28 January 2014

Hedgeweek: AIFMD - make sure you’re connected

The requirement for private equity and real estate fund managers to appoint an independent depositary under the AIFMD is a major development and, for many managers, a move into uncharted territory.

Until now, many alternative managers have been reluctant to seek early AIFMD compliance, availing of the one-year ‘grandfathering’ period which runs until 22 July, 2014. Large fund management houses, with their own compliance and legal departments, have had AIFMD in their sights for some time and are much better positioned to interpret the nuances of the Directive. Smaller groups, however, are still trying to work through the details.

The complexity of working under the rules of the Directive is heightened for AIFMs managing multi-jurisdictional fund structures. In such cases, the AIFM is faced with ensuring that every layer of the fund structure complies with the idiosyncrasies of each Member State’s interpretation of the regulation.

AIFMD will require much more than a simple review of operations. It is a highly pervasive and demanding directive that requires strong partnerships. Tracking ESMA updates and implementation is a full-time task for compliance, legal and product teams. Managers will have to implement an operational framework, understand the risks that need to be mitigated and demonstrate that they are doing as they say.

The depositary lies at the heart of the Directive and plays a key role in the day-to-day life of the AIFM and its alternative investment funds. Managers should choose a depositary that can provide a strong network and demonstrate that it has real experience in each relevant European location of handling a variety of asset classes (global equities, private equity, debt instruments, real estate, OTC instruments, collateral management) along with good controls and appropriate interfaces.

The administration function, particularly with respect to not-in bank assets such as real estate, is equally important, given that the NAV calculation and reconciliation process will form a key part of a depositary’s cash monitoring and general oversight function. This plays to the strengths of global institutions that have the scale and breadth to offer managers support as both fund administrator and depositary. One clear benefit of this is that the operational process will be more streamlined - the depositary has fewer external third parties to deal with, and the frictional costs to the manager are mitigated. After all, the depositary role is to ensure safekeeping and oversight of the assets of the fund while ensuring that the AIFMs can pursue its investment strategy without introducing undue delays. Managers will want to keep their contracts and service level agreements as straightforward as possible and their practices and procedures consistent across Europe in terms of how they interact with their counterparties.

One scenario that private equity and real estate fund managers will want to avoid is overreliance on third parties. This can represent an increased operational burden and result in higher costs being applied by the depositary. Furthermore, it can result in over-engineered processes and duplication of tasks.

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