Cap intro model could be threatened by AIFMD
Cap intro teams at prime brokers could be forced to rethink their business model when hosting events or introducing hedge funds to potential investors within the European Union (EU) following passage of the Alternative Investment Fund Managers Directive (AIFMD).
Managers hoping to market to European investors must abide by the various national private placement regimes in effect across member states, some of which are stricter than others. Prime brokers, however, could face challenges too.
“Prime brokers have always had to tread a careful line and emphasise that capital introduction events are simply networking or educational exercises rather than formal introductions. This was partly due to regulatory concerns and partly commercial risk of 'come back' if investors lost money. AIFMD puts cap intro further under the microscope as a result of the decreasing number of countries which now allow private placement and the narrow interpretation of 'reverse solicitation' in many countries. Cap intro teams are likely to insist on even more 'health warnings' when hosting events or otherwise making introductions as a result,” said Martin Cornish, partner at MJ Hudson in London.
Prime brokers themselves concede cap intro could become more challenging going forward. “We are evaluating what we need to do and have been consulting with our legal counsel. We are going to have to watch what is happening in terms of regulation very carefully at an individual member state level. Furthermore, it appears we will need to enhance our documentation of the work we do, so as not to fall afoul of the regulators,” said the global head of cap intro at a major prime broker.
Cap intro has faced a number of challenges in recent years. The declining profitability of prime brokerage as a business coupled with Basel III capital requirements is forcing investment banks to scale back some of their value add services such as consultancy and cap intro.
A number of non-EU hedge funds are also starting to shun European investors for fear of being ensnared by the compliance obligations of AIFMD. The marketing challenges are exacerbated by the fact regulators have not clarified what constitutes reverse solicitation versus active marketing. Conservative lawyers have advised hedge funds to ensure their websites cannot be viewed by potential investors in certain member states lest they fall foul of the rules. One manager said his general counsel advised him against distributing business cards in some EU countries or speaking at conferences.
One manager in New York said the likelihood of European regulators pursuing a hedge fund for a breach of the marketing rules were slim, although added his firm would not take any chances.