AIFMD Implementation Challenges: PART 1
Since the Alternative Investment Fund Managers Directive (AIFMD Implementation) (2011/61/EC) went into effect on 21st July 2011, Alternative Investment Fund Managers (AIFMs) (i.e. hedge funds, private equity funds, real estate funds, and institutional funds) have faced a number of significant operational implementation challenges.
Appointment of a Third-Party Depositary
Under the AIFMD all AIFMs must appoint a single depository for each Alternative Investment Fund (AIF) it manages.[1] In practice, the appointment of a suitably qualified and resourced depositary may be a time-consuming and difficult process to follow. For AIFs based in the European Union (EU) (EU-AIFs), depositaries must be based in the home Member State of the AIF, thereby limiting the choice of the depositary. The appointment of a depositary must also be evidenced by a written contract that adheres to 18 detailed contractual particulars that must be contained within the contract, e.g. services to be provided for each asset type, description of safe-keeping, and oversight functions to be performed for each asset type and geographical region, confidentiality obligations. Depositaries also face what has been anecdotally referred to as ‘near strict liability in respect of the safekeeping of assets (including AIF collateral assets), which means AIFMs must ensure that a depositary is both sufficiently capitalized in order to meet such level of liability and has sufficiently reviewed risks within any existing sub-custodian network.[2] A depositary is also obliged to assess the risks associated with the nature, scale, and complexity of the AIF’s strategy and the AIFM’s organisation in order to devise appropriate AIF oversight procedures. Rising AIFMD compliance costs, together with limitations on the use of AIF collateral, may result in some AIFMs opting for undercapitalised depositaries with latent sub-custodian risks, and increased AIFMD operational risk.
AIFMD Data Management and AIFMD Annex IV Reporting Obligations
AIFMs may find it particularly challenging to adapt existing data management systems to comply with new AIFMD reporting obligations. AIFMD disclosures include initial and ongoing investor disclosures (e.g. AIF objectives, strategy, leverage, depositary, vehicle, historical performance, net asset value) and regulatory reporting. AIFMs need to collect data from a range of disparate sources (e.g. asset managers, custodians, and administrators), and countries (e.g. multi-jurisdiction operating model), and so may have difficulty designing and implementing a cost-effective AIFMD reporting architecture. AIFMs must provide an Annex IV AIFM report which provides management and fund information, and an Annex IV AIF report for each fund held containing information relating to assets, risks, and investor types. These reports must be submitted on an annual, semi-annual, or quarterly basis (dependant on the type of AIF), and the different EU Member States may have different reporting timelines. AIFMs must answer 41 detailed questions; choose from nine variations of the AIFM report or 45 variations of the AIF report; populate 38 data fields for the AIFM, or 302 data fields for each AIF; complete each report within a 30 day timeframe. The increased level of granularity of data required for AIFs[3], strategies[4], investments[5], financial instruments[6]; structures[7], and risk profile[8], may make mapping of Annex IV data to existing data subsets (e.g. investors, market risk, liquidity risk, counterparty risk, and trading data) particularly onerous. AIFMs must also ensure that they have systems in place to extract data from the relevant systems or repositories, aggregate the data, validate the data, and perform controls testing and audit procedures.
An efficient and reliable outsourced Annex IV reporting solution may therefore be the most cost-effective method of AIFMD compliance for many AIFMs.
For more information on our AIFMD IV reporting solution and prices, please email DataTracks at: enquiry@datatracks.eu.
[1] The depositary can be a credit institution registered and authorized in the EU; an investment firm registered in the EU and subject to capital adequacy requirements; or other categories of institution subject to national prudential regulation in EU Member States.
[2] In practice this means that they are liable in respect of the custody of all financial instruments held, as well as all financial instruments held in custody by a delegated third party.
[3] For example, identification codes, domicile, or prime brokers.
[4] For example, investment, hedge fund, private equity, real estate, or fund-of-fund, strategies.
[5] For example, principal exposures, geographical focus, portfolio concentrations, typical deal/position size, or investor concentration information.
[6] For example, financial instruments such as securities, derivatives, physical (real/tangible) assets, or collective investment undertakings.
[7] For example, master/feeder, umbrella/sub-fund, or fund-of-funds, structures.
[8] For example, market risk, counterparty risk, borrowing and exposure risk, and liquidity and investor liquidity profiles.