Funds and games

Regulation from the EU is just one of several concerns for the funds industry, according to in-house and private practice lawyers


Peter Astleford
Peter Astleford

A large number of regulatory changes have taken place or have been proposed in the past two years affecting the financial sector. Of the recent regulatory changes, which has had the greatest impact on the funds industry to date?

Jeffrey Bronheim, general counsel, Cheyne Capital: When the Alternative Investment Fund Managers Directive [AIFMD] was published certain provisions could have harmed the hedge fund business in Europe. While the final directive is more appropriate it will still require many person-hours to understand and implement. In the past few years we have seen changing, inconsistent and often complex short-selling restrictions imposed by ­various countries and regulators, ­occasionally without warning. These appear to have had minimal impact in calming market volatility or slowing the fall in share prices, but they have certainly increased the operational costs of doing business and had a significant impact on trading strategies.

Matthew Cavanagh, general ­counsel, Christofferson Robb & Company: Clearly, the AIFMD – not from the perspective of an impact on our day-to-day activities, but rather from that of needing to keep on top of its detailed terms and constantly assess its potential impact as it has moved through its various guises. Otherwise, the banking regulatory capital rules have been of direct ­relevance to us due to the nature of our investment strategy.

Laetitia Muir, general counsel, Reech AIM Partners: As a European alternative investment fund manager we believe the AIFMD will have the biggest impact on our business owing to its extensive nature and the requirements under it. Keeping in mind that we are regulated by the FSA in the UK it will also be interesting to see the changes brought about by financial services regulatory ­architecture reform.

Janene Waudby, general counsel, Cube Capital: To date the remuneration rules, which came into force early this year. These have had little attention in the press, but have revolutionised how bonuses are paid in the industry. Put simply, neither bankers nor investment managers can receive big cash bonuses any more. The main impact for our business was felt because the rules were adopted with only a few weeks’ ­notice of the precise terms. Smaller firms such as ours were forced into making decisions without knowing what the final rules would say.

Richard Perry, head of financial services, Simmons & Simmons: The regulatory changes with the greatest impact on funds so far have probably been the restrictions on short-selling/transparency requirements. These have had a massive impact in terms of the systems and procedures our clients have to maintain to ensure compliance and stay up-to-date, and also some consequences for the transactions they enter into.

The combination of some regulatory developments in the area of market abuse regulation and a more aggressive approach from regulators in policing the rules has had a significant impact on asset managers. There is more rigour in ensuring there are no breaches and being able to show there are adequate controls in place. Investors do not see insider trading for their accounts by their appointed managers as ’added value’: evidence suggests they will want to withdraw their money immediately.

Pre-empting regulations, the banks are reducing their proprietary trading businesses. Many of these teams have spun out into new asset management businesses. This is ­potentially a significant change to the market landscape.

Peter Astleford, co-chair of financial services, Dechert: The AIFMD will require all non-Ucits [Undertakings in Collective Investment in Transferable Securities] funds to meet new structural requirements and is likely to lead to additional requirements being imposed on Ucits as well. Some of these provisions, such as the rules on depositaries’ liability, have been imposed without any real consideration of the practicalities. At the moment this seems to be the most far-reaching change.

The market reforms envisaged by the European Market Infrastructure Regulation and MiFID II are also potentially far-reaching, although it is difficult to know what their impact will be at this stage. The position of non-EU managers doing institutional business into Europe, for ­example, will be materially affected by MiFID II, but we do not yet know the full details and practical impact.

Have you begun to address the possible effect of the AIFMD on your company yet? What impact do you think it will have?

Bronheim: We have created a multi-cell Ucits and a multi-cell Qualified Investor Fund to deliver onshore investment products for clients who prefer it, and to have an alternative to offshore funds should they be disadvantaged by the AIFMD. The impact would appear to be manageable, but this will depend on the outcome.

