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Regulated fund market set to grow with direct lending vehicle

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With total hedge fund AuM now nearing USD3trn, the last 12 months have been a noticeable period of growth for the industry at large. Admittedly, 2014’s performance figures aren’t as strong as 2013 but as the regulatory dust in Europe settles many more managers are striking out and launching new funds.

Indeed, Clive Bellows (pictured), Country Head, Ireland, at Northern Trust, observes that the most obvious trend this year is “growth”.
“Across all asset classes we have seen significant new fund launches and inflows into product. Of our USD420bn in AuA our top 25 clients account for about USD370bn of that. Of those 25, 22 have seen net inflows into their funds this year.
“In terms of asset classes, where we’ve seen the most growth and the most fund launches this year has been in real estate. We are seeing existing players launching new products and a number of the big US property managers coming in and establishing Irish-domiciled vehicles to invest in Ireland’s commercial property sector. Most of the launches we’ve seen have been QIFs to support a single property; not AIFMD-compliant QIAIFs,” explains Bellows.
The Irish economy is probably the one that has emerged the fastest from the challenges of the Eurozone and that has created opportunities. Bellows says that whilst managers are choosing Ireland to domicile the fund to pursue a pan-European real estate strategy “most of that initial investment, not all, has been focused on Irish commercial real estate”.
John Bohan is Managing Director of Apex Fund Services in Ireland. A few years ago, Ireland saw a lot of US vulture capital funds moving in to snap up distressed assets when its real estate sector imploded. With the economy back on track and commercial property prices rising, these have been replaced by more mainstream PERE managers.
“There’s been a lot of land re-zoned for commercial and retail purposes in the last Irish budget so it’s an asset class that has once again become very attractive, especially given the growth rates we’ve seen over the last 12 months. The QIAIF regime has opened up the door. There are a lot more US managers beginning to look at it who aren’t seeing quite the same level of hurdles as previously. The conformity isn’t as complex as managers originally thought.
“For example, we are seeing managers with funds of USD50-100m in AuM beginning to consider the external AIFM solution to take advantage of the third country passport when it comes into effect next July. The opportunity costs are not as great as once feared,” says Bohan.
Whereas once the typical hedge fund manager ran a Cayman fund and nothing else, today’s reality is one that dictates a need to run multiple fund structures in order to cater for different investors. UK and Scandinavian institutions have no problem investing in offshore vehicles. What AIFMD has done – and which ESMA hopes will develop the same kudos as the UCITS brand – is open up alternative funds to Europe’s more conservative institutional investors in Germany, France, Italy and so on.
This is good news, both for non-European managers who are still in asset raising mode, and investors who want continued access to top talent.
Ken Somerville is Head of Business Development at Quintillion Limited, the European fund administration affiliate of U.S. Bancorp Fund Services. He notes that there has been some real estate fund activity among its clients “but I wouldn’t say it has been significant. By a long shot, credit, fixed income and long/short equity are still the bulk of strategies that we see coming on stream.
“Managers who are looking at Europe for the first time are looking at the practical challenges of setting up the fund and the management company. In addition, they are looking at whether they need to adapt their strategy to meet European regulations before establishing a QIAIF or a UCITS. Clients we speak to are constructing their business plan to launch a vehicle next year; in Q3 we’ve seen a strong level of interest so that will hopefully translate to real opportunities in 2015 and beyond,” confirms Somerville.
According to Tom Kirkpatrick, European COO at SS&C GlobeOp (Ireland), while most US hedge fund managers are considering how best to market into Europe, private equity managers are looking at options available to them.
“At the moment, some are considering a Section 110 vehicle; this is a tax efficient vehicle for private equity companies and could be an area of growth for Ireland. It will be interesting to see, as the brand recognition of AIFMD comes to the fore, whether US managers will take that extra step forward and come into the regulated private equity space,” comments Kirkpatrick.
Bellows confirms that Northern Trust is starting to see early signs of interest among managers wishing to launch loan origination vehicles.
“Questions remain around what types of companies those funds will invest in and how easy it will be to value those investments. These are going to be regulated products so we’ll have full responsibility as the onshore depositary. We have to be certain that we can independently value these funds. They may be used for infrastructure projects where the assets will be less easy to value. Until somebody comes up with a definitive product and says ‘This is what we plan on putting into the fund’, the industry can’t be 100 per cent clear on how that process is going to work,” cautions Bellows.
Bohan is unequivocal in his response: “It’s definitely a big opportunity for Apex Fund Services. We have offices in 34 different locations and we see lots of different strategies launch. Now that managers have the ability to establish a loan fund using an Irish regulated structure it certainly opens that door for us.”
Colin Keane, Country Head, Ireland, SS&C GlobeOp notes that its clients are particularly interested in the ICAV and how that could work in tandem with establishing a loan origination fund. “I believe that once it is fully enacted, alongside ICAV the loan origination vehicle will be of particular interest to the US private equity market as the ICAV allows check the box provisions for US taxable investors,” says Keane.
David O’Keeffe is CEO of SMT Trustees (Ireland) Limited (“SMT Trustees”), part of Sumitomo Mitsui Trust Bank Ltd (SMTB), the largest Trust Bank in Asia with over USD2trn in assets under custody. O’Keeffe says that there will potentially be a tangible benefit as SMT Trustees will now be in a position to service any newly established European loan funds out of Ireland. Previously, SMTB established a number of offshore funds for Japanese institutional investors where the investment policies were large bank real estate and corporate loan funds, where these funds purchased such loans on the secondary market.
