At the end of last year, the accountancy firm of KPMG produced a report that the European Union had commissioned to gauge the effect of the Alternative Investment Fund Managers Directive (AIFMD) on the financial sector and on consumers. Implementation differs greatly between EU countries.

No reform of the AIFMD is going to happen before the EU generates an internal report on the matter in 2020, which makes it impossible for us to tell how AIFMD II, if and when it happens, will affect British AIFMs. The  report contains plenty of evidence of different national standards of implementation and is based on 478 sets of responses from people and institutions.

The general effect of the AIFMD

The report has reservations about the quality of the data on which it rests but still concludes that the AIFMD has had no statistically significant effect on AIF net assets. Competition between AIFMs has only increased slightly and the large majority of trade bodies said that the directive had not influenced their decisions about where to invest and had not inspired them to invest through EU/EEA AIFs rather than others. More than one-third of respondents indicated that the AIFMD had been bad for them and had not helped AIFMs to rationalise their operations and processes. A majority indicated that administration, investor disclosure, risk management and regulatory reporting costs had all increased. A significant proportion, but not a majority, indicated that distribution costs had increased as well.

My score for the AIFMD in this field: nul points!

One of the objectives of the AIFMD, according to the EU, is to “strengthen and deepen the single market, thereby creating the conditions for increased investor choice and competition.” [NB The European Union uses the term 'single market' to describe the complicated tangle of national protectionist barriers and all partial immunities to and total exemptions from those barriers that lie within its borders.] There was even talk of an AIFM brand that would be as successful as UCITS. KPMG's findings suggest that the AIFMD has not achieved this objective. To be fair, however, the directive was primarily concerned with financial stability and the management of risks; the prosperity of alternative investment managers was only its secondary objective.

Reporting requirements

Respondents questioned the need for the large volumes of data that the AIFMD forces firms to send off to their regulators. They thought that differences between nations' reporting procedures and their regulators' interpretation of the directive were costly. Firms want regulators to publish aggregate figures regularly, the better to provide all market participants (including investors) with better information about the market than they have now. Most regulators told KPMG that they monitor and analyse the data that they receive, but most of them do not make it public.

My score for the AIFMD in this field: un point!

Although the directive's disclosure requirements have attracted strong criticism, it is hard to see any political appetite for a reduction in disclosure, especially since politicians want to improve stewardship and governance. The AIFMD does not apply the disclosure requirements relating to the acquisition of major holdings and the control of non-listed companies to small- and medium-sized enterprises, so many fund managers are likely to have remained unaffected by these requirements. Long may it continue.

Marketing passports

The report suggests that the EU marketing passport suffers from the fact that member states differ in their interpretation of 'marketing' and 'pre-marketing.' In relation to non-EU AIFs and AIFMs, things vary markedly depending on national rules and the demand for non-EU AIFs among professional investors. KPMG's respondents thought that national private placement regimes (NPPRs) were good and some interviewees called for non-EU passports to be introduced.

My score for the AIFMD in this field: deux points!

This is another case of general disinterest in a main initiative of the AIFMD. Had the EU marketing passport taken hold, NPPRs might have disappeared three years after the AIFMD came into force. Their survival, and now positive support for them, suggests that fund managers can keep using them to market funds effectively and that investors have no need of the marketing passport.

Valuation

On this subject KPMG says: "The binary choice in the valuation rules between internal or external valuation, and the differing national interpretations of the extent of the liability of external valuers, are assessed on the basis of responses and desk research as having impaired the effectiveness of the rules for some asset classes and in some [EU] member states. It has placed more focus on internal processes. Also, it is reported that there are fewer available external valuers in some member states, which lowers the level of competition and could result in higher fees charged to AIFs/AIFMs."

My score for the AIFMD in this field: trois points!

Before the AIFMD came into force, investors were wise to value risks and the independence and quality of fund administrators were (and still are) regarded as vital for this process. If AIFMD helped the process along at all, it encouraged people to concentrate more on valuation policies, guidelines and responsibilities. For EU AIFMs of non-EU AIFs this meant squaring the triangle of responsibility between fund board, fund manager and fund administrator.

