Executing your distribution strategy in Europe
Ian Lynch: First and foremost, fund managers need to decide whether they want to establish a UCITS or an alternative investment fund (AIF) regulated under the Alternative Investment Fund Managers Directive (AIFMD).
The decision to go down the UCITS route will be driven by the type of investor the manager wants in their fund. If the manager is looking to solicit capital from a mixture of retail and institutional investors, then it would be advised they establish a UCITS. Some conservative institutions in the EU, for example, can only invest into UCITS.
Enthusiasm is growing for UCITS in Europe and globally, particularly Asia-Pacific and Latin America. Demand for UCITS reached its highest level in 2014, with Assets under Management (AuM) rising to €11 trillion, an increase of 16%.
Conversely, if the manager wants to attract more professional or institutional money, an AIF would be better suited.
The decision to launch a UCITS or AIF will be determined by the investment profile of the manager as well, which is obviously correlated to the nature of the prospective client base. The liquidity terms in UCITS are generous (mostly daily), which means managers must adhere to a number of investment restrictions. Their underlying investments must be liquid and transferable and there are curbs on leverage. AIFs are not bound by these investment limitations given they are marketed to institutions.
Another consideration for managers is determining how they establish a local presence in the EU. Some may elect to appoint a management company, which can enable them to passport across the member state bloc. Others may prefer to establish bricks and mortar in an EU jurisdiction.
Ian Lynch: While the passport does give UCITS and AIFs an ability to distribute freely across the entire EU, different jurisdictions have different requirements. UCITS IV was introduced to remove impediments or national barriers which made it challenging for some managers to distribute across certain countries within the EU.
Despite UCITS IV, managers need to be aware that some regimes still have their own additional requirements, such as the appointment of local paying or distribution agents, and reporting obligations. AIFMs which use national private placement regimes (NPPR) as opposed to the full AIFMD passport must be mindful that different jurisdictions will also have nuances in their rules. Managers must be mindful of these too.
Beyond regulation, there are a number of cultural issues managers need to be aware of. Investors in some countries will not buy into standalone funds directly but rather through banks or independent financial advisers (IFAs). It is important fund managers recognise these investor buying trends and tailor their businesses accordingly. Despite these challenges, UCITS does remain the leading mutual fund wrapper globally. Furthermore, there is nothing to prevent an AIFMD brand replicating the success of UCITS although this will take time to develop.
Ian Lynch: We are certainly seeing a trend whereby managers of traditionally offshore structures are migrating onshore. Europe has the second largest funds industry in the world and a sizeable institutional and retail investor landscape. Some institutional investors cannot allocate their capital into offshore structures for a variety of reasons. As such, a move onshore by managers can result in improved capital raising opportunities. Equally, the operational process of moving business onshore – either to Ireland or
Luxembourg – has been tried and tested many times, and it is straightforward.
Some firms regulated under AIFMD are looking beyond the NPPR regimes to move fully onshore. Most though are seeking to solicit capital from the core jurisdictions as opposed to all of the 28 member states. Non-EU hedge fund managers are not just establishing AIFs but also UCITS. We have seen a growing number of hedge funds launch alternative UCITS, which have increased by 75% to €302 billion over the last three years. These UCITS hedge funds are not necessarily clones of their original funds, but rather cousins as there can be some tracking error. Nonetheless, investors are aware of this and this has not dampened their enthusiasm.
Ian Lynch: Guernsey, Jersey and Switzerland have all been told by the European Securities and Markets Authority (ESMA) that their regulatory regimes all meet AIFMD compliance criteria and they will be granted the passport. However, the Delegated Act confirming this passport extension has yet to be passed by the European Commission.
Other jurisdictions including the US, Hong Kong and Singapore have been notified by ESMA that more analysis needs to be done before a decision on the passport is firmed up. We believe consultations will be published in summer 2016. This will be a long process and passport extensions may not happen until after 2018.
The uncertainty around time-frames for the passport is a major driver behind the decision by managers to move onshore. Another issue is that some non-EU managers do not feel comfortable with reverse solicitation. The idea that investors initiate communications with non-EU managers carries with it significant regulatory risk, and it can hardly be described as a viable or sustainable marketing strategy. As such, fund managers are no longer seeking to rely on reverse solicitation. This again is pushing more firms towards onshore jurisdictions.
Ian Lynch: AIFMD requires managers soliciting capital from European investors to appoint a depositary or depositary-lite. The depositary offers safekeeping of assets, cash-flow monitoring and fund oversight, and it is subject to strict restitution liability for any loss of assets. A depositary-lite is exempted from strict liability. While the appointment of a depositary is an additional cost for fund managers, it does add a level of protection for their underlying clients, which many appreciate.
The liability provisions in AIFMD could be severe for depositaries, so it is essential fund managers utilise a service provider that has a strong balance sheet. BNP Paribas Securities Services, for example, has approximately €1.3 trillion in Assets under Depositary, and its balance sheet strength serves to reassure institutional clients.
It is also important that managers appoint a depositary which has experience. BNP Paribas Securities Services has been providing UCITS depositary services for many years, and this puts us in excellent stead to deal with AIFMD.
Finally, it is key that managers select a provider with a broad product offering. In other words, the provider should not only be an extremely credible custodian and depositary but also offer fund administration, transfer agency and middle office services. If multiple providers are carrying out all of these roles, it can lead to confusion and overlap. It is certainly more cost-efficient for the manager to have a single service provider catering for all of these requirements.
Most importantly, fund managers need to look towards a service provider which has a strong geographical presence across the EU and one that understands all of the different regulatory and investor intricacies in each jurisdiction.