Kai Braun considers the Alternative Investment Fund Managers Directive (AIFMD) and finds that operating models have stabilised  

Alternative investment managers continue to adapt their governance and operating models to align with the needs of investors and regulators. This is a dynamic environment with the factors influencing the shaping of platform design constantly evolving. One year into the era of the Alternative Investment Fund Managers Directive (AIFMD), the European Securities and Markets Authority (ESMA) has provided first guidance regarding the functioning of the new passport regime for European AIFMs as well as its possible extension to non-EU fund managers. 

This is a good time to reflect and review the different governance models and structures that have been implemented by managers of alternative investment funds (AIFs); EY invited 15 managers of alternative assets to a roundtable discussion for this purpose. It is also a suitable moment to try to predict the possible evolution of global operating models of alternative fund managers.

When the AIFMD was first introduced the overarching question was whether the new regime was sufficiently flexible to allow managers to implement their existing operating model. If not they might have to change their business fundamentally to become AIFMD compliant. The question was asked in the context of a large variety of actors – from local niche players to global asset managers – managing funds based on legacy structures put in place in an unregulated or lightly regulated environment.

The initial feedback from AIFMs operating in a live environment is positive. It is becoming evident that:

• An AIFM setup is far less burdensome than expected, both from a structural and a cost point of view;
• Concepts of good governance are generic and in line with industry guidelines (including AIFMD);
• AIFMD offers outsourcing opportunities;
• Some AIFMs now focus mainly on oversight and governance elements of the directive and outsource or delegate administration and middle office activities;
• Service providers have broadened their range of services to offer flexible support and assistance solutions, which can be adjusted to all types of operating models;
• AIFMD has proved to be flexible and has not prevented any player from implementing its preferred operating model, including specific needs for different asset classes;
• The EU passport appears to be the most efficient and sustainable tool (from an operational and risk point of view) for implementing a European distribution strategy.

Kai Braun

As expected, models used by the different managers are manifold but it is possible to identify common themes amongst the market participants. All seek as much leverage as they can, given their existing structure, resources and processes. 

Portfolio management is one of the two core functions of a manager in the context of AIFMD. The organisational structure of an AIFM and the resulting operating model largely revolve around the entity that takes final investment decisions. It is interesting to note the directive itself leaves the definition of portfolio management open. This thankfully enables managers to apply the concept in ways which adapt to different vehicle-specific legal requirements as well as practical operational considerations.

Today, almost half of local managers do not delegate the portfolio management function. The decision on whether or not to delegate is largely driven by the practical considerations of the particular asset classes. In the private equity and real estate markets, where the number of transactions is low but of high volume, the portfolio management function is typically retained at the level of the AIFM and decisions typically taken by its board of directors. 

For AIFs investing in financial assets where the number of transactions is higher the tendency is to delegate the portfolio management function to an entity that is entitled to take portfolio management decisions. The same is true in situations where the fund appoints an external third-party AIFM.

Since the implementation of AIFMD, Luxembourg has become a centre of excellence for risk management of AIFs of all sorts. In some areas, the precise definition of an AIFMD-compliant risk manager was lacking, but the Association for the Luxembourg Fund Industry (ALFI) and other associations together with the relevant practitioners defined the required roles and responsibilities. Today, risk managers represent the backbone of many Luxembourg-based AIFMs. Group functions are used for the provision of information and source data without making any judgments or interpretations. However, a detailed review of this information and compilation of formal reports takes place at the level of the Luxembourg risk management function.

Practical considerations as to how the valuation oversight function is performed

AIFMD introduced the concept of a third party valuer with responsibility for the valuation function where an AIFM does not have such a function internally. Even though this concept seems not to be new (real estate has traditionally been valued by external appraisers, over-the-counter (OTC) derivatives are typically priced by administrative agents), the strict liability defined by the directive is a clear burden to the valuation experts. AIFMs therefore had some struggle initially to identify the most suitable valuation model.

Practical considerations as to how the valuation oversight function is performed tend to differ between the private equity and real estate sectors and financial assets, with the latter being closer to a pan-European UCITS model. The table specifies the different options.

The appointment of an external asset or liability appraiser requires both initial and ongoing due diligence of the appraiser. Frequent – in some cases day-to-day – contact with the external appraiser as well as monitoring calls are implemented to review the service quality and perform due diligence on the appraiser. 

Luxembourg’s AIFs have clearly found their way in implementing a sound governance structure in line with AIFMD based on a mix of delegation and in-house tasks. The market for alternative funds and therefore the models are split into four different categories. The first distinction should be made between liquid alternative investment funds and the more illiquid private types of funds such as those investing in private equity and real estate. 

The remaining two models are based on the type of AIFM itself, that is in-house or group AIFM versus a so-called third party management company. And while the models described in this article are not fit for everybody’s needs, they provide a good insight into major trends and common themes currently found in the market.

The first year has shown that AIFMD is ultimately less of a burden than initially estimated and that the way platforms and management companies had been conceived is working in practice. The coming months and years will now show how efficient the new structures can be run from a pan-European or even global perspective and how successful the passport regime can be in raising additional capital.

Kai Braun is partner and Luxembourg Alternatives advisory leader at EY Luxemburg