COMMENTAR Y
Operational Risk Management for Alternatives Non-alpha-related news and views
QUENTIN THOM, QT ADVISORS
2014 will continue to be a challenging time for the industry as regulations begin to take effect, further increasing the barriers to entry for new managers. Recent prime broker surveys report increasing global investor appetite, including for new funds. Deutsche Bank’s 12th annual Alternative Investment Survey 2014 predicts $3 trillion hedge fund assets by the end of 2014 (up from $2.6 trillion in 2013) and attributable to near equal performance and inflows, per the investor community surveyed. Further, more launches are expected this year by second-generation managers, rather than prop traders spinning out, seeking precious seed capital. In this issue:
1) We Q&A Pierre-Emmanuel Crama, a fund of funds operational due diligence practitioner, on ODD hot topics for 2014. I note a recent observation on quantity versus quality from William Jenkins, director, ODD, Amundi Alternatives: “Whilst the amount of ODD done in 2014 will be the highest ever, feedback from hedge fund COOs is that the quality of the reviews varies enormously. This is a result of the size of some houses’ buy lists and the experience of those available to complete the work. ODD on administrators, a great source of corroborative evidence and pivotal to the successful operation hedge fund itself, has not increased proportionately.”
2) We hear from Bill Prew on AIFMD, with only a few months to go until the end of the AIFMD transitional period, 22 July 2014.
3) We learn from lawyer, Peter Bibby, more about the FCA’s proposed changes to the approved persons regime and the associated implications.
I have no doubt that corporate governance will continue to be a closely debated area by both the industry and the HMRC. Matt Auriemma, principal at Highwater, noted, “The role of a hedge fund director has never been more important or more topical. We believe corporate governance is a process that when assessed by investors should give them comfort that the company will be directed in a way that benefits them collectively.”
A recent COOConnect survey on cyber security illustrated a need for industry improvement and the risks investors must consider. Succession planning too is likely to continue to rise up the agenda for investors and scrutiny will continue to be applied over fees and expenses.
Quentin Thom Editor & Founder, QT Advisors
8. Lack of internal cash management expertise. 9. Disclosing managers’ AUM instead of fund’s AUM when running managed accounts. 10. Misleading marketing literature.
How can a manager best prepare for an ODD visit? 1. Arrange all the team members (senior and junior) to be available upon request.
2. Send all the materials requested prior to the on- site visit and, therefore, make best use of face to face meetings.
3. Be transparent. 4. Demonstrate fixing or work in progress relating to material issues raised in previous ODD visits.
How can the overall ODD process be improved? 1. Spending more time interviewing the independent directors.
2. Verify with all the outsourced parties their roles and responsibilities.
3. Focus on the areas of weaknesses during on-site visit and provide clear feedback and recommendations to the manager.
AIFMD: AIFM APPLICATION UPDATE The knock-on effect on depositary on- boarding Bill Prew, INDOS Financial Limited
Recent data published by the FCA highlights just how many UK managers have taken advantage of HM Treasury’s (HMT) announcement on 20 December 2013 and delayed their FCA variation of permission applications. Previously managers needed to be authorised by 22 July 2014 but now they only need to have submitted an application to the FCA, and be AIFMD-compliant, by this date.
OPERATIONAL DUE DILIGENCE Quick fire Q&A Pierre Emmanuel Crama, experienced independent ODD practitioner
What are your hot ODD areas for 2014? 1. As more examinations are expected from the regulators, I will look to see managers inviting compliance consultants to perform mock audits on a periodic basis.
2. To rationalise the cost structure, more outsourcing is expected for small and mid-sized managers.
3. Continued focus on expense allocation between the fund and the manager. 4. AIFMD readiness. 5. Succession planning with monetisation of value for the founders retiring and leaving the firm to the next generation of leaders.
6. Implications of larger managers leveraging off 54
of their back and middle office platform to share costs with smaller managers.
7. Innovation in fee structures by emerging managers.
What are some of the most common weaknesses you are seeing amongst emerging managers? 1. Too many hats worn by the COO. 2. Relying too much on outsourcing models coupled with a lack of routine checks of the service providers used.
3. Lack of corporate/fund governance. 4. Unrealistic about the break-even point, e.g., by underestimating the increasing costs of regulation.
5. Trying to become institutional with a small operational team.
6. Not investing sufficiently in information technology, e.g., OMS, PMS.
7. Lack of scalability to manage hoped-for growth.
The recent FCA statistics show that it has received around 45% (or 361 out of 800) of the expected number of AIFM applications. Several more managers will likely submit their applications by 22 April 2014, the date by which “complete” applications need to be received by the FCA in order for it to authorise firms by 22 July.
It now seems inevitable there will be a large number of managers that will not be authorised by 22 July. No-one knows for sure what the consequences of this will be for managers and investors. This is partly because HMT’s amending AIFMD Regulations have not yet been published but also because there are a number of grey areas including the ability for firms to market after 22 July if they are not authorised AIFMs.
In common with delays in the FCA applications, there are also delays with AIFMD depositary selection
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