Andy Creber of RBC Wealth Management explains how he sees the AIFMD impact custodians and how his company is well positioned to thrive within Guernsey's newly-regulated environment.
The Alternative Investment Fund Managers Directive (AIFMD) will come into effect in July 2013, creating a single regime for the industry across Europe. This development, combined with wider economic uncertainty, will have a significant impact on custodians.
However, the sector in Guernsey continues to thrive as the industry is transformed. The AIFMD measures make it clear that custodians will be liable for lost assets held in their custody. In order to avoid this liability, custodians will have to demonstrate: that any loss was caused outside of their control; that they have taken all reasonable precautions to avoid loss; and that the assets were suitably protected. Furthermore, the directive does not allow custodians to sub-delegate this liability to their appointed sub-custodians.
Prime brokerage is included under the custodian liability, and this is likely to put custodians' thirst for hedge funds utilising these services under scrutiny, as regulators look for this sector to be 'insured'. In the worst case scenario, if a prime broker were to fail then the custodian could potentially have to replace the collateral and/or assets immediately, in accordance with AIFMD, before pursuing a counter-claim with an unknown outcome over a long period of time. Hopefully this will be addressed, as it is in the interest of all parties for this liability risk to be dealt with fairly. However, this remains a moving target given that the appointment of the prime broker is driven by the investment manager, which means that the custodian could potentially demonstrate that it was 'forced by the special circumstances' and seek protection under Article 21(13).
Key provisions under Article 21 of the AIFMD
For an EU Alternative Investment Fund (AIF), the Alternative Investment Fund Manager (AIFM) must appoint a single depositary, which must be an EU credit institution, an EU investment firm, or an institution eligible to be a depositary under Undertakings for Collective Investment in Transferable Securities (Ucits).
For a non-EU AIF, the AIFM must appoint a single depositary, which can be a non-EU credit institution or investment firm, subject to equivalent prudential regulation, or is from a third country not listed as a Non-Cooperative Country and Territory by the Financial Action Task Force (FATF).
Under the AIFMD, an eligible institution also includes scope to allow lawyers, registrars and notaries to be classed as depositaries. This may help funds, such as real estate, where there may be small amounts of assets with low volumes of trading. While this scope is wide, the AIFMD is clear in that the depositary must be liable to the AIF and its underlying shareholder for the loss of any financial investments held in custody by the depositary. As such, AIFMs - and in turn their investors - will still prefer a traditional custodian with a strong balance sheet and a prudent track record.
Responsibilities of the depositary
The key responsibilities of the depositary under the AIFMD are similar to a fiduciary custodian for regulated funds, such as Ucits. Key areas include the monitoring of cash flows, the safekeeping of assets and the oversight of the management of the AIF. These duties will place the depositary at the heart of the AIF's central operations and will protect investors from additional risk. The premiums are likely to be high and although at this stage it is unclear what the price will be, depositaries will review these fees frequently to reflect industry claims. A fund with traditional assets and models is not likely to see premiums increase dramatically, but a hedge fund or vehicle with assets which are held further away from the custodian's control may be faced with significant premiums.
This could include assets like a Limited Partner (LP) investment with commitments or a prime brokerage arrangement with all collateral held with the broker. Some consultants are suggesting fee levels five times higher than currently charged. In light of this, it will be interesting to see if there is an appetite for AIFMs to launch new products under this regime.
An offshore perspective
From Guernsey's perspective, the regulators and industry bodies have already begun drafting regulation which will create a regime that is compliant with the AIFMD rules.
It is anticipated that this will be in place by the summer of 2013, allowing products to be distributed to countries which are also AIFMD-compliant. The chief executive of Guernsey Finance has said that Guernsey will apply for third-country passporting status when this option becomes available.
This will enable AIFMs in the jurisdiction and their investors to select their depositary of choice, based on their own selection criteria of corporate governance, commitment, experience and balance sheet strength. This choice will ensure that Guernsey remains well-placed to continue to grow and maintain their enviable reputation as a well regulated jurisdiction for the investment funds sector, whether sponsors target Europe or not. RBC Wealth Management's Corporate and Institutional business ("RBC C&I") is licensed and regulated to undertake the role of a depositary for mutual funds.
RBC C&I employs a 'best in breed' approach, so that regardless of where the fund is domiciled, the promoter and directors of the fund can be assured of a model which is focused at the top of the regulation playing field. This model will serve the new AIFMD well, as the additional responsibilities are not alien to RBC C&I and positions us favourably to provide an oversight 'fiduciary' role that safeguards the assets and protects the interest of the 'beneficiaries' - the shareholders and unit-holders. The depositary role has traditionally been overlooked by promoters, but since 2008 shareholder and regulators alike see the role as vital to providing the transparency and comfort which is now generally expected. As a custodian provider in the funds sector, investors are continually comforted by the strength and stability of RBC, which has been paramount to its success during the financial upheaval in the markets.
RBC C&I continues to expand its fund and custody business beyond the traditional hedge fund or fund of hedge fund offerings and to cover other alternative products coming to market which require an experienced and well-established fiduciary overseeing the funds' operation.
The AIFMD represents a positive development that will support further expansion into sectors including hedge funds, private equity and venture capital funds seeking a depositary.
Property and more esoteric alternative structures such as art, antique, commodity and fine wine funds are becoming increasingly popular as investors look to diversify their portfolios by minimizing the volatility of returns without forfeiting performance. With its flexible approach to these types of products, Guernsey should be a beneficiary of this new business. In addition, the emerging markets will continue to be a factor in any new business theme, with the BRIC countries representing a relatively new distribution region for the alternative fund industry in Guernsey. Another notable trend has been for institutional investors and ultra high net worth individuals to create their own managed account structure with their preferred investment manager. RBC Wealth Management is tapping into this growing area, providing transparency, liquidity and control to clients who would previously have invested in a fund of funds structure.
RBC Wealth Management's established track record in providing custody, corporate trustee and fund administration services, while leveraging the strengths of the broader RBC global network, places it heads above its peers.
Originally published in HFMWeek's 2013 Guernsey Special Report, May 2013.
For more information about Guernsey's finance industry please visit www.guernseyfinance.com.
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