FSA Funded Research on Impact of AIFM – €3.2 Billion initial Costs and a Host of Negatives

by Karl Hindle – London UK

With news dominated in the UK by the banking sector shake-up, a survey conducted by Charles River Associates on behalf of the FSA was published earlier this month...quietly.

The link to the document is here

The survey was conducted amongst EU Alternative Investment Funds (AIFs) and investors across the EU and the results are not surprising, but do raise more questions than answers for both politicians, investors and AIFs.

Reduced Investor Choice and Decreased Returns

Under the AIFM Draft Directive, AIFs will need to be domiciled in the EU in order to market to EU customers. The bulk of AIFs are non-EU domiciled with 94% of hedge funds based outside the EU. While some AIFs will establish an EU domicile to continue marketing to EU investors, it is clear that not all will and under the FSA projections, it is expected that 40% of hedge funds will no longer be available with private equity AIFs reduced by 35%; venture capital firms by 19%; and the liquidation of all UK investment trusts which cannot operate under AIFM in its present form.

This will naturally lead to reduced competition with AIFM effectively providing barriers to entry while EU investors will no longer able to access “best in class” AIFs leading to a reduction in returns as they will have compliance costs passed on to them.

One-off Costs Associated with AIFM Implementation

The FSA survey explores the issue of one-off costs associated with AIFM but there are some wide-ranging assumptions being used to estimate how many AIFs will be prepared to re-domicile in the EU in order to market there.

The FSA believes that “if enough hedge funds re-domicile in the EU to fulfil current needs”, and kindly note the “if” in that statement, the cost will amount to €0.9 billion for re-domiciling plus a further €0.6 billion mostly borne by larger AIFs who will need to alter their value chains and legal structures.

Note that this assessment does not take into account the impact of reducing leverage which is also going to result in increased costs and decreased returns – AIFM is targeting leverage because its proponents believe systemic risk is caused by it. This is also a major bone of contention as AIFM does not cover many methods of taking on leverage so while systemic risk will largely be unaffected, industry (and ultimately consumer costs) are dramatically increased.

Private equity and venture capital AIFs are expected to incur the largest cost for implementing AIFM with €248 million and €33 million respectively. There is also another example of cost being attached for little or no perceived benefit. The disclosure regime holds little value for larger investors who responded they already have adequate information for decision making, however, AIFM will compel public disclosure which it is felt, will provide valuable information to competitors outside the EU.

Investment trusts, which are peculiar to the UK, are facing liquidation under AIFM as they cannot operate, hence the growing interest in UCITS. The cost is anticipated to be around €543 million for transferring their assets to compliant structures.

Finally, real estate AIFs are largely untouched by AIFM in a regulatory sense but this does not mean they have escaped the impact of cost. Rearranging value chains and the re-domiciling of Channel Islands AIFs is going to cost €451 million.

Summary

Total one-off costs of implementing AIFM will be in the order of €3.2 billion. In addition there will be additional recurring costs in the order of €313 million. This will ultimately be passed on to the investor and will reduce returns in the short and long-term for EU domiciled AIFs. Consumer choice will be reduced because many AIFs will not seek to re-domicile in the EU, in fact, the FSA expects the majority of global hedge funds and other AIFs will not choose to do so. Significant costs will be incurred in monetary and opportunity cost terms which are not being replaced by matching benefits to the consumer, the industry or the economy.