Aifmd impact survey final results 2014

The impact of AIFMD
Research survey 2014

Introduction
In the last two months prior to the expiration of AIFMD’s transition
period IFI Global conducted a wide ranging qualitative research
survey with alternative fund managers, and other key opinion
formers, on the Directive’s anticipated impact on the industry.
The goal of this research is to find out how alternative managers,
and their service providers, expect that they will be affected by
the Directive. Whilst AIFMD’s introduction has been debated
for many years there has been little to no research, prior to this
survey, on what material impact the Directive will have on individual
businesses.
Managers with dedicated alternative assets of $197 billion, and an
overall AUM of approximately $2.5 trillion, took part in this survey.
Interviews were also conducted with London based fund lawyers
as well as a number of fund governance firms and consultancies.
73 organisations participated in the survey of which 71% were
managers.
71%
11%
7%
Consultancies
Fund governance firms
Lawyers
2 The impact of AIFMD – Research survey 2014
Overall breakdown by
industry category
(73 organisations)
71%
11%
7%
Consultancies
Fund governance firms
Lawyers
Managers
11%
Overall breakdown by
industry category
(73 organisations)
Managers
11%
Manager catagory
breakdown
(56 organisations)
23%
19%
17%
Hedge fund
41%
Hedge fund of fund
Multiple
(ie long only with hedge etc)
Private equity & real estate

The impact of AIFMD – Research survey 2014 3
Contents
Summary of the overall conclusions 4
Benefits vs drawbacks 6
Forecast AIFMD winners & losers 8
Investors 9
Risk management 11
Reporting & regulatory issues 14
AIFMD platforms & ManCos 15
Conclusion 17

Summary of the overall conclusions
l There was universal agreement amongst interviewees that the European
alternative fund industry is going through a period of substantial structural
change. But the role that AIFMD is playing in this process is more open to
question. A majority of survey respondents believe that the Directive will act
as a catalyst for changes that, in many cases, were already occurring on the
operational side of the business. Others see AIFMD as a profoundly negative
development that, in and of itself, puts the other regulatory measures
introduced since the market crisis into the shade. And a small minority of the
boutique managers that were interviewed for this survey see the harm that
the Directive will do to their businesses in almost existential terms.
l Despite the fact that it took many years to draft, with each new development
followed closely in the press and discussed ad nauseam at industry
seminars, the survey found a surprising degree of uncertainty on how much
AIFMD will really impact interviewees’ businesses. This particularly applies
to alternative fund distribution. It also applies to depositary and particularly
‘depo-lite’ topics. But the area where there is most uncertainty is in risk
management. There is a great deal of doubt as to whether AIFMD’s risk
management provisions are really a compliance matter (some sort of box-ticking
exercise) or something potentially more fundamental – possibly
even bringing about a step-change in the way that portfolio management
decisions are monitored and made.
l Aside from the question raised above, the majority of survey respondents
do not believe that AIFMD’s risk management provisions will be much, or
perhaps even any, benefit to investors. Some respondents even suggested
that there is a real danger that regulated AIFs will lull investors into a false
sense of security which could well be dangerous. The concern is that
investors will do not the same level of due diligence on regulated AIFs as they
do on unregulated offshore alternative funds.

Summary of the overall conclusions
l At the time that the fieldwork for this survey was conducted, in June and July
2014, a number of interviewees were concerned that their applications would
not be approved for some months to come. Those that are in this camp were
worried that their ability to do business might be hindered as a result. The
possibility that investors might delay making allocations to funds because
authorisation has not been granted was raised. There was fierce criticism of
the how the FCA has handled the application process: those most familiar
with it stated that the regulator has not devoted sufficient resources to
AIFMD approvals.
l AIFMD is expected to initiate a period of innovation and creativity in European
fund structuring but it will also help bring about the end of the era of fund
product innovation that the industry was famous for over the last two
decades. How alternative fund strategies are ‘packaged’ to investors as a
result of the Directive will very likely change considerably over the next few
years. But the strategies themselves will be no different than before.
l The Directive means a very considerable increase in managers’ costs and
time spent on ‘unproductive matters’, as one interviewee put it. And a
significant number of survey respondents said AIFMD’s carrot, the passport,
is of little to no interest to them. (These are interviewees from what one of
this group described as the ‘real’ alternative management houses, more
commonly known as the boutiques, as opposed to the large mutual fund
complexes with their alternative ‘lite’ funds.)
l The results of this survey suggest that the AIFMD winners are managers
that have UCITS fund ranges and/or multi-billion organisations that have the
resources and structure to take AIFMD’s regulatory burden in their stride. The
losers are the boutiques. More than one of those that was interviewed from
this category think that the ultimate goal of the Directive is to severely curtail
their development; it is believed that the powers that be in Brussels have
never been comfortable with relatively small, and previously lightly regulated,
specialist alternative fund houses that have sprung up in London over the last
10 to 15 years.

