Hedge funds breaching leverage limits must report to ESMA, AIFMD Level 2 rules state
AIFMD Level 2 rules will require hedge funds to report to ESMA if they breach leverage limits of three times their Net Asset Value (NAV), the head of the asset management unit at the European Commission has confirmed.
Caps on leverage cannot be ruled out
The precise nature and frequency of the reporting is not yet known. “The latest leverage limits would certainly have a significant impact on hedge funds across the board, with strategies such as CTA and arbitrage being disproportionately affected. However, it is not wholly clear what hedge funds need to report and how frequently they need to do it. If, for example, they have to report to ESMA on a daily basis, then that could be an operational headache,” said one operational due diligence expert.
According to the UK Financial Services Authority’s (FSA’s) latest hedge fund survey, aggregate leverage stands at 3.8 times NAV although some strategies such as fixed income arbitrage currently employ leverage of 12 times their NAV.
ESMA could have the right to impose mandatory leverage caps on funds during bouts of market stress, or if they believe a particular manager poses a systemic risk. Whether or not caps are used regularly is yet to be seen but given the perilous state of some the region’s banks, it cannot be ruled out.
ESMA’s methodology to calculate leverage has been described as flawed. It will add the hedge fund’s balance sheet to any notional underlying derivative position and then divide it by the NAV. This formula could therefore make some managers appear more levered than they actually are, according to AIMA.
AIFMD will come into force in July 2013.