EUROPE

UK 2013 - the Year of Regulation

Background The Alternative Investment Industry will start to become highly regulated during 2013. This is the first time that the industry will be expected to comply with high levels of regulation. This global phenomenon is arriving in a number of guises. However there is no doubt that it will have a substantial effect upon the day to day operations of managers, increase operating costs and, as a result of the costs involved, have the potential to reduce returns for investors.

In North America we are seeing the implementation of the Dodd-Frank legislation and FATCA. In Europe we will be seeing the start of the Alternative Investment Fund Management Directive (AIFMD).

Asia is watching with interest. These are massive initiatives and will have a major effect upon how managers organise themselves going forward.

The desire of tax authorities to prevent global tax avoidance has resulted in the US authorities introducing FATCA – with the sole intention of tracking down global income not previously declared on US tax returns. Other governments are watching the success (or otherwise) of the legislation with considerable interest – the complex piece of legislation could become a global model. The data collection process – to be undertaken by managers – is both complex and detailed and is not without cost.

Both Dodd-Frank and the AIFMD are political and legislative responses to the loss of investor assets in Madoff and similar schemes. Substantial numbers of private investors, as well as institutional funds, lost money through fraud. The legislators have had to respond and have done so in very different ways – European legislators taking a much heavier hand compared to the US. The resultant legislation will substantially increase both workloads and accountability and will often require the appointment of arid party Depositary – something not necessarily

required previously and certainly not a cheap exercise.

The US is currently ahead in the “Timetable” – having speedily implemented its Dodd-Frank legislation. The AIFMD is due to commence in Summer 2013 and will affect every manager who is either located within Europe or intends to market its funds across Europe. FATCA similarly comes into play during summer 2013.

Implications Both the volume and complexity of the legislation is having a major effect upon fund managers and their organisations. Augentius specialises working with the Private Equity and Real Estate managers and we are already assisting clients with issues and helping them manage through the processes.

Traditionally such managers have been small, boutique, investment houses. Focussed around the asset management processes and being actively involved in their portfolio investments, few Private Equity or Real Estate managers have had the need for substantial “back office” resources or infrastructure. With the increased level of legislation not only are managers having to consider how they manage their businesses going forward but also how they are able to resource to meet the legislative and reporting requirements going forward.

Managers will require a far higher degree of structure than in the past. All procedures and practices will have to be reviewed, documented and evidence put in place that they are being followed – this is a massive task – and one that many firms are not in a position to take at the present time. Third parties can assist and guide but the reality is that this has to “belong” to the firm in question and not just be “imposed” on it by a third party. If it is imposed the manage- ment team are unlikely to put into practice.

Both Investors and Regulators are becoming more demanding. More data needs to be collected, understood and processed. Systems need to be enhanced and developed and resources hired (if that is the considered option) to cover this additional workload. Undoubtedly the fixed costs of the Manager will increase at a time when management fees are fixed or even reducing due to the difficulties of the fund raising market.

Whilst many managers within the Private Equity and Real Estate communities have carried out this work themselves in the past – this is all now changing. The risks of getting it wrong are substantial – something a manager cannot afford.

In addition the investment managers’ world is becoming “globalised” at a rapid rate. Not only is there now a need to comply with international legislation, the investors are truly global and legal structures are becoming more international and multi-jurisdictional creating complex international operating issues.

As a consequence there is an increasing trend to outsource work to the professional administrators around the globe. Outsourcing provides a flexible solution – you only pay for what you need – and provides levels of technical ability and technology unlikely to be achieved by the manager in-house.

The outsource providers themselves are sophisticated businesses, expert in what they do and for many a very safe pair of hands.

As the world becomes more complex and competitive, the businesses that survive and grow will be those that are expert in everything that they do and deliver the required products and returns to their clients/investors. The days of the “jack of all trades” have gone - it is the experts that will survive. And that means doing yourself what you really are good at and delegating the rest to other experts.