Cavanagh: We have undertaken a ­review of the rules of the AIFMD to determine whether the directive ­impacts our business. Our assessment, including advice from outside counsel, is that our current structures and funds/managed accounts will not be caught by the AIFMD. We do, however, keep a watching brief on the AIFMD with regard to our structures and marketing plans. It will ­obviously be a real consideration for us, given that we are not caught by the directive, if any one-off future marketing or fund proposition were to bring us within the operation of the AIFMD, as the compliance costs might outweigh the opportunity.

Muir: Despite the 2014 deadline to apply for authorisation under the AIFMD, we have initiated a process to identify actions needed to comply with the directive. We are of the view that while the European ’passport’ scheme would simplify the process to market for our funds in various EU jurisdictions, some of the restrictions under the AIFMD such as capital adequacy restrictions, leverage restrictions, external valuation experts, ­remuneration caps and depository requirements may lead to additional cost for minimal benefit.

Waudby: Yes, we are considering it, but in the absence of seeing the FSA’s rules on the subject it is hard to judge the precise effect. The biggest impact is likely to be that it will drive us, and probably others, increasingly offshore. This is because we believe that no UK-based adviser will be able to do any discretionary management without being designated under the AIFMD as the ’manager’ of the relevant funds, and there can be only one manager under the rules. If this is correct we expect it to have a big ­impact on any fund structure with an offshore manager and UK-based ­adviser that does some discretionary management. Such businesses will inevitably end up relocating more staff offshore.

Do you think offshore jurisdictions will maintain their popularity in the funds industry? If so, why?

Bronheim: While some clients have expressed a preference for onshore funds, the vast majority remain comfortable with Cayman Islands funds – their risks, regulatory oversight and performance. Our funds have strong corporate governance and the assets are held by onshore banks and brokers. The offshore jurisdictions continue to strengthen their regulations to remain competitive. However, further tax and regulatory changes may impose additional limitations on ­certain offshore jurisdictions.

Cavanagh: Middle Eastern, Far East Asian and other emerging market investors do not have any issues with the use of offshore jurisdictions, which have largely only been demonised in the EU, UK and US press. The negative publicity over offshore jurisdictions is likely to fade once the media and public realise that the ­economic position Europe and the US find themselves in is essentially independent of the presence and ­activities of offshore jurisdictions.

Muir: In our view, the popularity of offshore jurisdictions is driven by the lighter regulatory requirements and tax benefits in such jurisdictions. In light of recent regulations such as the Dodd-Frank Act and the AIFMD, we believe offshore jurisdictions will continue to be in demand. Having said that, in the wake of the financial crisis there has also been increased demand for regulated products such as Ucits by certain investors which has forced some fund managers to consider redomiciling their funds to onshore jurisdictions.

Waudby: In Europe, we believe there will be a market for offshore funds at least until 2018 when the rules may tighten again. In other markets, such as Asia, there is no regulatory catalyst that may cause offshore funds to fall out of favour. As a result, the question of whether offshore jurisdictions will maintain their popularity will vary from jurisdiction to jurisdiction and investor to investor. Certainly, the question of how to package fund products has become more complicated, depending on fund strategy, the dominant markets involved and the nature of the end-investor.

The question is only partly ­answered by the regulatory environment. We remain predominantly ­influenced by investor demand and expect this to continue.

Perry: For the time being, offshore jurisdictions will broadly maintain their popularity as fund domiciles. Our experience is that the main allocators of capital to funds historically domiciled in offshore locations are, in general, not convinced about the added value of an onshore-regulated jurisdiction.

The benefits of a European ­marketing passport for Europe-domiciled funds are currently ­counterbalanced by the uncertainty around the precise consequences of the depositary requirements for such funds. To date, this has not produced any clear momentum either way and therefore offshore jurisdictions have largely ­retained their popularity.

Astleford: Jurisdictions such as Cayman will do whatever is needed to ensure they can continue to do business into Europe. Their popularity outside Europe remains largely unchanged in any event. There is likely to be an increase in the use of onshore funds. Depending on how the AIFMD is implemented, significant regulatory obstacles may emerge, but at this stage they still benefit from an established, efficient, and user-friendly regime.

