Editor’s Letter – August 2015

Issue 106

Originally published in the August 2015 issue

One year post-AIFMD implementation, THFJ interviewed AIMA Deputy CEO Jiri Krol, who highlighted three areas where the industry argues for change. On remuneration, many hedge funds avail of ESMA/FCA proportionality regimes, and alignment of UCITS V with AIFMD on remuneration, which has been signalled by recent ESMA consultation, is welcome. But subjecting even bigger firms to the full regime is “very intrusive, prescriptive and unjustified as few systemic-risk issues arise out of individual compensation at hedge funds,” says Krol.

AIFMD-leverage measures also seem unsuited to the objective of gauging systemic risk in any meaningful way (and hedge fund leverage anyway looks miniscule versus banks when measured on a comparable basis). AIMA has written to Lord Jonathan Hill asking the European Commission to revisit ESMA’s original advice that a more sophisticated measure of leverage is added. Presently the gross and commitment methods of calculating leverage seem crude and inappropriate for multiple reasons. “They are inadequate in terms of understanding where the risk lies and in dealing with derivatives,” says Krol. For instance, a 40 times levered position in a three-month interest rate contract is deemed a leverage multiple 40 times greater than an unleveraged 50-year zero coupon bond, which has roughly five times as much interest rate risk – as those who bought ultra-Bunds in April will know from their double digit losses!

Notional exposure also overstates the risk of option positions that risk only the premium paid. The AIFMD methodology for netting and offsetting exposures related to hedges can both under and overstate risk. AIMA’s paper identifies many more weaknesses, with illustrative examples. AIMA also observes that the gross and commitment methods are not comparable with the more sophisticated methodologies applying to banks, or even those applying to other regulated funds! Krol thinks it is confusing to have “UCITS, ’40 Act funds and AIFMs all looking at leverage in different ways.” Harmonisation would be helpful and “some kind of a globally consistent measure of leverage is needed and we are very much on the forefront of that debate,” argues AIMA.

A rocky playing field also restricts EU investors’ choice of non-EU managers. Although the UK, the Netherlands and the Nordics have accommodating private placement regimes, other countries have created obstacles. ESMA’s advice on passporting non-EU AIFs and AIFMs, (initially recommending only Switzerland, Jersey and Guernsey) matched AIMA’s expectation that “very few jurisdictions will get the passport extended to them because they have to satisfy a detailed assessment in terms of investor protection, systemic risk and even reciprocal market access.” This extends well beyond the original intention for basic criteria on exchange of information, documentation and avoiding FATF blacklists, according to AIMA. Krol thinks it superfluous for ESMA to fret over home-country e.g., US rules, when European rules need to be met anyway by those wishing to obtain authorisation under the third country passport rules. The old (1992!) dream of a Single European Market could be revived. “Now that the European Commission is trying to create a pan-European private placement regime for securities—perhaps they should do the same for funds, and model it on the US regime with disclosures and limits on investor types,” Krol suggests.