“Even before this loan origination announcement was made, we saw a good deal of these funds, which are managed by some of the biggest and best global investment managers. A number of funds launched by this year alone include loans as an asset class or at least have loans as an investment component to them. We expect there will be keen interest in originating loans as opposed to having to buy them in the secondary markets,” states O’Keeffe.
Quintillion is well placed to support these loans given that its corporate trust business in London is a leading provider of European loan services.
“We already have a number of collaborations with the administration and investor servicing businesses and the loan servicing business where we have a common group of clients running offshore loan funds. We’ve got Cayman funds where we collaborate together, so if those firms extend into Irish loan origination funds, the fact that there’s a pre-existing working model could be a significant advantage,” says Somerville.
One of the immediate challenges facing AIFMs is regulatory reporting in the form of Annex IV – something that even non-EU managers who are privately placing their funds in Europe must adhere to. Pacific Fund Systems last month announced the launch of an automated Annex IV reporting solution within its PFS-PAXUS system. According to Keith Parker, owing to the enormity of the work involved in collating the required data, and given the fact that its system contains an overwhelming percentage of that data, “there was a compelling case for us to design an Annex IV reporting capability for our clients.
“This new capability in our system should make the lives of AIFMs infinitely easier in terms of this challenge and also allow our clients, the fund administrators, to generate revenue for providing this service as the ultimate aggregator of this data.”
As well as having the ability to generate Annex IV reports automatically, the system will allow users to edit the data before providing an option of generating the XML file for submission. As Parker notes: “We don’t see language as a barrier as most of the data is numerical.”
Only those already using PFS-PAXUS will be able to avail of the AIFMD reporting solution.
Keane states that SS&C GlobeOp has already done a lot of the hard yards in terms of building a regulatory reporting solution given that it has built comprehensive data collection and report formatting software in support of clients filing Form PF, CPO-PQR, FATCA, EMIR, UCITS and other compliance and reporting rules.
“We ensure accuracy, control and transparency over the entire reporting process – from the collection of data, to the approval of the form, to the submission of the filing.
“With Annex IV there were some overlaps, some areas of difference, but we were able to start building our solution relatively quickly. That has proven to be very successful. Even managers who do not use us as their administrator are signing up for regulatory reporting services. We now service a substantial client base on both sides of the Atlantic.
“We have our clients’ fund data, a robust risk engine and a hugely experienced internal risk department, so the ability to manage large quantities of data and perform complex calculations has really helped us provide a complete outsourcing solution to our clients. New regulation often leads to a disconnect in expected treatments and methodologies across different regulators and their respective jurisdiction. Harmonisation will surely follow in time but because our staff operate across a wide range of funds and jurisdictions, we can feed a lot of that knowledge and expertise directly back to our client base,” comments Keane.
AIFMD is beginning to be made manifest, particularly in reference to the number of managers appointing depositaries. According to Northern Trust’s Bellows, getting the depositary solution in place was a major effort in the first half of 2014.
“We are live with over 40 authorised AIFMs. We had to recruit 40 additional staff into our depositary team this year; both to support new AIFMs and to do the additional monitoring that AIFMD requires of the depositary. We effectively, in the space of 12 months, doubled our depositary team,” confirms Bellows.
When asked about the particular challenges of providing oversight to PERE funds, O’Keeffe responds by saying that it is up to the depositary to ensure that it has sufficiently vetted the transfer agent who is going to be holding the books and records of private equity funds.
“These are regarded as ‘other assets’ when recorded in the name of the AIF and under AIFMD do not attract the same near strict liability for the depositary as financial assets held in custody. However, if such assets are held in the name of the depositary and are lost, the depositary is obliged to return the equivalent assets.
“European investment managers already managing onshore funds have a clearer understanding of AIFMD. For those who have been managing funds in the offshore world they are looking for the least amount of frustration, the quickest turnaround and the most cost-effective depo lite solution,” comments O’Keeffe.
Clara Dunne is the Senior Country Officer, Caceis (Ireland). Given that Caceis has approximately EUR50bn of PERE assets under custody, it understands the specific concerns of these managers as they start to move towards regulated fund structures.
“You need to be involved with them for the full lifecycle from initial investment to the exit, including managing capital calls and distributions. Whereas for more traditional asset classes we would be organised on a functional basis, for PERE funds we have client-specific teams; the same team provides a full service to the client from depositary services to cash monitoring, investor relations, etc. We find that works well because these managers have specific requirements, their investors have specific requirements and you do need an expert team who understands that as opposed to treating PERE as just another asset class,” says Dunne.
Bohan says that Apex Fund Services has made sure that it is positioned to provide a one-stop solution to its clients, noting that the firm has strengthened the alignments it has with the depositary banks (which are required to perform the asset safekeeping function for financial assets).
“We can provide full depositary services, all the regulatory compliance reporting, an AIFM wrapper (not necessarily with us). We have mapped out every aspect and integrated the costs into one complete package. One-stop doesn’t necessarily mean all services have to be provided internally. We still maintain that having an independent fund administrator from the custodian is a much stronger arrangement than having it all under one roof,” concludes Bohan.
Once direct lending gathers impetus, Ireland will see an increase in the number of regulated fund structures. Like Northern Trust, Ireland’s administrators and custodians are going to need to keep strengthening their teams, which in turn should create more jobs and deepen Ireland’s standing as Europe’s leading alternative funds centre. 

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