AIFMD: An Opportunity, Not a Chore

Mention of the Alternative Investment Fund Managers Directive, AIFMD, will typically elicit a groan among investment professionals, since many view the legislation as punishment of the financial industry by politicians from the European Union. After all, the directive was instigated as a reaction to the Madoff scandal and other industry issues that surfaced during the financial crisis. The implementation of AIFMD has been a burden for many fund companies, asset managers and suppliers to the industry, but the end result presents great opportunities for both investors and fund managers, which shouldn’t get underestimated. These include greater investment flexibility, better oversight and governance, and additional safeguards for increased investor confidence.

Many investors have become increasingly wary of non-registered investment funds such as Irish QIFS, Luxembourg SIFs, and Cayman hedge funds since the financial crisis. This wariness has been driven by a common fear that oversight and governance of these funds is not as robust as that for UCITS funds. Trustees and fiduciaries have been mindful that a scandal involving such funds could seriously damage their brand and reputation. As a result, a number of private banks, wealth managers, and even pension funds have restricted their investment into fund vehicles exclusively to UCITS funds, which has also been actively encouraged by local regulators in many cases.

However, UCITS guidelines are designed primarily for retail investors, and they can be very restrictive for many investment strategies. For example, bank loans, which are a popular instrument in a time of rising interest rates, are restricted to a maximum of 10% of a UCITS fund. Additionally, many assets, such as direct real estate, can’t be held within a UCITS fund. Therefore, while a number of sophisticated investors recognise the benefits of the UCITS governance regime, they dislike the investment restrictions it imposes. AIFMD can change this.

The directive introduces an oversight and governance regime that is comparable to that of UCITS without many of the investment restrictions. It also introduces new safeguards for increased investor confidence. For example, the new rules require custodians to take on additional depositary obligations whereby they will for the first time become responsible for ‘non-custody’ assets, including foreign exchange, swaps and futures. This is a great example of how AIFMD provides investors with an additional degree of comfort and reduces the opportunities for fraud and mispricing.

Furthermore, AIFMD requires non UCITS funds to become Alternative Investment Funds, AIFs, which are managed by fund managers registered with their local regulator as Alternative Investment Fund Managers. The AIFs authorised by the Irish authorities are known as Qualified Investor Alternative Investment Funds, QIAIFs. AIFs essentially have the same governance and oversight requirements as the current UCITS regime. However, their investment restrictions are much more flexible and AIFs have a marketing passport valid throughout the EU, without promoters having to worry about private placement regulations.

On the whole, the changes triggered by AIFMD will open up a broader and more interesting investment opportunity set for wealth managers and institutional investors who had previously decided to restrict themselves to UCITS funds because of governance concerns. AIFs will allow investors to take more risk while others will have greater freedom to hedge and manage risk. There is also the possibility that the “AIFMD” brand could gain the same international recognition that “UCITS” has attracted, and that it could become the most accepted fund vehicle for sophisticated investors worldwide.

Over the past year, the industry has been focused on the detailed and difficult implementation process of AIFMD. It now needs to start considering the opportunities the directive creates for investors and fund managers, and recognising the extent and the potential of these changes.

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