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DOW JONES     AIFM directive an illusion for regulators, a growth opportunity for European Custodian banks or US hedge funds (Hedge21)

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Hedge21     posted : 08/01/14   10:38 pm


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AIFM directive an illusion for regulators, a growth opportunity for European Custodian banks or US hedge funds :


How to seek alpha without risk for investors and if possible with a guarantee of asset?

This is the idea of Ucits, the gold standard for retail European investment vehicles which had a consequence to decrease the risk appetite of European retail.
Oddly more you regulate and try to protect investors, less is their appetite to invest

Constraints imposed on strategies , and risk using the Ucits wrapper reduce potential return by increase of fees which are used to pay ( management performance + risk controlled by Custodian bank )
Consequently, Investors take risk to invest in funds, pay high global fees ( Asset managers+ Custodian banks) for less net return .


AIFM directive continue to follow the same logic to try to protect investors even if they want to take more risk and invest in Hedge funds. The idea is to provide a regulated onshore alternative vehicle without the constraints on strategies, liquidity and leverage forced on managers by ucits rules.

Just remember that Ucits IV is composed on two parts and an other vehicle for Luxembourg hedge fund called SIF ( Specialised investment fund)
Ucits part 1 and Part 2 :

“The criterion defining whether a UCI is subject to Part I or Part II of the 2002 Law is the planned investment objective, as Part I applies only to UCI the sole objective of which is the investment in transferable securities, whereas a UCI may invest in activities such, inter alia, alternative investments (i.e. Hedge Funds), venture capital, and real estate.

The Specialised Investment Fund (SIF) is a regulated, operationally flexible and fiscally efficient multipurpose investment fund regime for an international, institutional and qualified investor base. In comparison with institutional funds created under Part II of the Law of 20 December 2002 on undertakings for collective investment, the SIF is characterised by greater flexibility with regard to the investment policy, broadening of the sphere of investors and a more relaxed regulatory regime”

Opportunities:

* There is a high probability of :
- transfert all part 2 Ucits funds on AIF funds
- An opportunity for Ucits part 1 to leave UCIT for advantage of AIFM directive

For a fund manager Ucits fund become less interesting than Aif funds.( Aifmd is less regulated than Ucits IV and V especially in term of reporting)


AIFs include the best elements of Ucits without the investment and liquidity restrictions that sometimes hinder performance of alternative Ucits compared to offshore funds following similar strategies.


Onshore hedge funds will increasingly dominate in future. While Ucits continues to be the gold standard in terms of marketability, AIFMD provides a potentially fruitful alternative vehicle for tapping into institutional demand for onshore products.

AIFM directive is without doubt the best opportunity for manager of Ucits funds to leave Ucits IV and Ucits V for more liberty in term of strategies and risk .
Remember that Ucits V and AIFM directive give more responsibility contingency for custodian banks.

The important issue is the cost, remember that part 2 funds and Sif paid less fees to custody banks than Aif funds.

US Hedge funds will need to have AIF vehicles to be active in Europe in the future. It is important to have an onshore offering as investors want more regulated structures
US hedge funds have an opportunity to have European institutional investor via creation of Aif fund and try to transfer cash from European AIF hedge funds to his US Hedge funds in Bermuda via Swap for example.

Market:
New regulation will accelerate concentration Custodian banks to decrease cost in a market managed by lowest prices. Thus, it creates a Concentration of risk on Custodian banks and Clearing house.


Interest for investors?

A more complex regulation will create an increase of cost consequently an impact on fees.
AIFM directive and Ucits V increase the role of custodian banks (risk management, reporting…) and consequently competitively between Mutual Funds and ETF.
Remember , Higher are the fees less is the probability of return.

Systemic risk
The reality of this entire directive is to reduce a possible systemic risk.

Explosion of reporting need by for Esma (minimum 36 pages/report ) the same logic than Dodd-Franck ( too much details to be applied or checked in real time by different auditors and others control department)
By The way, do not forget that US funds do not follow this regulation.
If a new Maddoff would like to create a US funds with European Investor . Aifm directive and Ucits IV and V will no be able to detect a fraud or too late( if the Custodian banks do their job to conserve securities.)

Europe believe that AIFM and Ucits V can reduce the systemic risk via diversification vision.

Crisis of 2008 show that diversification do not really work.
Moreover if you concentrate custodian banks in Europe , the risk of counterparty increase .
In addition, Custodian banks use the same ratio or theory that did not work during the last crisis like the value at risk ( var) , the same stress test (proving that French and German banks are totally sure ( example Dexia ))

Due to low interest rate Custodian banks which make cash with repo have now a real problem of return and should take more risk ( security lending for example .)

As for Dodd-Franck, Volcker rule or Emir , it is always the same thing theory you have a plenty of restriction with solution to avoid this restriction , so in practice you are allowed to do everything you want ( Market maker , hedging activities or security lending ) but if you failed , regulator can identify who is responsible .
Penalty will be applied but at the end the too big too fail continue to work and the new European banking plan (copy of Cyprius plan) will impact retails repo and after European States. ( thanks Germany)

Personally, the systemic risk increase in Europe for 3 reasons:
- Stress test not serious, and I bet that all French and German Banks will officially succeed next stress test in 2014 like Dexia in 2009
- Concentration of Custodian banks
- lake of repo return create a risk appétit from Custodian banks .Remember that Custodian banks have a decrease of their revenue ( low interest rate for repo, less return from their customers mutual funds (need to reduce fees )
- New banking regulation and directive create the illusion that the risk is under control and pushed asset managers to take more risk.
- Too much regulation creates exceptions on this regulation.
- Regulation detect risk not in upstream but a posteriori
- Ratio like ( var…) not enough to manage risk
- Difference between Hedging, market making, and trading still Fuzzy.
- SESF will enter in game only after bankruptcy of Shareholders, debtholders, and retails repo.
- And the best risk for 2014 is the next European Election, last news show that European people want less Europe and it should have some effect on next bank regulation.


Consequently Aifm is without doubt an opportunity for US hedge funds to have access at European cash but it is especially an opportunity for Custody banks to provide more reporting and take more fees.

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