Interview: COO Connect speaks to Jiri Krol, AIMA's director of policy and government affairs, about the AIFMD
To say the European Union’s (EU) first draft of the AIFMD (Alternative Investment Fund Managers Directive) would have been damaging to the UK (and European) hedge fund industry is an understatement. It would have been disastrous. Reviewing the original proposals laid down in 2009 makes for uncomfortable reading. However, the end legislation which passed late last year was considerably less toxic than many in the industry expected. The role played by the Alternative Investment Management Association (AIMA) has been cited by many as being one of the key drivers that helped modify the original proposals. COO Connect editorial speaks to Jiri Krol, AIMA’s director of policy and government affairs, about its work and the potential ramifications of the AIFMD.
Editorial: AIMA has been at the forefront of speaking to EU politicians involved in formulating the AIFMD, was this a struggle?
JK: It certainly took a lot of effort to explain to numerous people involved with the legislation that elements of the proposals would not work. It is important to remember the origins of the AIFMD – it was created in a very short space of time and I don’t think there was much awareness of what the industry actually did. AIMA needed to make these politicians aware of what our members do and explain why this regulation would not work. If it had been passed in its original form, it would have resulted in a lot of hedge funds going out of business or leaving the EU. Even for those that survived the onslaught, the proposed regulation would not have achieved its stated objective. Many of those putting forward these rules believed the industry should be regulated in a Ucits format. This was the biggest problem we had with the policymakers. We had to stress that hedge funds are not Ucits and do not operate in a Ucits format. Most hedge funds could not fit in a Ucits format. The politicians needed to be more open and flexible. However, in the end we found a compromise that was broadly acceptable to both those who wanted stricter regulation and to our industry and members as a whole.
Editorial: Are there still elements of the AIFMD that are going to be problematic for hedge funds? What do you believe are the main flaws in this regulation?
JK: Yes. There are still elements to the AIFMD that do not make much sense to us. For example, one policy requirement goes directly against everything we have learnt from the Lehman collapse - that is hedge funds should not be reliant on a single counterparty. The legislation, however, is forcing hedge funds to use a single depository. This is an outcome that is far removed from what we would have preferred. The depositary is obliged to hold assets but it is unlikely to be able to hold all of the assets itself – especially for certain funds. Therefore, the depository will need to find a sub-custodian in other jurisdictions. It raises the question as to whether there is enough flexibility in the legislation to easily allocate these custody functions. Furthermore the depositary could be liable for losses which could be incurred as a result of the behaviour of the third party custodian over which the depositary may not have full control. This is potentially very expensive and will drive up costs, which is going to be detrimental to investors.
Editorial: Are there any other areas of AIFMD that you feel are particularly onerous?
Remuneration is an issue. It was not even in the initial proposal but has clawed its way in. The EU’s rules on remuneration are largely based on the banking directive. They have been copied and pasted into the hedge fund world. Some of these banking rules are already starting to be applied to asset managers in the UK. However, many of these rules cannot be applied yet they have been copied over into the AIFMD. Hopefully, we will use proportionality provisions like for the banks. Another bone of contention is leverage. Fortunately, we have moved away from the world where the European Commission would be setting hard leverage caps in the legislation. Leverage instead will be set by the fund or manager in compliance with their stated investment policy. Yet the possibility remains of supervisory authorities imposing leverage caps in the event of a disruption to the financial system or a build up of systemic risk. I don’t know what the outcome will be. I hope such restrictions will only be used in very exceptional circumstances like in the event of a single large manager posing systemic risk which cannot be mitigated otherwise. At the moment, the Financial Services Authority's surveys show there is no single hedge fund manager posing such a systemic risk.
Editorial: Do you feel hedge funds have been unfairly targeted by the EU?
JK: Long only funds and private equity funds will also be hit heavily – it is not just hedge funds. But there are many policymakers and politicians who do not see the value that hedge funds bring to the financial markets and society as a whole. Some would even go as far to say that they subtract value from society. There have been some tough voices in the discussions and the compromise we achieved in the end is recognition that contrary to extreme political voices, our industry is a positive force in the market. With this regulation, firms will hopefully now be perceived as a legitimate part of the mainstream asset management industry in all EU member states, which we felt we were even prior to the AIFMD.
Editorial: How important was AIMA’s lobbying efforts in curtailing some of the more extreme language originally peppered in the AIFMD document?
JK: I would say the changes in the legislation were the result of a massive, collective effort on the part of the industry – not just AIMA but also other trade associations, a large number of member state officials and members of the EU parliament, as well people in the national supervisory authorities. We have done our jobs – we have been active in educating people, in trying to propose constructive solutions when we were faced with destructive drafting. We tried to make regulation work and meaningful, as well as help policymakers achieve their goals. It was a broad effort. Investors such as pension funds and insurance companies were a hugely positive force. They highlighted their end investors, such as teachers and policemen in the Netherlands, for example, would suffer with the legislation. Interestingly, the proposed directive was perceived as unfair to such an extent that it galvanised quite a lot of resistance even among member states which do not have a big alternatives industry.
Editorial: Are managers prepared to deal with the AIFMD?
JK: I think few managers have prepared. Contrary to popular belief, UK managers are regulated already so a lot of the provisions in the directive will not be too dissimilar from existing UK regulation. For example, in terms of conflict of interest rules – you hopefully won’t find anything new. However, we do need proportionality to be hardwired in the secondary rulemaking which is about to start. The implementation phase anyway is long enough for people to prepare – the directive will be fully implemented in the first quarter of 2013.
Editorial: Do you think funds will leave the EU or UK because of this legislation?
JK: My prediction is no. I think some managers may certainly want to have a presence in other jurisdictions beyond the EU. But I certainly do not see a massive exodus from the UK. There are positive reasons for remaining in the UK ranging from the talent pool, the infrastructure and the access to investors, which you don’t always get in other jurisdictions.
Editorial: Hedge funds have a poor public reputation. What do you think they need to do to improve this?
JK: I don’t think this is going to be an easy task. The so-called speculators have had a negative perception in society for millennia. If you look at any so called anti-speculative laws passed in jurisdictions throughout the centuries, they are always unfairly targeting people, accusing them wrongly of causing problems created by others. The current financial crisis is a good example. The only thing one can do in this environment is to patiently educate people and explain what we do, how we do it and work with those who may have a misconception of what we do. We need to explain to them that we are not engaging in dark alchemy but asset management.
Editorial: How prepared are you to deal with the possible onslaught of future legislation?
JK: We are prepared. We have planned out our activities over the next couple of years in great detail. We are not just focused on Europe but we are also involved with the US Dodd Frank Act and various Asian regulatory activities. In the last two years we have published a record number of submissions to the various regulatory and policy making bodies.
Editorial: What lessons have you learned from dealing with the EU that you intend to apply to dealing with the US lawmakers?
JK: You can never do enough in terms of education. You should never assume that people know what our members know. In the US, people aren’t as fearful of hedge funds as they are in Europe. There was less backlash against them in the US. However, we do need to continue with constructive engagement. This was something we were doing before AIFMD came to the fore and AIMA has been extremely active in constructive engagement – it works after all.
Krol was appointed director of policy and government affairs for AIMA in April 2010. Prior to this, he worked at the European Commission where he was responsible for the coordination of its policy towards the Financial Stability Board and G20. He has also worked at the European Commission’s Internal Market Directorate General, where he was responsible for the drafting and negotiation of the Markets in Financial Instruments Directive (MiFID) implementing measures.