COOConnect spoke to Jiri Krol, head of government and regulatory affairs at the Alternative Investment Management Association (AIMA), the hedge fund industry association, about the impact on its members of the rising burden of regulatory reporting.

COO: Fund managers are supplying a lot of regulatory reports to regulators around the world. How useful are these reports to the regulators, and what are they doing with them?

Krol: At the moment, we have yet to see any actions resulting from the collection and analysis of the data supplied either through Annex IV under the Alternative Investment Fund Managers Directive (AIFMD) in Europe or Form PF, as mandated under the Dodd-Frank Act. Admittedly, we have seen a report published by the Office of Financial Research (OFR) of the Department of the Treasury in the United States, which analysed the potential systemic risk posed by the asset management industry, but this did not look at hedge funds, and the research did not utilise Form PF data. What we do know is that systemic risk data is being used by the Securities and Exchange Commission (SEC) in its inspections and examinations of private funds. Of course, in the United Kingdom the Financial Conduct Authority (FCA) and its predecessor, the Financial Services Authority (FSA), has been collecting data from hedge funds in its hedge fund survey for some years. Its publication has been extremely useful in dispelling some of the oft-repeated myths regarding the risks posed by the hedge fund sector. The International Organisation of Securities Commissions (IOSCO) has been attempting to collate some hedge fund industry data as well, but the type of information in IOSCO reports has been limited so far. In our view, the single biggest benefit we as an industry could have from systemic risk reporting is obtaining some of the data back in the form of aggregated information, similar to what the FCA hedge fund survey does, so that any potential policy intervention and discussion around it can have a meaningful foundation. For example, the recent consultation by IOSCO and the Financial Stability Board (FSB) on the criteria to identify systemically important funds or managers (see “What happens when fund managers become SIFIs,” page [TK]) has been conducted in the dark, without all the involved regulators and central banks or the general public having access to aggregate data about the industry as regards size, leverage, liquidity profile or other key risk measures.

COO: How challenging has regulatory reporting been for fund managers and why?

Krol: It is one of the most challenging tasks a manager will have to undertake, and this is something that has been repeatedly overlooked by policymakers and sometimes by managers as well. Designing the reports has not tended to be at the forefront of policy discussions, with detailed debate on the matter often put on the back burner. AIFMD Annex IV reporting is a good example, as we are only now receiving finalised guidelines on how these reports are to be generated. From the perspective of the manager, some of these reports run into thousands of pages, and sometimes regulators ask for data that is not always clear-cut, and subject to interpretation. Understanding the type of data, that regulators want, and the means by which it is calculated, is not always easy. Another challenge for managers lies in building systems to capture the data properly and consistently. It can be very complex and expensive when you are dealing with legacy IT systems. There is rarely a plug-and-play solution to collecting all of this disparate data from multiple sources.

COO: How useful are these reports for investors?

Krol: The reports are not meant or designed for investors but to help regulators gauge systemic risk. We hear some investors going to managers and asking for their Form PF, for example, but the contents of the form may not even be that useful to investors, given the complexity of positions or the frequency of portfolio turnover in some strategies. In other instances, these reports could contain highly confidential information that managers do not feel comfortable disclosing to their investors. The same applies to Annex IV. But this does not mean investors do not or should not get appropriate information from managers. For example, AIFMD has its own separate risk reporting and disclosure regime which is more tailored to investors’ needs.

COO: Will we see a global, consolidated regulatory reporting standard spanning multiple jurisdictions?

Krol: It would have been nice to see a common report across the United States combining Form PF from the SEC and Form CPO-PQR supplied to the Commodity Futures Trading Commission (CFTC). In an ideal world, this would have been consolidated with the Annex IV that is submitted to the European competent authorities under AIFMD. Regulators globally have missed an enormous opportunity to standardise systemic risk reporting for funds in general. So now, as the industry has spent considerable time, effort and money to comply with all of these different reporting standards, it would not be advisable to go back and re-do everything. It would render many of the expenditures to attain compliance across multiple jurisdictions duplicative. But this does not mean we should not wish to move towards a consolidated standard in the medium term. There is a clear demand on the managers’ side to streamline and harmonise reporting as much as possible. And this does not just go for systemic risk reporting. It is relevant for all other types of reporting, with derivatives reporting to trade repositories being a good example.

COO: Do you anticipate the contents of these reports will change?

Krol: No I do not, or at least not in the short term, for the reasons stated above. We have barely started the new regime so we will need some time to think and digest what is being reported in the first place. The general content is broadly fine, and managers do not necessarily dispute the idea that regulators need to have a good picture of what individual funds as well as the industry is doing, especially as regards some of the key metrics and exposures. However, the methodology behind the questions is occasionally flawed and needlessly divergent. It would be nice if regulators in the United States and the European Union harmonised their methodologies behind, for example, the calculation of leverage and Regulatory Assets under Management (RAuM). Take leverage. The United States essentially uses a balance sheet measure of leverage, whereas Europe uses the gross and commitment methods. This needs to be sorted out over time, as it suits neither managers, investors nor regulators to receive data which cannot be consistently compared across the globe.

COO: Looking forward, what are the biggest regulatory challenges for managers?

Krol: The European Market Infrastructure Regulation (EMIR), which forces managers and their counterparts to report details of exchange-traded derivatives and over the counter (OTC derivatives to trade repositories is proving a challenge. EMIR reporting has been compounded by all of the confusion surrounding the generation of Unique Trade Identifiers (UTIs), which is designed to avoid double counting of transactions, so trade repositories are struggling to reconcile trades (see the COOConnect Guide to Derivative Reporting in Europe, page 22). Unlike Dodd-Frank, EMIR demands two-sided reporting, which is a burden. Going forward, the EU Securities Financing Transactions Regulation will oblige managers to report details of their securities lending, and repo activities to trade repositories. It will also potentially force managers to report details of securities financing transactions and re-hypothecation of funds’ assets to investors. The Markets in Financial Instruments Directive II (MiFID II), due to be implemented in January 2017, will also have a substantial impact for those managers who still retain MiFID entities, as they will be less likely to rely on third parties for their transaction reporting.

COO: So there is a lot of reporting still to come. How can managers best leverage the experience they have with compiling previous reports and apply it to the rules yet to take effect?

Krol: I have heard from managers in the United States considering marketing to investors in Europe through the national private placement regimes that they are leveraging a lot of the skill-sets they acquired when filing Form PF and applying it to Annex IV. While managers are unhappy that they must supply an Annex IV to each and every regulatory authority in which they have a marketing operation, they seem to be coping, and the PF experience has proven useful in that regard. Most managers will not file more than three or four Annex IVs. Likewise, larger managers in the United Kingdom who have submitted data to the annual FCA hedge fund survey have found Annex IV to be less of a strain. However, all of these regulatory reports do present a significant cost, and therefore a barrier to entry, particularly for the smaller managers. Most of all, managers need to think about designing internal systems which can be flexible in accommodating new data and reporting requests. After the financial crisis, reporting has become something which regulators assume is a basic prerogative. Very few regulators and policymakers want to hear arguments against more reporting based on costs or the complexity associated with it. The fact that we already have a massively complicated web of reporting relationships and obligations spanning short positions, individual transactions, derivatives trades, commodities positions, risk concentrations and so on, seems to be whetting their appetite for further obligations and ever different slicing and dicing of data. We try to make sure that anything that comes out is sensible and, to the extent possible, non-duplicative, but it is a challenge.