How important are the emerging markets for the industry and your business?

Cavanagh: They are of increasing importance as a source of funds and a location for investments. As emerging markets increase the sophistication of their investment products and investment communities they will become increasingly important as a source of investors and a location for investments.

Muir: Our firm has a strategic growth initiative focused on Asia. We see the region as important for future opportunities and opened a Singapore ­office more than two years ago. While visiting the office my impression was that the region was abuzz with ­energy and expansion.

Waudby: All our investment platforms feature investing in emerging markets – some of our investments are in Mongolia and Vietnam, among other locations. We are in a challenging investment environment now, where many developed countries are experiencing slow growth and will do for some time to come. Many emerging markets have a good growth story presenting attractive investment ­opportunities, as long as we can ­manage the associated risks.

Perry: Emerging markets will always present opportunities for investment for the asset management industry. One development in recent times is that some of these markets are now home to substantial amounts of investor capital that asset managers want to tap. This is particularly true of the BRIC countries, with pension funds and sovereign wealth in China being particularly visible recently, but it is also true in Africa.

Astleford: They have clear potential to deliver greater levels of profit – and risk – than developed markets. The AIFMD may present particular ­problems for specialists in this area.

Has a legal function become more important for a fund management company in recent years?

Bronheim: We group legal work into the following areas: fund creation, amendment and operation; counterparty documentation; trading transactions; firm matters; and regulatory. All these areas have required increased legal resources – internal and external – throughout the financial crisis and subsequent regulatory onslaught. For a large, sophisticated ­alternative asset manager to deliver what investors require it must have a sufficient legal function.

Cavanagh: The cross-border nature of the investment management ­community’s work, along with increasingly sophisticated structures, has resulted in a need for investment managers to build and maintain ­execution capacity in-house, and an ability to retain internally the necessary know-how from a structuring, reporting and investor relations ­perspective. The growing size of many funds and managers also means that an in-house legal function is increasingly cost-effective.

Muir: I’d answer an unequivocal ’yes’. However, it’s not the legal function per se that’s important, but rather the ability to understand and support business objectives. One of the most important ways to achieve this is to become highly commercial and sometimes take more risks than we, as lawyers, are used to, in order to capture upside growth for our business in volatile times. Furthermore, it is important that the legal and compliance teams work closely together to provide viable and innovative ­solutions to the business’ complex ­issues. If you get all this right it can be a rewarding experience, both ­personally and for your organisation.

Waudby: A compliance function has certainly become more useful in the past few years as the rules have become more complicated. For firms such as ours, I think a legal function was as valid 10 years ago as it is today. In general terms, a pragmatic senior legal counsel brings valuable perspective to an international alternative investment manager business. I was appointed early in our group’s life cycle. This means I have been behind the development of many of our risk management and operational systems, as well as advising on deal, regulatory and compliance issues.

Perry: A legal function has become essential for fund managers of any scale, whether their focus is retail investors, institutional investors or somewhere inbetween. Where we are seeing most change is the increased institutional investment in hedge funds and private funds of various types. These investors have high expectations of the infrastructure of a manager, including its legal function, and they will typically test this through rigorous due diligence. A rapidly changing regulatory environment has also made the general counsel’s role at a fund manager central to the management decisions of the business.

Astleford: Yes. In the alternatives world this is both because the industry has matured and the experiences of 2008 – in particular the collapse of Lehman Brothers. Fund structures continue to evolve, regulation continues to increase and the sell-side continues to restructure and invent new products and services – all of which requires legal input. In the main asset management market there is more internationalisation and the development of new distribution channels and platforms, all of which involves legal structuring.

Lawyers required

The arrival of the EU Alternative Investment Fund Managers Directive, on top of an onslaught of more general financial services regulation, has led to an increased role for lawyers in the funds industry. As the onshore vs offshore debate continues to rage fund managers are looking for new sources of capital.