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How to access Europe using third party AIFMs

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Alternative fund managers wishing to continue to market their funds into Europe have to navigate unchartered territory. The AIFMD only really kicked in last July at the end of the grandfathering period, since when both EU and non-EU AIFMs have started to treat the directive more seriously. 

This is a complex piece of regulation and, in a similar fashion to the UCITS framework, managers have multiple options available to them. This report considers one option in particular – appointing a third party AIFM (or Management Company), and the fund distribution benefits that this can bring; be it for new funds launches or redomiciled funds. 

“The broad scope of the directive changes the management and fund raising regulatory landscape dramatically for an AIF Manager who chooses to offer and place shares of an AIF inside the European Economic Area (“EEA”),” says Simon Hookway, Consultant, Bruton Street Consulting LLP, a leading London-based provider of outsourced and consultancy services. 

The Bank of New York has suggested that full compliance with AIFMD, whereby the manager takes on the responsibility in-house, adds approximately USD300k to USD1m per annum to operating costs (depending on AuM). One-off set up costs range between USD100k and USD250k. The AIFM needs substance – including physical offices, senior management officials, a CCO and risk manager, reporting mechanisms, not to mention the appointment of multiple service providers including an independent depositary. 

“ESMA uses the directive as a means to impose further complexity, costs and time constraints on AIF Managers, further raising the performance bar which managers must achieve before investors, who the directive seeks to protect, begin to benefit (their original reason for investing),” adds Hookway.

When faced with such a prospect, the third party AIFM route becomes highly desirable. 

“We see some tremendous interest in our AIFM services, both in terms of having a sub-fund on our platform – MS SICAV SIF – and in terms of being appointed as the third party AIFM. Regarding the latter, we’ve been successful converting a few managers who fell below the EUR100m threshold and therefore remained out of scope. Now they are ready to comply in full with the directive but they don’t want to go through the pain and hassle of the regulatory process of getting approved, or having to make changes to their processes and structures. 

“Also, these managers are EU and non-EU domiciled and have decided to appoint us as the AIFM whereby we delegate the portfolio management back to them and we retain the risk management, administration functions and so on,” explains Kavitha Ramachandran, Senior Manager, Business Development and Client Management, Maitland Luxembourg. 

A lot of non-EU managers realise that the sands of time for reverse solicitation are fast running out. 

By 2018, any AIFM, EU or otherwise, will have to have an AIF for marketing and distribution purposes. The benefit of appointing an external ManCo is that a New York-based manager can safely enter in to a sub-advisory relationship, where they join a platform and the Investment Manager delegates the portfolio management function back to them. At the same time, that manager can freely market their AIF, in full knowledge that all the regulatory and compliance demands are taken care of by the outsourced AIFM.

And that is a major advantage to US managers as it immediately circumvents one of their biggest fears: namely complying with remuneration rules. 

“What we’ve done at ML Capital is to provide a complete solution set. One being the Montlake QIAIF platform, the second being the launch of ML Management Ltd, which is our AIFM ManCo.

“The idea is that by doing all the heavy lifting, we allow the manager to focus on running their strategy, whilst we take care of operating the new fund structure for them and supporting their asset raising ambitions. For managers operating in the US, by using a third party AIFM and platform, it removes the risk of them getting caught up in the remuneration rules,” confirms Richard Day, COO of ML Capital.

The firm has been running its Dublin-domiciled Montlake UCITS platform since 2010. Last December, it set up the Montlake QIAIF platform. Whilst some platforms are happy to support start-up managers, in a kind of incubation arrangement, this is not what ML Capital is bringing to the table.

“We are not trying to provide regulatory arbitrage for managers trying to get up and running and learn what it means to operate under the directive. We focus on managers running existing structures but who do not have an onshore European solution. If you look at our client roster, 95 per cent of clients we work with are long-established fund managers,” adds Day. 

An important consideration for managers when selecting an AIFM is the depth of operational expertise in areas such as Annex IV reporting. At Cordium, they have created what they call the Cordium Total AIFM Solution (CTAS); a Malta-based AIFM solution. 

“Annex IV is a challenge. That’s the one area that managers have been struggling with. The point of using something like CTAS is that the manager doesn’t have to worry about the burden of Annex IV as they know our team at Mirabella Financial Services will take care of it. The idea of the report is to provide systemic information in an aggregated form. The FCA has had IT issues getting their reference numbers and access to GABRIEL in a timely fashion, some managers have received messages telling them to submit via email while others have had access to GABRIEL but the scheduling has not been right. 

“So aside from the complexities of the report, there are implementation issues for managers to deal with as well. Everybody has been struggling to get to grips with the content and also the submission challenges,” explains Bobby Johal, Managing Consultant at Cordium.

The CTAS solution is interesting. On the one hand, managers can become their own AIFM. On the other hand, they use an outsourced AIFM. With CTAS, however, Cordium sets up the AIFM on behalf of the manager, thereby allowing them to retain full ownership, and takes care of everything from an operational standpoint. 

One of the key elements of the directive, in relation to risk management, requires managers to have an intimate working knowledge of the strategies they propose to market in Europe. As such, any hosted AIFM solution must have highly qualified risk professionals that can work with a spectrum of investment strategies; PERE funds as well as hedge funds. 

