Asian hedge funds may face hurdles in tapping investors based in the UK and Europe under new text issued by the European Commission on the implication of the Alternative Investment Fund Managers Directive (AIFMD).
The “supplementing rules” also call for more stringent terms for hedge fund managers in European Union member countries which delegate functions such as risk or investment management. As a result, the running of a Europe-based global or multi-strategy fund – with managers running portfolios out of Asia or the US – would be unfeasible.
The draft text, contained in a 110-page document, was issued last week, with the hedge fund industry given a deadline of next week to respond to the proposed rules. The sector has criticised the deadline as being too short, and has raised concerns that hedge funds may be more strictly regulated than retail funds.
If implemented, the biggest impact for Asian fund managers would be the barriers imposed when marketing to EU-member countries. For example, “if [an] Asian fund is being marketed across Europe, there needs to be arrangements in place between the Hong Kong regulator and regulators in all the relevant jurisdictions” in which it is to be offered, says Simon Crown, partner in Clifford Chance’s financial regulatory practice in London.
“What’s likely to happen in July 2013 [is that] Asian managers will be prohibited from marketing in some jurisdictions” where regulatory arrangements are not in place, says Crown, who foresees a potential “patchwork” in terms of Asian hedge fund availability across Europe.
The European Securities and Markets Authority had previously proposed playing a role in co-ordinating a passporting system that would resemble the Ucits scheme, as non-EU managers cannot be regulated under the AIFMD until at least 2015.
However, the text suggests that the co-operation arrangement includes a requirement that regulators outside of the EU enforce European regulation on their resident hedge fund managers. Crown likened it to “the EU trying to expand its jurisdiction”, adding: “What these arrangements will do is try to get local regulators to do the job for [the EU].”
Andrew Baker, chief executive of global hedge fund trade association Aima (Alternative Investment Management Association), says the proposed requirement of having “third-country regulators enforce EU law in their territories” would be “extremely problematic, if not impossible” for regulators to put into force. He called on the commission “to clarify this issue in their final text”.
The supplementing rules also propose that each alternative fund have only one fund manager. This would preclude a global hedge fund based in the UK or Europe from having managers overseeing portfolios being run out of Asia and the US, for example. “A multi-manager structure will no longer be possible,” says Crown.
Instead, an EU-based fund manager that needs to delegate portfolio or risk management functions to Asia or the US would need to do so under a delegation agreement. The supplementing rules raise the bar for the qualitative standards of the individuals who will be delegated the tasks. While there will be increasing restrictions on the ability to delegate functions, it will still be possible to do so, adds Crown.
The text also has suggested more stringent requirements for custodian banks that serve EU hedge funds as a depository. They will be liable for client collateral even after it is transferred to counterparties. Custodians would be charged with oversight and safekeeping the status of the assets, with the responsibility of recalling them from counterparties that are at risk of insolvency.
Custodian banks say the requirement will raise the cost of servicing funds, leading to closures among smaller hedge funds that are unable to cover the added expense. It could also possibly lead custodians to exit the market, they claim.
David Aldrich, head of strategy at BNY Mellon global client management, notes that under the text “all collateral must be held in custody – both collateral provided to a third party and that provided by a third party for the benefit of the fund, and further that all assets in custody must be controlled by the depositary”.
He notes that similar arrangements already exist in the industry for the “very largest users for OTC [over-the-counter] derivatives through tri-party collateral management services” from custodial banks, such as BNY Mellon.