Disclosures to investors

Respondents to the KPMG survey believed that the rules that govern disclosures to investors to be found in Article 23 of the AIFMD are "excessive in quantity." Because of this, according to the report, they often prevent investors from understanding an AIF’s investment proposal clearly and some people largely ignore them.

My score for the AIFMD in this field: quatre points

Disclosures in prospecti for the purposes of Article 23 of the AIFMD concentrate on investment strategy, legal protection, the identities of AIFMs, depositaries, administrators and other service providers, delegation, valuation, liquidity risk management, arrangements for the issue and sale of units or shares and fees, charges and expenses. It is this last point, non-standardised disclosure of charges, that might cause alarm in view of the problems created by MiFID II’s attempts to oblige firms to give out pre-and post-sale information about costs and charges.

Risk management

Private equity and real estate sectors questioned the necessity of a full and hierarchical separation of risk and portfolio management, especially for smaller AIFMs.

My score for the AIFMD in this field: cinq points

The requirement for independent risk management arrangements did not sit well with illiquid investment managers, for whom risk management was integrated into the initial 'due diligence' and continuing management of the assets. The FCA did take a proportionate approach to this requirement.

Remuneration

The responses to the KPMG survey question the coherence of the AIFMD remuneration rules with other laws and guidelines (especially for AIFMs that are part of corporate groups). People were worried about mis-alignments between risk management at fund level and remuneration reporting at entity level and the partial inclusion (or, indeed, the exclusion) of carried interest and the remuneration of partners from 'compensation' (remuneration) figures.

My score for the AIFMD in this field: six points

This is another area in which the FCA implemented the directive proportionately and did not apply many of the more onerous parts of the remuneration code. A continuing difficulty is the EU’s application of regulation on a service and product basis, especially in cases where banking or insurance groups have established or acquired investment management subsidiaries.

Use of debt

The survey indicates that the use of a lot of borrowed funds to amplify returns from an investment ('leverage') is rare. Respondents and interviewees noted that it would be helpful to apply the same methods for calculating debt for both the AIFMD and UCITS, but only after the International Organisation of Securities Commissions (IOSCO) has completed its work on the subject.

My score for the AIFMD in this field: sept points

The AIFMD dictates that each authorised AIFM shall set 'leverage' limits in respect of each AIF that it manages. As noted above, people are still worried about the systemic risk posed by hedge funds but each time this is considered in an official report, the debt levels are not reported as high.

Consistency of implementation in all EU states

Of the respondents to the survey who expressed opinions, nearly half thought that EU countries do not apply the AIFMD consistently, but they also think that the discrepancies lie in only a small number of areas.

My score for the AIFMD in this field: huit points

This finding deserves eight points for the ironic acknowledgement that progress towards a single market in AIFs and a Capital Markets Union [27 years after its foundation, the EU still lacks an integrated capital market] continues despite the fact that progress towards these goals is uneven between nations.

Management passporting

The report suggests that statistical evidence indicates that the EU management passport is working well.

My score for the AIFMD in this field: dix points

This has been to the benefit of such jurisdictions as Luxembourg, Ireland and the UK because it allows funds established in one EU jurisdiction to be managed in another. Since the AIFMD permits a fund to delegate portfolio management or risk management to an undertaking outside the EU, we should see less use of this passport after the UK leaves the union. The UK has now struck up co-operative agreements with the remaining EU member-states.

The effectiveness of the AIFMD as a whole

After a slightly incongruous beginning, the report starts where we end, with the broad conclusion that the AIFMD has helped the EU greatly in its efforts to create an internal market for AIFs and a standardised and stringent regulatory and supervisory landscape for AIFMs.

My score for the AIFMD in this field: douze points

The report admits that the AIFMD and ESMA have not influenced the behaviour of the investors whom the directive was meant to protect. It also shows that market participants want regulators to provide them with public insights into the risks that alternative managers present. These significant observations should be weighedagainst the very broad,and perhaps inevitable conclusion, that AIFMD has played a major role in creating an internal market for AIFs.

* Jonathan Wilson can be reached on +44 (0)20 3146 1869 or at jon@elliswilson.co.uk