“We’ve written countless manuals, upscaled our operational procedures, developed different risk reporting frameworks. We’ve got an array of documentation and monitoring programmes that try to anticipate different variations in clients’ strategies. We’ve embraced that challenge, as any hosted AIFM should,” states Johal. 

Timothe Fuchs is the CEO of Luxembourg-based Fuchs Asset Management. In his opinion, managers must ensure that every counterparty used by the AIFM is experienced and proficient. 

“The ultimate goal is to avoid a manager who appoints us having to change the way they do business internally. You have to be as flexible as possible. That comes with working with professionals that know their business. It allows us to focus on running the ManCo business, organising the life of the fund, making the administrative/legal/risk aspects efficient. We don’t need to go against the portfolio manager, as they are the ones running the fund. It’s about giving the manager full independence and allowing them to stay true to who they are,” emphasises Fuchs.

“For bigger institutions they can separate out a lot of the functions and operate as an AIFM but for medium-sized managers – up to USD1bn in AuM – I think it makes more sense to go with an outsourced solution. If you outsource some of the functions, you get the advice of a professional that understands your business and will help you in different situations.”

Pierre-Yves Augsburger, Director of Fuchs Asset Management notes, quite rightly, that managers shouldn’t try and do everything themselves. 

“The world is getting more complex. It’s better to pay for an external AIFM than to pay for internal problems, such as friction within the team that could arise from dealing with compliance/regulatory issues that they have no expertise in,” says Augsburger. 

“Administrator-type platforms don’t really have the ability to comment on whether an investment decision is appropriate or not. You need to understand the underlying investment. That’s where we’ve had a lot of success. We’ve had clients come to us after collecting a series of quotes and what they’ve said is that they want to work with a platform that has bona fide markets people as opposed to administration professionals,” opines Bobby Console-Verma, group CEO of Tower Gate Capital, whose Tower Gate Platform specifically targets PERE funds. 

In any outsourced arrangement, the manager effectively acts as a sub-advisor to the platform AIF. Not all platform providers will have the nous to interrogate a private equity fund and make value judgements on the soundness of the investment decisions As with everything AIFMD-related, different AIF Managers will look for different things depending on the strategy they are running. 

“For example, I sit on the investment committee of a number of funds. Whenever they want to make an investment they provide notice, we attend the IC meeting and reach an agreement on that investment decision. It’s another invaluable service you are providing because at the end of the day it’s the platform that bears significant risk. The platform has got to be incredibly well run and you have got to have the right blend of people,” states Console-Verma.

From August onwards last year, Console-Verma observes that interest was building among PE managers in particular, even among managers with up to USD1bn in AuM who have no desire to go down the costly route of getting regulated. 

“To run an in-house AIFM costs three times more than it would to go down the platform route. That doesn’t even take into account the time savings. It’s a sensible, logical route and managers are starting to understand this. My prediction is that we’ll see more real estate companies becoming interested in the Tower Gate Platform in 2015. We are currently in discussion with one RE manager with assets north of USD1bn to act as the AIFM,” confirms Console-Verma.

According to Hookway, important considerations when doing due diligence on platforms established to host services include:

• The scope of the host’s AIFMD licence;

• Portfolio management capability;

• Risk management experience and tools

• Advisory and marketing tools;

• Service provider framework and relationships.

“Platforms such as Integra offer Non-EEA managers who wish to operate inside the EEA the opportunity to take advantage of the services offered by professionals and market leaders such as PwC and SS&C Fund Services, while continuing to be able to market their existing track record. Non-EEA Managers can establish a cell under the platform umbrella which then leverages off the passporting facility previously available only to EEA-based AIF Managers,” comments Hookway.

Expanding on the key considerations when performing due diligence on an outsourced AIFM, Peter Northcott of KB Associates, an operational consulting firm, adds: “I would suggest that the investor checks that the AIFM is well capitalised, that’s critical. You want to avoid reputational damage. You should have some sense of who the other users of the AIFM are. Also, you need to be sure that the outsourced risk management product is credible. And finally, assess whether the AIFM is offering good value for money.” 

Clearly, there are many advantages to appointing an AIFM but when asked what the main risk is, Ramachandran states that it is the loss of independence (if managers decide to join the platform). 

“Ultimately, there’s another party involved. There have been questions over disclosures and how this would be dealt with under AIFMD; those have yet to be answered. The disclosures to investors, details about remunerations and so on. It’s a sensitive issue for US managers, as compared to EU managers who are already complying with transparency requirements under MiFID and CRD rules, and it’s something they need to get comfortable with. This is where the education and interaction with the AIFM helps. We can explain to them what is required and provide continual updates,” says Ramachandran.

Also, the strength of a platform’s team has to be carefully assessed. 

“The platform you appoint has to have the right blend of personnel and, as an adjunct to that, the platform has to be operationally robust and well run to cope with the sheer volume of work required, particularly the reporting function. What we are good at is technology. We originally started as Tower Gate Capital, which was a technology incubator. We’ve been implementing systems using our portfolio companies to build systems to cater for these myriad reporting functions under AIFMD,” concludes Console-Verma. 

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