be a real issue for UCITS. It wasn’t in 2008 because there was no leverage behind the buyers of UCITS funds because they were traditionally all long-only managers. But you know, people were still worried. I remember talking to one major bank that had a huge fund network and all their senior people were worrying about the liquidity in their funds if it spread into long-only panic. No one’s really shouting about this, but I do think there’s a real issue.

What changes are expected with UCITS IV?

Well, I think the first thing they allow is cross-border mergers, but [having read an article spelling out the effects of the new rules] I concluded that because of the national tax interests that still exist within the EU, a lot of these things are not going to be possible. Because if you want to merge two fund structures, you have to basically get to the point where you are comfortable there’s no cross-border tax, you don’t create a taxable event, effectively, and our advice thus far is that more often than not you will create a taxable event. So I am somewhat suspicious that UCITS IV is only really the first stage, and obviously you need tax harmonization across borders before you can really bring it in and we all know that’s going to take a very, very long time. I think it’s probably something for the bigger fund groups...If you’re a megabank, you’ve been the product of several mergers, you’ve got lots of different SICAV structures, being able to merge those would be fantastic. And that may be the thing that’s possible. But for the average company ... is it really a major change? I’m not certain.

One of the stated goals of the new AIFM regulations is to ‘unify’ the European market. From what you’ve said, that would be a positive thing. Do you think it will ever happen?

I think, in theory, there is an awful lot being done already, but I have to say that, once you’ve got your registration in Luxembourg, the fun is only just then beginning. I mean,...you need to put in UK reporting status, you need to put in Austrian tax transparency, you need to put in German tax transparency, you need to apply to each of the local regulators for approval, you need to then apply to the Swiss for separate registration, French registration costs, I think, EUR 30-40,000 ...There is a lot of political capital still invested in local fund structures... UCITS is getting there but it’s still a painful process. Probably our largest single cost is cross-border approvals of funds, and the legal advice that goes with that, and everything has to be translated ...it really is quite extraordinary. The myth of UCITS is that you go to Luxembourg, you get your passport and everything is fine. It doesn’t quite work like that.

So much post-crisis focus has been on regulating the management side of the business, what do you see as the responsibility of the investor?

I think there’s a lot of responsibility on the management company to get comfortable that the person they’re selling to is a sophisticated or professional investor. I mean, if we get that wrong, the problem is our problem – its’ not just the individual’s problem...You know, we get a lot of pushback from our applications [people] that say, ‘I don’t want to give you a statement of my net assets,’ ‘I don’t want to tell you if I have a pre-nup. I’m just not prepared to disclose these things.’ There are issues where the individuals really resent the scrutiny they have to be put under, but I’m sure there are a lot of individuals who have £100,000 they want to put into a fund and they say, ‘Oh yeah, I’m a professional investor’ and they tick all the boxes. I’m sure that does go on.

My personal view is that, as a manufactured product, dealing with private individuals is the most difficult, and the worst thing we [can] do as a business. If a private individual comes to us, our advice is to go and talk to your bank or your financial advisor and get them to apply on your behalf because [laughs] we really don’t want to deal with you. Which doesn’t sound very sensible, but actually, when you think about what requirements an individual has to go through to prove they are a sophisticated investor, it becomes quite obvious that you don’t want to deal with them.


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