Benefits vs drawbacks
Following are the main benefits and drawbacks of AIFMD mentioned by survey
participants:
Benefits
l AIFMD provides managers with the opportunity of having their funds
passported across the EU.
l The Directive will encourage potentially significant numbers of investors to
allocate to alternative strategies for the first time. And many existing investors
will likely allocate more. This combination will result in a sizeable growth in
alternative fund managers’ AUM in Europe.
l Alternative fund fragmentation will end. AIFMD will require those running
alternative funds in future to have strong and stable infrastructure, real
economies of scale with well-resourced service providers. The Directive will
therefore result in industry consolidation – including service providers as well
as managers. In future the vast majority of European alternative funds will be
run by fund management houses with deep pockets.
l The Directive has already unleashed a wave of fund structuring creativity
that is expected grow strongly over the coming years. In particular third
party AIFM compliant ManCo platforms are in the vanguard of this trend. A
number of different outsourced AIFM compliance opportunities are also being
presented to managers at the moment, and it is expected that there will be
more of these in future. Managers said that they are receiving a lot of offers
from providers of outsourced services at the moment.
l AIFMD will encourage managers to place greater emphasis on risk
management, especially at board level. The evolution of risk management
into a broad and holistic discipline in investment management (with various
elements in addition to market risk) maybe one of the most beneficial
outcomes of AIFMD.
(NB: not one respondent said a benefit of AIFMD would be investor protection.)

Benefits vs drawbacks
Negatives
l There is much concern that AIFMD will lead to a very considerable increase
in costs with little to no compensating rewards. This view was most forcefully
expressed by the managers interviewed with AUMs of less than $1 bn.
Managers interviewed with AUMs below $1 bn say that AIFMD has increased
their cost base from between 33% to 50%. Hardly anyone in this category
sees any compensating benefits from this increased expenditure.
l The cost imposition imposed by AIFMD is forecast by all to be especially
harmful to the start-up manager market. Some of those interviewed fear
that it might effectively disappear. Should this occur it will have a knock-on
effect on alternative fund product creativity in Europe. “London has been a
centre of hedge fund innovation; that will no longer be the case”, said one
interviewee.
l Investors will be lulled into a false sense of security because they will regard
regulated AIFs as being safer than offshore unregulated funds. Despite the
fact that AIFMD has been enacted as an investor protection measure not
one manager interviewed for this survey, when asked to list AIFMD’s benefits,
mentioned investor protection. Given that this is main purpose of the
Directive this is a surprising finding.
l Non-EEA resident alternative managers will be discouraged from
accessing the EU market. This will mean that there will be fewer investment
opportunities for EU investors from overseas managers. There is a danger
that a ‘Fortress Europe’ protectionist mentality could develop in the EU’s
alternative fund industry as a result of AIFMD. ‘Fortress Europe’ might be
welcomed by EU based fund management complexes but it will be of little
benefit to the region’s investors.

