Since the middle of last year, alternative investment managers who offer offshore investment must comply with the AIFMD Depositary-Lite regulations in order to market those funds to investors inside of Europe.
The change in regulations caused a new industry offering services to help compliance with regulating, and performing the role of depositary to jump up. This new industry is as important for alternative investment managers as it is interesting for investors.
Over at COO Connect, INDOS Financial Ltd., the first such company licensed by the Financial Condust Authority, set out its predictions for the year ahead. The firm, which came into being to take advantage of the European legislation, is optimistic about the future of the fledgling industry. Here are its predictions for the months ahead.
1. Managers don’t stick around. Given the novelty of the industry, many alternative investment managers will be reviewing the performance of depositaries in great depth this year. INDOS expects a lot of movement as they separate the good from the bad, and look for greater transparency and better service.
2. Investors pay attention. After a year of hearing about the depositaries in letters and annual reports, hedge fund investors are, according to INDOS, going to start paying attention to the role this year. This will lead to questioning of who was chosen to fill the position.
3. Conflicts of interest arise. In the rush to become compliant, many investment funds have the same or related companies performing investment services for them. This is going to lead to questions of conflict of interest, particularly between Hedge Fund Administrators and depositary providers.
4. Regulatory redefinition. After a year of actually operating in the wild, regulators are likely to refine and redefine the actual role of the depositary. The way in which the providers are selected, and their consistency of service are likely to receive particular focus.
5. Reverse solicitation backfires. The practice of having clients enquire about a fund under their own steam is called revers solicitation, and it has been mooted as one inexpensive alternative to the expense of marketing through a depositary. INDOS says the practice is set to die in the face of mass adoption of depositaries by alternative investment managers.
6. ESMA enforces segregation. The European Securities and Markets Agency will, according to the predictions, enforce segregation of assets between Alternative and non alternative investments this year. The AIFMD already imposes such separation on depositaries, but the changes could hit Prime Brokerages particularly hard.
7. ESMA lets non-EEA funds get AIFMD Passport. A passport under the AIFMD allows a fund to market and operate in each member state of the EEA. Currently funds from the US and elsewhere have set up in each member state individually. With a passport, which INDOS doesn’t expect to be available until January of 2016, those firms could set up all over the bloc at once, but would be forced to comply with full depositary requirements.
8. Depositaries discharge liability to Prime Brokerages. This has already been underway in recent months, but INDOS expects the discharge of liability from depositaries to Prime Brokerages to continue until regulators attempt to put an end to it, if that is indeed their intention.
9. Depositaries settle down and develop. Now that certain companies have gotten a solid foothold, medium term strategic efforts are likely to be made by depositaries. Transitioning from the depositary-lite framework to full depositaries, migrating toward the UK for FCA approval, and other growth strategies are likely to become apparent as the year progresses.
10. Fees stabilise. After a volatile few months, fees for depositary services are likely to stabilise in 2015 according to the predictions. The value of the services is likely to become apparent, and the price differences will be more notable.
INDOS sees itself as particularly well positioned to help alternative investment funds to overcome the new regulatory challenges, and the majority of the company’s predictions appear to argue for its own success in the coming year. The firm may be biased in that regard, however, so it’s best to take these predictions with a grain of salt.
Managers and investors will want to keep abreast of developments in the industry, however, and see if the market runs according to the INDOS plan. The depositary is set to be a vital part of the fund services framework in the years ahead, and the shape of the industry will have wide-ranging effects on fund marketing, accountability and expenses.