As the market counts down to the scheduled July 2011 implementation of UCITS IV, many participants, especially the alternative asset management space, have had to make sure they are fully prepared for any changes.
With the full implementation of UCITS IV on the horizon, Global Custodian spoke exclusively with Dermot Butler, Chairman of fund administrator Custom House Group, on what it will mean for the alternative investment sector.
Q: How has the landscape changed for fund administrators over the last few years?
A: Since both the credit crunch and particularly Madoff, there has been very much greater investor, particularly institutional investor, pressure on funds to have administrators and for those administrators to be clearly independent. Indeed, three Swiss banks took a stance that they would not invest in any self-administered funds in the US, unless those funds appointed an independent administrator. This has been accompanied by a greater demand for “transparency” in many of its different interpretations. However, the demand for transparency has resulted in the demand for a wide variety of reports, both standard and customised, to be provided by administrators, to both managers and investors and providing data, for example, on attribution, including sector, geographic or asset type.
The introduction of some quite draconian regulations – more in the US than in Europe, as yet – will mean that administrators are going to have to support managers in providing the information required under the Dodd Franks Act/SEC registration. None of this is particularly problematic. It just requires more systems and interfaces between the administrator and the investors and/or managers.
Q: We have UCITS IV coming up and many are seeing it as a positive step to opening up these markets. What is your view and what negative impacts do you see arising for the industry?
A: I personally have a philosophical, somewhat negative approach, to UCITS for alternative investment and hedge funds. This is because I believe that a lot of people who have jumped onto the UCITS bandwagon haven’t thought it through. This is for a number of reasons. One is cost, both to establish and operate a UCITS. Secondly, investment restrictions in UCITS preclude many hedge fund strategies, unless they go through a potentially expensive and performance trimming procedure to enable the hedge fund to operate under UCITS restrictions, often utilising swaps and/or other derivatives.
Although I am negative and I could go on with other reasons as to why I am negative, there is no doubt that some hedge fund and alternative investment strategies are ideally suited to the UCITS structure and, if the manager has sufficient initial capital for the fund and a distribution network, then the UCITS product could prove to be a very valuable and successful product. UCITS impose minimum two-weekly liquidity, as a result of which the majority of UCITS funds offer daily liquidity. This itself does not work for some hedge fund strategies and, therefore, investors must be happy that they are not going to end up with a gate, should the market turn sour.
Q: What impact will it have for fund administrators and how do you play a part at minimising these risks?
A: UCITS IV, together with the new regulations and investors’ demands, will force administrators to provide, not so much a better, as a more complete service. There is pressure from managers to outsource much more than they used to and administrators are expected to take up that slack. Similarly, as I have stated above, the administrators are going to be required to provide support to managers in ensuring compliance with both the Dodd-Frank Act and the European AIFM regulations when they are published. Additional services will be required, including, for example, the verification of the existence of assets. This was not generally part of the administrator’s contractual commitment, however, since Madoff and Petters and the refusal to accept responsibility for verification by the big five auditors, it looks as if, once again, the duty will fall on the administrator.
On the whole, verifying the existence e of assets is not difficult, just time consuming and, in some cases, may require some forensic accounting. This is an additional task that administrators will charge for and, as such, it will make running a fund more expensive, but you can be sure that complying with Dodds Franks and the EU regulations will already increase compliance requirements and costs, which will be passed on to the investor.