Forecast AIFMD winners & losers
Winners
l Large managers with well-known brand names and substantial resources
l Managers with UCITS fund ranges and established distribution channels
across Europe
l Technology providers with AIFMD solutions, particularly in risk and
reporting
l The EU’s two leading fund domiciles of Dublin and Luxembourg (the
emerging ‘Dub-Lux duopoly’)
l The risk management industry and those with risk experience that want to
be NEDs
l Law firms
l Consulting firms offering AIFMD solutions
Losers
l Boutique managers
l Alternative UCITS funds
l The start-up manager market including service providers that focus on this
market sector
l Smaller fund domiciles catering for European start-up managers
l Investors (approximately 20% of those interviewed believe that investors
will be net losers)

Survey respondents were asked what views their investors
have of AIFMD. Replies to this question were largely equivocal.
The majority of interviewees say that there is very little investor
demand for regulated AIFs, to date. However others say the
disclosure provisions in AIFMD are welcomed particularly by
northern European institutions.
A variable level of understanding on AIFMD was reported by
managers of their investors. Many experienced alternative
institutional allocators are said to be knowledgeable (but many
intend to continue using existing offshore structures if they
can). Less experienced alternative investors have little to no
knowledge of the Directive as yet.
Just 30% said that the Directive has broadly been welcomed
by investors. Those that are in this category suggested that
institutional investors will increasingly require funds to be
compliant with the Directive before considering an allocation.
One interviewee said that pension funds are known to have
a ‘herd mentality’ and that once some of the market leaders
demand AIFMD compliance others will follow.
But those that are in this are camp are also largely sceptical
about the potential of the Directive to expand the market for
alternatives to new investor groups, at least in the short term. A
small number of interviewees, however, said that AIFMD should
help in Germany. One of the reasons why German institutions
have been slow to allocate to alternative strategies (relative to
those in The Netherlands and the Nordic region, for example) is
because most of these funds have been unregulated offshore
entities, to date. Lightly regulated offshore funds have not been
popular with German institutions.
The survey came across many managers who said the extra
costs that have been imposed on them by the Directive will be
passed on to their investors. Therefore AIFMD will prove to be
unpopular with them. Hedge fund boutiques and private equity
Investors
“AIFMD has raised
the administration
costs in our funds by
approximately 50%,
but I do not expect
any investor will ever
be able to identify a
single benefit they
have derived from
the expenditure they
have been forced to
undertake” – $800 million
long-short equity manager
“The number one
priority for investors is
return. By adding to
costs the increase in
regulation takes away
from returns. This will
deter investors; it will
not encourage them”
– quant macro manager

Investors
managers interviewed focussed on how increased costs will take
away from their funds’ net returns.
However not all managers said that their extra costs will be
passed on. (It seems that boutiques will be required to pass
on these costs in order to remain profitable but the largest
managers surveyed will not be required to do this.) Interviewees
were therefore split on whether the increased regulatory costs
will be passed on to investors. Approximately 35% of managers
surveyed believe that investors will not allocate to those that
attempt to pass on increases in their regulatory costs.
There is a widespread concern expressed by interviewees that
investors will perceive regulated AIFs as being safer than offshore
funds and will not do the requisite level of due diligence. For
example through its extensive reporting requirements AIFMD
allows risk management respectability to be bestowed on a
number of manager organisations that does not appear to be
justified. Many investors may not understand this.
“We have experienced
the full spectrum of
interest from ‘not at all
interested’ to ‘if you are
not AIFMD compliant
we won’t invest’”
– large PE manager

Interviewees were asked how their risk management practices
might be impacted by the Directive. Responses show that the
approach that is being taken by the larger fund groups to risk
management, those with AUMs in excess of $1 bn, is in many
cases significantly different from those of the boutiques. This
difference was evident prior to the introduction of AIFMD but the
Directive seems to be acerbating these disparities.
Boutique managers interviewed are being forced into multi-tasking
risk management with various other functions as a result
of AIFMD. Boutiques surveyed see AIFMD’s risk management
provisions primarily as a compliance function. On the other hand
large managers interviewed stated that risk management needed
to go through a re-appraisal following the market crisis. Their
view is that the market crisis occurred because it was assumed
the worst case scenario was based on what had happened
in the past rather than a set of circumstances that hadn’t yet
evolved.
As a result there is a widespread view amongst the larger firms
surveyed that risk management has evolved into something
that is a great deal broader and more complex than risk
measurement. They believe that much of the real skill lies in
making sensible judgements about the future. Scenario stress
testing has become standard at large fund management houses.
And larger managers interviewed are increasingly using the term
‘enterprise risk’ to cover operational risk, linked to strategic
risk within their businesses, including governance as well as
traditional market risk.
The results of this research suggest that the larger the
organisation interviewed the greater the emphasis that there
is on risk management; but this has had little to do with
AIFMD. AIFMD might end up being a net negative for real risk
management. The degree of multi-tasking envisaged by a
number of the smaller managers surveyed might not be healthy
for real overall risk reduction.
Risk management
“I am not sure that
those came up with
these requirements (re
risk management) really
understood what they
were doing”
– fixed income manager

