Regulations such as the Alternative Investment Fund Managers Directive (AIMFD) is set to change relationships between custodians and their institutional investors, particularly when it comes to emerging markets.
At a State Street briefing on Regulatory Reform: The Impact on Alternatives, regulatory experts Keith Burman and Sven Kasper set the scene with the run down of the key regulatory developments impacting institutional investors in 2013 and beyond.
AIFMD will become effective as of July 2013, with the final level 2 Regulations due end of the fourth quarter 2012, and UCITS V will, amongst others, look to harmonize depository provisions within AIFMD. The European Commission has also consulted on UCITS 6.
In terms of AIFMD, the European Commission is expected to finalize Level 2 implementing measures in December 2012. Significantly, in 2018, it ESMA will issue its opinion on ending national (private placement) regimes. To this effect, some states (including Germany) are undergoing a wholesale re-write of their fund laws including the tearing up of a private placement.
On the Level 2 Consultation there remain some hotly contested topics that could have a significant impact on different sectors depending on the outcomes of the current discussions. These include:
Depositary liabilities for financial instruments and fund investmentsRequirements to monitor cash flowsArrangements with prime brokersThe treatment of collateral, restrictions on delegation and more
There are delays in issuing level two. As managers of European products you cant make a fundamental choice of what funds to be in, said Burman. As a result capital-raising has been difficult. Managers are choosing instead to raise smaller funds. They would love to get more money but it is not available to them. Onshore provides greater certainty in the in the long-standing regulatory regime.
Under AIFMD, custodians have to let their clients know the risks they are prepared to take with respect to their depositary liabilities in certain developing markets, which may in turn lead these institutional investors to stop marketing funds in in those markets.
In certain cases, fund managers will use derivatives to get exposure to a certain market, Burman noted.
Potential pitfalls, while it is easy to make comparisons with existing regimes in various countries, it is important not to underestimate the scale of changes being imposed on the alternatives fund industry, from managers, to boards, to administrators, depositaries, prime brokers and even regulators, said State Street.
“The principles are generally acknowledged to be sound but details of the regulations, imposed from the centre with limited nuances and covering such a wide range of business models, could incur significant costs and make some businesses unviable.”
Burman added: “On shares, there is too much reliance on the depository and that will concentrate risk. There is also a centralization of cash activities via a depository. Private equity funds will have to deposit cash to meet certain liquidity criteria with very little payback for the operations of the fund from a cost benefit analysis, particularly for the fund’s investors.”
The briefing also addressed the regulation for derivatives, the introduction of mandatory clearing of standardized contracts, risk mitigation for bilateral contracts and reporting rules for CCPs (except trading part of MiFID II). Agreement was reached in Feb. 2012; mandatory clearing is expected to start end-2013. However, ESMAs Verena Ross said last week that the deadline of next year is likely to move to summer of 2014. Additionally, the US Treasury two weeks ago said that foreign exchange, forwards and swaps will be exempt from clearing regulations.
On capital adequacy, CRD IV was published Jul. 11 to implement new Basel III capital / liquidity rules in EU. Solvency II introduces risk-based solvency requirements for insurers were slated from 2014 onwards. Delays are expected, however.
On taxation, the European Commission had a proposal for an EU Financial Transaction Tax, and, while there was no overall agreement on the EU27 FTT, 11 countries agreed on some form of FTT under an enhanced cooperation procedure.
The regulation brings with it a host of changes for the asset management industry. These include major changes to the derivatives markets: collateral and margin requirements for both OTC and cleared derivatives; transaction reporting, execution venues, i.e. Swap Execution Facilities (SEFs) and Organized Trading Facilities (OTFs); clearing agents, liquidity- increased capital requirements under Basel III: Volcker rule and Ring-fencing increased disclosure and reporting requirements.
This will mean significant data reporting obligations, which regulators may not have the resource to attend to, said Burman.
(JDC)