Regulation continues to weigh heavy on the shoulders of global fund managers. When asked the question, "What worries you most about your portfolio in 2016?" some 30 per cent of attendees said increased regulatory pressure, with 17 per cent citing higher jumps in volatility.
With more regulation coming down the pipeline, most notably the pervasive second iteration of Markets in Financial Instruments Directive, MiFID II, due to be transposed across Europe in January 2018, the need to update and improve operational systems and procedures will continue at pace to cope with increased transparency demands.
Indeed, the Alternative Investment Fund Managers Directive (`AIFMD') is designed to make fund managers more accountable but as Jack Inglis, CEO of AIMA, which represents the interests of the alternative funds industry, stated: "Regulation has three main objectives: to secure financial stability, to protect investors and to prevent market abuse. Those objectives need to be assessed. Personally, I don't think AIFMD has delivered more investor protection."
Regulatory costs
Thirty-four per cent of attendees said that increased regulatory costs was the single biggest impact that AIFMD was having on their fund(s) and 31 per cent said it was increased reporting requirements. The majority of attendees (42 per cent) confirmed that they were availing of the EU passport for marketing purposes in the EU, with 21 per cent still using national private placement rules and, perhaps surprisingly, 21 per cent using the reverse solicitation route.
"In terms of regulatory compliance, the reporting aspect is challenging for smaller fund managers. Cayman funds rely on NPPR and are grappling with the demands of reporting in different EU Member States. Moreover, a large number of funds will soon face an additional layer of reporting on their investors with Common Reporting Standards, which is similar to US and UK FATCA but for the fact that 95 countries have signed up to it. More compliance, more costs. This is making it harder for smaller managers. I would say less than 50 per cent of start-ups that I see coming through the door actually succeed in getting to market," reflected Heidi de Vries, Partner at law firm Maples and Calder.
Impact on market liquidity
One fear that some within the funds industry have with respect to the seemingly endless wave of regulation is that it is making markets more illiquid. That makes it more expensive to change a position, sometimes even impossible to change a position when counterparties refuse to trade, according to Thijs Aaten of APG, a large Dutch pension provider. "The lack of market making activity has become more prominent in the last couple of years. It is valuable. It provides immediacy to the markets. But it has been very much affected by regulation," said Aaten.
Inglis added that reporting was "the number one bugbear of our industry; not just regulatory risk reporting (Annex IV, Form PF), but transaction reporting under EMIR. The ESMA reporting template has 65 fields to complete per transaction; is that going to damage market liquidity? It very possibly will. It produces potentially worrying issues, especially for liquidity in bond markets."
Short selling disclosures have had some impact on liquidity in European equity markets and given the singular focus on improved transparency, at the pre- and post-trade level under MiFID II, this could disincentivise market making activity even further, going forward.
"MiFID II is a big item on our agenda," confirmed Sheila Nicoll, Head of Public Policy, Schroders. "What will regulators do with the information that is reported? The FCA recognises the importance of feeding back the information they gather under AIFMD. Regulators have a lot more data on AIF managers compared to UCITS managers, which opens the debate on whether asset managers are systemic or not." Nicoll believes that asset managers like Schroders will increasingly need to demonstrate how the liquidity in the group matches the liquidity of the underlying funds they invest in on behalf of their investors.
"It is our activities that might be viewed as potentially systemic rather than the entities we invest with. A fund manager is not likely to bring the financial system crashing down. I think that is where regulators are going to focus their attention going forward," suggested Nicoll.
Indeed, the FSB and IOSCO agreed last year to start looking at the activities of funds (both in the long-only and alternatives space) rather than just their size. "I think that was absolutely the right thing to do. It sent a positive signal that you can get things done properly when interacting with regulators," concluded Inglis.
Conclusion
There are significant regulatory and market challenges that lie ahead in 2016. But those managers who have the rigour and the discipline to continue to seek out inefficiencies in different asset classes will likely prosper. If anything, regulation, and technology, is pushing alternative fund managers to enhance their business operations and seek out greater workflow efficiencies.
This is another sign of the ongoing institutionalisation of the hedge fund industry. And with exciting hedge funds such as Devet Capital and Mint Tower impressing investors, there is plenty to be optimistic about.
