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Hedge Funds Face Compliance Hurdles of AIFMD

Alternative funds selling to European investors must meet ESMA's strict guidelines for trader reporting, risk controls, and valuations -- similar to SEC's Form PF.

But, American hedge funds are trying to avoid AIFMD, partly because of regulatory fatigue, he notes. Citing a BNY Mellon survey at the beginning of 2014 that said more than 80% of fund managers have yet to seek AIFMD authorization, said Delaney, noting that About 20% of US fund managers have sought compliance with AIFMD, while 80% haven’t done anything, he said.“Saying they don’t want to comply will have a detriment for US managers,” he  warns. A lot of U.S. fund managers will have a marketing conversation with a European investor and not realize this is illegal, he said.  Also, this will constrict the list of hedge funds available to European investors. With only 20% of US fund managers in compliance, a French pension fund that wants a long/short manager, and had a choice of 300 funds, post-AIFMD, that list is cut down to 60 funds.

US ambivalence toward AIFMD
A US fund manager has two options: they can set up a European company that will perform the management services providing oversight, risk compliance, and regulatory reporting. Or, they can appoint a management company such as DMS that is already approved in Europe to do that for them.  For example, DMS was set up in Dublin and has a 21 person-team that acts as a local office. “We do it for clients. We are acting as a management company. It is the management company that has responsibility to do the filing. It is under that license that the fund is being distributed,” he explains. A management company acts as the fund administrator and has the legal responsibility that the fund stays in compliance with the prospectus and AIFMD law, said Delaney.

If a firm sets up a European fund, it only needs to report to one country because the concept is that all the EU countries are peers. For example, if someone establishes a European fund in Ireland or Luxembourg, they can report to one local regulator.  According to Delaney, over 92% of funds have registered in Ireland and Luxembourg to date, which allows them to report to one regulator and to market their funds throughout the EU. However, if a non-European fund wants to distribute into the UK and Finland it has to go to each regulator separately. “For a non-European fund, that would involve going to 34 regulators, and reporting to those on a quarterly basis. That’s insanity,” he said. That is why the use of management companies is gaining traction.

As a consequence, many are hiring an AIFM to oversee the management of the fund, and provide the oversight, compliance and service provider oversight. The AIFM would also the file Annex 4 report to ESMA. Large managers -- a total of 26 firms -- have selected DMS as their local company in Europe, said Delaney.“We leave the stock selection to them and we allow the to use our Pan European distribution license,” he explains.

In July, Cordium, a global provider of compliance consulting, accounting, tax and software, said it launched “the first-of-its-kind” Cordium Total AIFM Solution (CTAS) domiciled in Malta for a fixed-fee. “While the AIFM is operated by Cordium, the client retains total ownership,”stated the company in its press release. CTAS offers a full service solution to the AIFMD bottleneck, distinct from both  the in-house approach and the AIFM-hosting outsourced approach while delivering advantages over both,”states  the release.

DMS also provides reference data to comply with AIFMD.  But Delaney claims that isn’t the significant challenge of AIFMD.  The data challenge is in getting information from the hedge fund’s fund administrators – the Cedol and ISIN ticker symbols, value of the position, and number of holdings and market value, said Delaney. Then they are required to calculate VaR and to perform stress testing. DRM goes to Markit, Bloomberg and Reuters to get the underlying data.

To launch its own risk management service, DMS hired three from State Street including Jason Poonsooamy, formerly head of Product Management within the Global Risk and Analytics Division in Dublin.  It set up DMS Risk Management Services and built its own in-house risk system, which takes in data from RiskMetrics MSCI (Morgan Stanley Capital International). The reason that DMS chose RiskMetrics MSCI was that it could move around the templates. “We were able to take the outputs of their risk system and build it into our risk reports,” he said. Once the risk report is generated, it automatically generates the Annex 4, he explains.  

According to Data Art, there are many challenges around implementation and reporting, and some firms have yet to establish the level of systemic risk oversight necessary to protect investors.

Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio

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