When regulators hand you lemons, make lemonade

Meeting the AIFMD isn’t easy, but new technology and internal procedures can ultimately result in GPs complying with the directive to turn the firm into a more well-oiled machine, writes Carol Penhale.

This article looks at some of the requirements of AIFMD and considers how by using the latest technology to meet these requirements firms can turn the challenge of compliance into much broader opportunities for the business.

For starters, AIFMD requires more frequent and detailed reporting on remuneration, especially to show that managers have demonstrable “skin in the game” by tying their compensation to their investments. In particular, the content, payout types and rates for remuneration are now under scrutiny as at least 50 per cent of variable remuneration has to be paid in units of the fund or equivalent and 40 percent to 60 percent of variable remuneration must be deferred throughout the lifecycle of the fund and must vest no faster than on a pro-rated basis over three to five years.

This sophisticated calculation needs to be taken into account during planning for new investments to ensure the alternative investment fund (AIF) and underlying entities have sufficient cash flow and equity structure to pay the business in “what if” analytics. It will also necessitate the need for a paper trail for the audit process down the road, for which Excel is a precarious platform. And so, firms are increasingly seeking better tools to manage business, operational and cash flow risk

Apart from reporting for AIFMD, many organizations now have a similar need to understand transparency on executive compensation more broadly in their firms. Firms over a certain size, for assets and employees, have to have an executive compensation committee. The AIFMD stringent reporting rules, in place to ensure portfolio managers that carry out deals are transparently remunerated and that compensation is commensurate with the longer term of investment, are even more relevant, with responsibility specifically assigned to executive compensation committees.

That’s why front office technology that helps firms “set up” deals and do the what if analytics, not only around the expenses and the potential cash flows but also stringently adhering to the compensation payout requirements and reporting transparency that are necessary for AIFMD is so important. Indeed, it will be key, in particular in assessing potential exposure and possible impact on users, while also enabling firms to meet AIFMD reporting stipulations.

Owning the assets 

AIFMD also addresses issues relating to asset segregation and ownership. These are often complex, especially where depositaries are involved. According to the European Securities and Markets Authority (ESMA) Consultation Paper on Guidelines for Asset Segregation under the AIFMD¸ “the depositary shall verify the ownership of the AIF or the AIFM acting on behalf of the AIF of such assets and shall maintain a record of those assets for which it is satisfied that the AIF or the AIFM acting on behalf of the AIF holds the ownership of such assets.”

Other key stipulations relate to the timeliness of proving both ownership and segregation and include: “the depository shall keep its record up-to-date” and “the third party segregates the assets of the depositary’s clients from its own assets and from the assets of the depositary in such a way that they can at any time be clearly identified as belonging to clients of a particular depositary.”

Custodial service providers are currently wrestling with a viable method to prove verification on ownership “on demand” and on asset segregation for their underlying clients, the asset management firms.

Most struggle to show proof of ownership in an eloquent way “on demand” and many don’t have the systems or technology to handle segregation easily at all let alone “at any time” as stipulated under AIFMD.  Fortunately, some data management and analytics solutions are now beginning to address these issues. Increasingly, they are providing the electronic audit trails key to providing proof of asset segregation and ownership, using data visualization to show transparency and flow though on holdings – and, critically, in relation to the stipulations of the AIFMD, doing this in real time.   

Reporting and data handling 

These kinds of audit trails are also vital in delivering proof with regard to the wide range of stipulations within AIFMD relating to reporting and disclosure.

As part of the directive, a GP has to make extensive disclosures to its regulator, and prospective investors before they invest, relating to a range of criteria. Specifically, fund managers need to do so in relation to the fund’s investment policy; the legal implications of the contractual relationship entered into and how the AIFM ensures fair treatment of investors (including details of any preferential treatment of particular investors).

It also needs to carry out the same processes with reference to fees, charges and expenses; valuation procedures and information on the remuneration policy.

The ability to support an accelerated turnaround on reporting and data handling is a key element of AIFMD therefore. But, by meeting these stipulations, firms can also achieve a much broader range of business benefits. And this is especially pertinent in the current climate where reporting cycles are reducing from annually, or semi-annually, to quarterly and monthly. Firms need to work out how to do the reporting and get data to support it within these tighter timescales. By making processes more efficient and  cost-effective for AIFMD reporting, firms’ investment in smart technology also promotes more effective operational workflows for the business outside its regulatory obligations.

Again the audit trail, date and time stamps and user IDs are key.  And with the latest systems, unlike with costly and unwieldy Excel speadsheets, firms can have full audit control and a comprehensive electronic trail. Indeed, firms ultimately need to maintain a fully transparent record of their entire history so if they file today and a year on get questioned on it, they can go back and look at what the numbers were; what the valuation policy was and when it changed without hunting through Excel spreadsheets.

Doing nothing to invest in better tools and data is a false economy. If firms invest in a platform that captures the relevant data and transaction history that means moving the data out of Excel, which is where much of the business risk and operational cost is for these firms. Recent data management and analytics tools are also key in winning new business. Consider what a benefit it would be for firms to have all the numbers for all the deals they had ever done at their fingertips within a single system.

They could then carry out gap analyses against potential deals with all the deals they had done previously for an in-house gap analysis. And they could do all of this within a corporately-supported system.

Investment in this groundwork for technology improvements to support AIFMD also positions these organizations well to carry out the due diligence they need to do to turn deals around quickly. Having granular data at their fingertips is helpful to firms not just from the standpoint of AIFMD but also for improving the business opportunities for new deals – either to sell properties in the alternative investment space, for example, or to rapidly carry out due diligence on investments they want to buy and win new business in a highly competitive environment.

It is yet another compelling example of how the stipulations of AIFMD can be turned from challenge to opportunity for alternative investment firms and help to drive extensive benefits for them today and long into the future.

Carol Penhale is chief client experience officer at Taliance, an analytics provider for front and middle office functions.