Risk management
Hardly any managers surveyed plan to hire additional risk officers
as a result of the arrival of AIFMD. Larger managers interviewed
stated that they already have well-resourced and sophisticated
risk management departments. As a result they can largely take
AIFMD in their stride. Many of the smaller managers are not able
increase their risk management resources as a result of AIFMD
reporting and other regulatory expenditure.
The results of this research suggest that fund boards are not
ready for AIFMD’s risk management requirements. No one
interviewed thinks that there are enough people with risk
management experience available to serve on the boards
of hedge funds (private equity and real estate are a different
matter). Risk management is often being confused with risk
measurement by fund boards.
Managers say that it is very difficult if not impossible to
find people with real risk management (as opposed to risk
measurement) experience to serve on boards in the locations
where these funds are domiciled. This is because, historically,
risk management has never been embedded in fund governance
practices.
Governance has traditionally focused on due diligence and
operational functions. Interviewees said that those that sit on
boards in fund jurisdictions come from a legal, auditing or fund
administration background. Fund boards have always had a
risk oversight role but those that fall under AIFMD now bear
additional responsibilities that are codified by the Directive.
Written rules have now taken the place of general principles.
Survey respondents from private equity and real estate fund
backgrounds gave very different answers to those from the
hedge fund sector, quoted above.
“Most of what we are
being asked to do we
were already doing
anyway”
– large alternative and long
only manager

Particularly those respondents from the Channel Islands, where
many of these funds are domiciled, are less concerned about
the risk management board stipulations of AIFMD. Respondents
from Guernsey and Jersey said that board risk supervision skills
are sufficient for private equity and real estate funds.
Risk management
“It will take some time
to sort the board
requirements out”
– fund governance firm

Reporting and regulatory issues
Many respondents, especially boutiques, made the point that
AIFMD should be seen as a part of a general unwelcome trend
to regulation that is fundamentally changing their business. The
Directive has arrived at a time when managers have had to digest
numerous other regulations.
One manager who uses a lot derivative instruments said that his
firm has to follow approximately one million pages of rules, some
of which are overlapping. He added that his firm can be required
to report certain trades 11 different times.
The overall regulatory Tsunami will prevent start-ups from being
launched. The consensus is that a London base hedge fund
manager needs a minimum of $250 million in AUM to get to break
even in even in the simplest strategies.
Regulations are also criticised for been overlapping. This overlap
occurs between regulators in the major capital markets (for
example Dodd-Frank and Sarbanes-Oxley in the US with AIFMD)
and between the FCA and the regulator in the jurisdiction where
the fund is domiciled. Managers interviewed, both large and
small, said that regulators should more coordinated. The lack of
coordination adds to cost, time and frustration.
The difficulties expected by Annex IV reporting requirements were
raised by some respondents whilst others admitted that they had
yet to get on top of this. Those that did raise the topic said that
they were surprised by just how much Annex IV covers, and the
fact that it includes reporting on qualitative as well as quantitative
data. Annex IV appears to be a whole new world for many
boutique managers surveyed – most have not been required to
provide information like this before. It is likely to be the most painful
aspect of AIFMD for many survey respondents. Many interviewees
were still finalising their rregulatory reporting templates for AIFMD
when surveyed.
For start-ups ‘$1 bn is
the new $100 million’
– long-short manager with
$1.5 bn AUM
“We are concerned
about how certain
measures are being
interpreted and applied
by different countries”
– lawyer
“From now on I will only be coming to Europe for
vacations” – large US west coast fixed income manager
“What will they do with
all the information that
they will be getting?
The FCA’s systems
might be able to do
something with the
quantitative data points
but what about the
qualitative data?”
– global macro manager

