Taking Aim at AIFMD

The first wave of alternative investment fund managers authorized under a European regulatory directive had to file their reports on October 31.

The onus of reporting under Annex IV of the Alternative Investment Fund Managers Directive (AIFMD) is a major concern of alternative fund managers. AIFMD requirements, aimed at enhancing transparency among a wide range of traditionally under-regulated alternative funds-hedge funds, private equity funds, real estate funds and others-and their managers, are complex. They are intended to result in a reliable view of any alternative fund domiciled in the European Union, or marketing to investors in the EU.

Annex IV requires the reporting of about 340 data points from across fund, portfolio, risk and liquidity systems. The regulation captures such an array of fund managers that there will be very different experiences of reporting, according to John Vaughan, head of product for fund administration, middle-office outsourcing at BNP Paribas Securities Services, and Paul Ellis, Dublin-based head of product strategy at HSBC Securities Services.

Some simple funds may only have to fill in some of the fields; others may find collation, transformation and validation of the required data very challenging indeed.
But overall, says another fund administrator executive, commenting anonymously, there is significant concern in the industry about how reporting will work.

Sourcing Challenges
Vaughan describes some of the challenges. The European Securities and Markets Authority (ESMA), the regulator administering AIFMD and Annex IV, has defined a number of classifications that will be new to asset managers. These include some 70 sub-types of assets, for example. Vaughan explains: "To produce the report, you have to classify all your fund holdings by these sub-types. It's quite a lot of nitty-gritty work to be able to map the data and produce those classifications."

Hedge funds that use a mixture of different strategies need to specify their strategy. Fund managers must declare the percentages of ownership by different investor groups in the fund. "Those classifications didn't really exist in the past either," says Vaughan.

The anonymous fund administrator executive adds that the data required has to be drawn from a number of different sources, from the aggregate portfolio data classically held by a fund administrator to the risk data classically held by a fund manager. It requires a lot of thought by internal IT departments or business analysts-and many alternative fund managers don't necessarily have that kind of architecture.

Ralf Menegatti, Luxembourg-based product owner, asset management at regulatory reporting and risk management software vendor AxiomSL, believes many fund administrators will struggle with the data collection and transformation challenges Annex IV presents. Some 30% of the required data has not been integrated into the systems fund administrators use, he says.

This figure is a conservative estimate, according to Menegatti. "Suddenly, alternative fund managers have to collect more than 300 data fields that touch risk reporting, net asset value (NAV) calculations, market data collection and so on," he says. "That has to be aggregated and then transformed in order to populate the fields."

Smaller funds especially will find this difficult, Menegatti adds. Prior to his role at AxiomSL, Menegatti was a product manager at USB Fund Services; his team there were able to assign data owners to particular data streams. Smaller funds, however, don't have the capacity for that kind of governance. "That is why I think that 30% is even low," he says.

Data Quality and Integration
The fund administrator source adds that US-based alternative fund managers may think they are ready for AIFMD because they have systems in place to deal with Form PF, the equivalent US Securities and Exchange Commission regulation. But while there is overlap between the two regulations, it may not be possible to simply replicate the data between them due to nuanced differences.

The fund administrator executive says Menegatti's figure of 30% probably isn't far off, but says he would put it differently. An alternative fund manager could have up to 75% of the data needed for Annex IV reporting on their own systems and need only collaborate with an administrator to make up the rest of the report. Vaughan agrees: "What we've seen when we act as administrator and transfer agent is that we can feed roughly 50% of the data from data that we hold in our platforms and probably a little more from static data sources that are easy to get. The rest can be sourced from the manager itself."

As with any reporting regime, data quality is a key issue. "You may have, for example, a big fund accounting system and a compliance system-these are the core systems and they are fed data like prices or market data from different data providers every day," says Menegatti. "When it comes to reporting, you can see the prices, but you have so many sources for certain prices that you don't have the reference price for it. It's the classic reference data problem-trying to find the system that has the best and most data."

Funds need to focus on data quality, because the regulators will be noticing, he adds. "Many market players are playing a poker game with the regulators," says Menegatti. "They seem to be thinking ‘the regulators won't look at the data; they can't really check it.' But the regulators are very well prepared. They have built several databases where they will collect the data and compare the companies with each other on reporting and liquidity figures, market structure figures and net asset values. They will compare these figures with the publications these funds have to do.

"Some very interesting statistics will come out over the next six to nine months. I expect that based on these statistics, we shall see additional regulations emerging, because new data raises new questions and new measures for the market."

Solution Choices
So how are firms choosing their AIFMD compliance solutions? "Larger firms tend to use multiple service providers, none of which will have all the data required for AIFMD reporting," says Ellis. From end to end, the manager takes on the task of
collation, warehousing, review and presentation to the regulators and individual member states.

"There's a job of work to be done to bring all that data together," says Ellis. "If you have an alternative fund manager running across many service providers, they will not automatically want to take over the data of another service provider, particularly in the case of AIFMD reporting for clients that are dealing in less liquid assets, or assets where there is no common security identifier when the same position is held by different funds across different service providers."

Alternative fund managers that have a lot of information already in-house, on the other hand, may use their own records to complete the recording, with vendor data used as a golden record for validation in the review process. "In that model, we
tend to see managers looking to their service provider for data that is relevant to the form, but they may be using the data as part of their internal controlled environment to essentially validate the information that they have gathered internally," says Ellis.

Other funds may choose to go with an outsourced solution, where the vendor works with the manager, transfer agents and prime brokers to assemble the required data, though the directive holds the manager ultimately responsible for the quality of the report.

Alternative fund managers outside Europe may imagine they can get around reporting obligations with reverse solicitation. However, this is increasingly being considered less of an option, and any firms that have marketed in a European country should consider their obligations.

Dublin-based Kieran Fox, director of business development with the Irish Funds Industry Association, says that among US alternative fund managers, "the nature of the discussion has changed over the last six months. Before that, there was largely an element of thinking they could find a blanket way around AIFMD and rely on reverse solicitation.

"They have now moved away from that to saying that for the vast majority of managers in the vast majority of situations, it's probably not a valid option, and therefore the option open to them if they want to attract European investors is to choose between private placement, which many countries are making increasingly difficult, or to establish a structure within AIFMD," says Fox.

Non-EU firms can make use of marketing passports, but how these will work is still uncertain. In fact, many uncertainties around AIFMD remain. However, alternative investment fund managers still have to report their Annex IV requirements—with the next reporting deadline coming up on December 31—or risk losing their authorization to practice in Europe.