What protection does the AIFMD really provide?
While the directive's goals may be laudable, the legislation misses the mark, argues BDO's Michelle Carroll.
I should really start by stating I am not in favour of the current Alternative Investment Fund Management Directive (AIFMD), and I therefore have an inherent bias against it. But, putting my bias to one side, let's consider what the directive offers the professional investor.
As yet, we are still not certain what the final Level 2 rules will look like, but we do, however, have a broad understanding of its principles. The directive's primary purpose is to ensure all alternative investment fund managers are managed responsibly across the EU. This involves maintaining a certain amount of liquidity and capital and ensuring that appropriate risk management is in place, conflicts of interest are avoided and appropriate valuation is applied. To me, this all seems reasonable.
The second area of the directive's focus is to outline the responsibilities of the depository. Post-Lehmans, there were concerns regarding the segregation of assets and identification of the legal responsibilities of the depository in making good those assets, and the directive defines those responsibilities. Again, it seems sensible to outline an understanding as to what depository risks exist, what depositories must adhere to when managing those risks and design clarity over the issue resolution process.
The third focus area is reporting to investors. The directive supports consistent reporting to all investors across all types of alternative investment funds and includes reporting of the managers' remuneration. Additional reporting has been put in place to let the investor know the type of borrowing the funds are exposed to. The referral to the manager's remuneration in the fund's accounts is unnecessary, and there is debate to be had regarding template reporting. Through conversations I've had, I know some of the industry is supportive of this.
Finally, the AIFMD states that if the EU is to avoid the spread and effect of systemic risk, each local regulator needs data for analysis to be submitted regularly, and each regulator should hold the power to react accordingly. In an extreme scenario, giving a local regulator the ability to intervene seems reasonable to me.
On balance then, the AIFMD is sensible. Why, then, is it disapproved of by so many within the industry?
I believe this is because it does not work at a granular level, because the professional investor should not be told how to think, because it goes too far down the wrong routes and because those implementing it either do not quite know what they are asking for or because they are possibly using the AIFMD for ulterior motives (think private equity).
For instance, the data required for analysis by each EU regulator is too diverse to identify themes, and at a basic level, there is too much data being requested. Even if the data provided did identify a systemic risk, it would take too long to analyse conclusively, and the damage would already be done.
The question we are left with is what investors should do. For professional investors, I would advise the following: take the four AIFMD focus points outlined above, incorporate these points into your own requests for information during your assessment of risk and return, and do not ever think that an AIFMD regulated alternative manager represents a reduced risk alternative fund.
This possibly belies the real reason the AIFMD is unpopular - the truth is that the directive is most probably a reaction to professional investors not carrying out robust due diligence in the first place. In short, it is the price we pay for the absence of consistent, intelligent, professional due diligence. If there is to be an appropriate level of investor protection, then strong due diligence is still required. I do not believe the current directive will be able to deliver this for us. As it stands, it will merely add more cost to both investors and alternative funds.
Michelle Carroll is a partner at BDO Investment Management