AIFMD platforms & ManCos
AIFMD is anticipated to lead to a large growth of various third
party platforms and sub-advisory relationships. The structure of
these is expected to evolve significantly in the years ahead. The
results of this research show that they are being used by larger
managers as well as the boutiques.
The third party ManCo option, in particular, is welcome by
many interviewees. They are likely to be used by many larger
managers surveyed as well as smaller ones – and by European
based managers as well as US ones. Interviewees say one of
the chief selling points is their ability to do the risk management,
as stipulated by AIFMD, in the jurisdiction where the fund is
domiciled.
Fiduciary firms interviewed say that their ManCo platforms offer
managers in the US an opportunity to get into the European
market without having commit large amounts of capital and
resources. And taking away a lot of the headache of AIFMD’s risk
management requirements is also a big selling point.
Some managers surveyed raised questions about the
relationship between ManCos and the funds on their platform
from both a branding and governance perspective.
For example one respondent said that he is concerned that
ManCos can get in the way of the relationship between the
fund’s directors and the investment manager. He said he is
concerned that ManCos are dictating what information the
board can see but it is the fund’s directors that will bear the
responsibility if something goes wrong.
“We have joined a
ManCo platform in
Dublin; this is a good
option for us”
– long-short manager with
$1.5 bn AUM
“Our business is
growing rapidly; we are
seeing interest from
both the US and the
UK”
– fund governance firm
with offices in Dublin and
Luxembourg

Domiciliation
Most comments received on domiciliation came from the
lawyers and consultants surveyed; managers had little to say on
domiciliation other than expressing a general view that they did
not think AIFMD would require them to change the domiciliation
of their funds. This included those whose funds domiciled in
jurisdictions outside the EU. For example many of those surveyed
with funds based in Guernsey and Jersey are taking advantage
of the opportunity to use private placement rules put in place in
the Channel Islands to meet their AIFMD requirements.
A clear majority of lawyers and consultants surveyed, however,
said that there is a general and growing trend by alternative
managers to domicile in Dublin and Luxembourg. But this is not
necessarily a result of AIFMD. Hedge fund managers have been
using Dublin as a domicile, where many have had their funds
administered, for a number of years now. Equally private equity
managers have been using Luxembourg for some time too. It
is expected that AIFMD will increase this trend but when the
fieldwork for this survey was conducted it was too early to tell.
The popularity of alternative UCITS funds, which does require EU
domiciliation, was mentioned by a number of interviewees. One
manager interviewed had just returned from a trip to Switzerland
where some of the people he visited, despite being outside the
EU, had asked him if he would consider putting a UCITS wrapper
on his funds.
On the other hand many of the hedge fund boutiques surveyed
said that they are very happy with Cayman and had no plans to
make any changes.
“We would never
re-domicile, we are
happy where we are,
but we might decide
to launch future funds
for European investors
from within the EU”
– private equity manager
“We always advise our
clients to domicile their
funds in the jurisdiction
that is going to be most
acceptable to their
investors, at the end of
the day it is that simple”
– lawyer

Conclusion
l Most boutique managers cannot see any real advantages to AIFMD; a few
say that they might move offices to centres outside Europe
l The emphasis on risk management in the Directive will be of little real benefit
to most investors and in some situations, paradoxically, could conceivably be
dangerous
l The European alternative fund industry will become yet more institutionalised
than it is today; on present trends there will few independent alternative
managers left in the EU with AUMs below $1 billion by 2020 (but the EU
might not include the UK by then)
l Nobody surveyed said that one of the benefits of AIFMD will be investor
protection
l There will be a considerable growth in manager alliances, third party
platforms and related activity to obtain distribution; for the passport to be
worthwhile accessing well established distribution channels will be essential.

Aifmd impact survey final results 2014

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Aifmd impact survey final results 2014