Deutsche Bank has released a white paper on how managers can chart a smooth course through AIFMD implementation, and argues that adoption of an integrated model will be the most cost-effective option, with minimal disruption to a hedge fund business.
Entitled ‘Charting a smooth course through AIFMD implementation’ its aim is to highlight the changes and challenges that face alternative fund managers, and how Deutsche Bank’s AIFMD-compliant solution is able to help managers operate under full compliance and transparency under the Directive.
One of the key changes is the central role that depositaries will now play and the strict liabilities that will apply to them. Never before have Cayman-based hedge fund managers had to think about using depositaries. Now they will.
The appointed depositary will be held liable for the loss of any financial instruments that are held in custody on behalf of the AIF, or for the loss of financial instruments held with third-party sub-custody accounts.
What this means is that the depositary will become much more important in the terms of the AIF manager’s decision making process. It will want to know exactly which prime brokers are being used, what markets they are trading in, because they will be on the hook for anything that goes awry. From 22 July, they will be responsible for three key functions:
- safe keeping of assets
- monitor cash movements between the AIF and its counterparties
- provide general oversight of the fund’s investment activities
“We have to deliver a solution now that protects investors. We believe that delivering that solution in an integrated model makes it much more cost-effective for a manager than in a non-integrated model,” said Mike Hughes (pictured), global head of Fund Services at Deutsche Bank.
Managers might understandably feel uneasy about this change in dynamic given that their prime broker(s) is the one that executes a fund’s strategy and is the most important part of the value chain. Managers will still be responsible for appointing their own brokers and fund administrator, but what Deutsche Bank is saying in this white paper is that the few external service providers the depositary has to deal with, the lower the cost impact will be on a fund’s TER: hence the benefit of integration.
As the white paper states: “We believe that AIF managers would be best served by consolidating their business with depositaries equipped to work with their existing prime brokers and that can also act as fund administrators, cash managers, transfer agents, and sub-custodians within a framework of appropriate “Chinese walls” and segregation of duties.”
Again, it all goes back to the liability issue. If a manager chooses a sole independent depositary, whilst maintaining all other service provider relationships, the depositary will need to run external data feeds from all concerned to provide effective oversight. This costs money, and comes with a high-risk premium. It also means that the depositary will effectively be duplicating the role of each external service provider.
“An integrated model…can avoid such duplication and offer cost benefits while more effectively mitigating risks (by allowing the provider to retain tight control of the assets). This increases visibility – keeping everything in line-of-sight through internal systems and controls. In addition to being more secure, this reduces the administrative burden, and – through greater transparency – aids compliance,” states the white paper.
Ultimately, amid all this change, managers want minimal cost and disruption. An integrated model – whereby most, if not all, of the risk, is kept in-house and allows the depositary to perform its functions more effectively – will often be the best way of doing so.
To celebrate what is a unique milestone in the fund industry, Deutsche Bank is hosting an exclusive event in Dublin on 22 July 2013: the day the Directive is transposed into national law.
“It is a very important day for the fund management industry. There is a lot of commonality between advisers, independent directors, depositaries, administrators, and prime brokers.
“We are bringing everyone together at this invitation-only event to celebrate the fact that a phenomenal change to the industry has happened and that means we’ll all face new challenges as well as new opportunities,” said Hughes. “AIFMD is here and Deutsche Bank is ready.”
