At the time of writing this article, the European Union is battling yet another crisis among one of its members, with the looming bankruptcy of Cyprus threatening to further destabilise the region at a time when it can ill-afford it. As the green shoots of recovery in the US start to bloom (the Dow having reached all-time highs earlier this month), and the Asian engine room continuing to power ahead, Europe continues to struggle under a mountain of sovereign debt and the political discord that goes with it.
From an investor's standpoint, when compared to the US and Asia, Europe currently represents the least compelling proposition for investment - low growth, high unemployment and increasing geopolitical risk. Will the Euro survive? Is the whole Euro "project" unravelling? And, at a time when it desperately needs to start attracting meaningful foreign investment in order to kick-start growth, what is Europe's response?
It has forged ahead with sweeping, protectionist, Euro-centric regulation (in the form of the Alternative Investment Fund Managers Directive (Directive)), which will ultimately make it more difficult and costly for investors (particularly foreign investors) to access European markets.
The Directive - What is it?
The aim of the Directive is to establish a framework for regulating the managers of Alternative Investment Funds (AIFs), which are essentially those collective investment funds which are not EU-regulated "UCITS" funds. Private equity funds, hedge funds, real estate and infrastructure funds are all caught. Even if it could be argued that the objectives of the Directive are desirable, they are objectives for another economic time - and not a time when Europe should be seeking to encourage investment of all types, arming the next wave of its investment managers to design innovative investment products and raise the much-needed capital to invest into economies that so desperately need it.
They are also objectives designed for a more vulnerable investor; not for the professional investor (which make up 70% of the investors in AIFs in Europe).
Rather than encourage innovation and entrepreneurialism, the Directive will bury managers under a mountain of paperwork, and expose them to increased costs as a result - costs that will either be passed onto investors (and likely dilute their already lagging European returns, making Europe an even less-desirable investment destination) or cause their businesses to become unprofitable. Either way, it is a lose-lose scenario for the European investment funds industry.
And all of this for regulation that is very much a politically-driven exercise and has been, in many cases, vociferously opposed by the alternative investment community.
So What is Going to Happen?
The question that we are often asked is whether the AIFMD "badge" will become akin to that attached to UCITS products. In our view, the answer is no. Why?
The Directive is unnecessary, and investors know it. Regulation to protect retail investors is responsible policy-making. Regulation to protect professional investors is not. Unlike retail investors, their professional counterparts have large in-house teams who analyse and stress-test investments - as well as the ability to bring in external asset consultants - and often negotiate bespoke investment terms direct with the manager. Institutional investors will feel no "moral imperative" to embrace regulation that has such a flawed basis.
Investors and managers won't wear the costs. The costs of implementing and complying with the Directive will be borne in one of two ways: either by hitting the AIF manager's bottom line, or by hitting the investors' returns. Either way, someone will be worse off - it is just a case of whom, and by how much. In our view, managers will look to devise investment structures that obviate the need for Directive compliance, while still enabling capital raising and investment in Europe. All other things being equal, when compared to their Directive compliant counterparts, these products will offer superior investment returns - an immediate competitive edge in a difficult fund raising environment. As this begins to happen, the "strength" of the AIFMD brand will diminish.
In the same way that AIF managers compete for allocations of capital, Europe is also competing for its allocation - the allocation by investment managers of a meaningful stake of their global capital pools. Europe can only hope to extricate itself from its current economic predicament by embracing investment by alternative investors - after all, these are the investors who will provide the next wave of venture capital for innovation, the private equity for growing business and the capital that builds our skyscrapers, bridges and roads.
Unfortunately, at the moment, Europe is not only uncompetitive when compared to other global markets, it must be careful not to become irrelevant. Combined with it's current economic malaise, the imposition of the Directive will only encourage investors to look elsewhere for investment opportunities.
Originally published in Business Brief, Issue 292 – April 2013
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