Friday, 1 July 2016
Last updated 5 hours ago
Jun 30 2014 | 6:01am ET
For most people in the Northern Hemisphere, July is a month to rest and relax, but for fund managers subject to new EU regulations, July has been a month to meet deadlines.
The European Directive on Alternative Investment Fund Managers came into force in July 2011 and was required by law to be implemented in all 28 EU member states (plus Norway, Iceland and Liechtenstein) by July 2013.
July 2014 brings further requirements, specifically for hedge fund managers based outside of the EU.
FINalternatives decided to get an expert opinion on the AIFMD implications for U.S.-based fund managers, so asked Jerome Wigny, partner at Elvinger, Hoss & Prussen and co-chair of the Association of the Luxembourg Fund Industry's hedge fund working group, what this means for them.
“The first thing to say is that it depends country by country,” said Wigny by phone from his Luxembourg office, dashing all hopes for an easily explained “one-size-fits-all” regime.
“[I]f you are the U.S. manager of a Luxembourg fund, then there is absolutely no...AIFMD consequence as long as you don't market that fund into Europe...You don't have to report, you don't have to adapt your structure, you don't have to change your documentation, it's really simple.”
“And that is really good because you have many legacy products that maybe used to be marketed in the EU and are not anymore or they just have been set up at the request of a given institutional investor in Europe and they are not...marketed, or they were set up for investors in the Middle East...”
The change comes if the manager wants to market that fund in Europe, in which case he (or she) “basically has to comply with rules that are the same as if it were a Cayman fund sold into Europe, so it needs a prospectus to be updated with certain disclosures,” among other requirements, said Wigny.
Complicating matters somewhat is the lack of a European definition of marketing—what constitutes marketing in a jurisdiction will be decided in that jurisdiction. “But,” said Wigny, “basically marketing is being proactive, so if you're completely passive and someone comes to you, that is not marketing.”
If you, as a U.S.-based hedge fund manager and want to actively market in the EU, you have a couple of options—one of which is an alternative fund manager passport.
The passport gives you access to European markets as long as you approach only professional investors (unlike UCITS funds, for example, which may be sold to retail investors).
“But that passport is only available in one scenario and that is when your fund is in Europe and your manager is in Europe,” said Wigny. “So, one of the things that is open to U.S. managers is to team up with or to hire a European manager to grant access to the passport.”
That solution is common among U.S. managers with subsidiaries or sister companies in Europe.
If you are a U.S. hedge fund manager wanting to market a European or non-European-based fund into Europe and you don't have a passport, you can still (as of July 2014) do private placements in select EU countries.
U.S. managers initially balked at the hoops they had to jump through to complete a private placement, but that's changing, said Wigny:
“A year ago, a number of U.S. managers would say, 'If it's so painful, I'll just stop selling into Europe.' But I was in New York two weeks ago, [and]...it's very rare, the U.S. managers that don't have at least 10%, 20%, 60% of their assets that come from European investors...They now realize that cutting off Europe is painful...”
“I think the evolution is from, 'Okay, then we don't sell into Europe,' to now trying to go for private placements but reducing it to the key jurisdictions. The key jurisdictions, because they're simple and there is enough appetite, are UK, Luxembourg and Ireland. Sweden, Finland and Holland are also fairly simple countries, because there's no gold plating [adding additional local requirements to the basic AIFMD].”
“And then in the second category you have a country which is large for alternatives, Germany, but there are extra requirements and so therefore it very much depends if it's a very key market or not—many would just wait and see for Germany.”
“And then in the third bucket you have the countries where they're not necessarily huge for alternatives and they're painful or impossible like Italy, Spain or France. But again, it depends on who the manager is and who its main clients are.”
The next July deadline (after this July 22) comes in 2015, when the European Commission must decide whether to extend the AIFMD rules to non-European managers.
“It means, on one hand, that the passport might be open to U.S. managers,” said Wigny, “but on the other hand, it would also mean that the U.S. managers would have to be regulated in Europe, and the experience to now is that you normally don't want to be regulated by another regulator than your home regulator.”
Even if the EC comes down in favor of extending the rules to non-European managers, it will simply be an opinion and it could be “one or two years” before it is implemented, Wigny himself has doubts such an extension of the rules will ever take place.
The final AIFMD deadline is July 2018, after which it is possible that private placements will be abolished and “either you have a passport and you can sell into Europe or you can't sell at all.”
That phase, said Wigny “is very remote and very unlikely and anyway, it will depend on the second phase, on what has been decided.”
One side effect of the AIFMD has been to make the UCITS wrapper appear more attractive to U.S. fund managers.
“UCITS is a bit like a mutual fund, so it's more regulated, it's more complicated,” said Wigny, “[but] now, because of the AIFMD...the other funds are also more regulated, are also more complicated.”
That makes UCITS funds—which have established rules and a track record and can be sold to retail investors—a more viable option for non-EU managers than they were pre-AIFMD.
Interest in alternative UCITS has grown "tremendously" over the past few years, said Wigny, who stressed these should only be set up if they truly fit the UCITS format. When strategy and format are a good fit—as with long/short funds—it's "probably just as simple" to create a UCITS fund “and the marketing passport is better than the one offered by AIFMD.”
Wigny said there are two key issues a manager must consider when weighing the possibility of launching a UCITS fund. The first is liquidity—shareholders must be able to redeem at least twice a month.
“The second thing is performance...Alternative managers were struggling...to explain to their investors why the performance in a UCITS is not the same as in a Cayman fund. Clearly, it's because there are more constraints in UCITS...If you short, you have to do it synthetically; you have more requirements in terms of risk diversification; you have a number of assets which are not eligible; etc; so the reality is that it's just a different animal and if you try to sell it on the basis of your performance in a Cayman fund, then it's difficult.”
In this brave new regulated world, Wigny thinks alternative managers should think more like car manufacturers:
“You build an SUV and you build a small car and you sell them for what they are.”