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The AIFMD in Focus: Valuations and Data Reporting Requirements Incoming

The controversial Alternative Investment Fund Managers Directive (AIFMD), which was first proposed in 2009, was published last month and is due to come into force over the next couple of years, includes key data related requirements such as increased transparency into valuations and new fund registration processes. A-Team Insight examines the latest and final version of the directive (as published last month in the Official Journal of the EU) and what the new requirements might mean for the data management and valuations function.

At a high level, the goal of the AIFMD is to create a level playing field and set basic standards for the operation of alternative investment funds in Europe via new reporting and governance requirements. Much like many other post-crisis regulatory developments (see the Office of Financial Research, for example, more on which here), increasing transparency for the purposes of systemic risk monitoring is a key aim of the directive, as well as providing much more data out to the investor community to restore public trust in the system.

To this end, these funds must register with their national regulators, then provide enhanced disclosure on their risk management systems and strategies, and their investment strategies. This increased operational transparency will throw a spotlight on their underlying risk and data management systems, thus compelling those with little infrastructure in place to begin to roll out new systems and technology. The new capital requirements for firms acting as third party fund managers (to whom these funds can delegate responsibility) will also likely further compel these firms to seek operational efficiencies to this end.

Regular reporting to the fund’s national regulator will also require them to maintain up to date data on the instruments they are trading, including supporting any standards requirements for the identification of these instruments. They will also need to provide data on the markets in which they are participating (including Market Identification Codes) and data on their principal exposures and position concentrations for each individual fund. This data must also be detailed in annual documentation for each fund.

On the deadline front, now that the final version of the directive has passed into law, the European Securities and Markets Authority (ESMA) must draft the details of implementation requirements for European member states by December. These requirements will then need to be transposed into national law and come into force in 2013. Thus the next couple of years should see these funds beginning to put new data and risk infrastructures in place.

One of the most contentious issues has been the requirement to use an EU domiciled depositary bank, which also must provide increased transparency into its own operations. During a recent roundtable on the subject of the AIFMD and organised by vendor Advent, Bill Scrimgeour, global head of regulatory and industry affairs for Institutional Fund Services at HSBC, explained that the introduction of depositories would have far-reaching effects on the hedge fund community. Not only will depositories be required to monitor and obtain data from these funds, they will also need to perform due diligence on the custodian and the prime brokerage communities, thus extending transparency requirements outwards to other players in the market.

Tom Kirkpatrick, managing director of enterprise risk management at GlobeOp, added: “The ability to present that data quickly, accurately and verified in a number of formats will be critical in helping both the depositories and investors to meet their objectives.” All players in these markets will therefore be compelled to invest in data infrastructure (if they haven’t already) to support these new, frequent reporting requirements.

In terms of risk management requirements of the directive, these funds must have in place “independent” capabilities that are separate from operating units, thus dividing the risk function from portfolio management, for example. The focus is on these firms being able to get a handle on all types of risk that impact the investment position of a fund and their overall investment strategy. Ergo, data – whether it is positional, reference or counterparty related – must be quickly accessible for reporting purposes.

On the valuations side of things, firms must establish what the directive calls “appropriate and consistent” procedures to allow for the independent valuation of a fund’s assets. In order to achieve this, the valuation must either be performed by an independent third party or by the asset manager, as long as there is functional separation between the pricing and portfolio management functions (the same as the requirement for the risk function).

As noted by Marcel Guibout, executive director of the fund accounting product in EMEA for JPMorgan Worldwide Securities Services, at a SIX Telekurs organised event towards the end of last year, the AIFMD is therefore compelling greater transparency into pricing models and methodologies. “The US market has always been more comfortable with evaluated pricing than Europe, but this is changing and there is much more acceptance of these methods now,” said Guibout.

On this note, GlobeOp’s Kirkpatrick indicated that the desire for increased frequency of net asset value (NAV) calculations has risen as a result of the incoming requirements: “Weekly NAVs are often required and so it’s important to establish sound controls to ensure accuracy in a much tighter timeframe. Therefore technology flexibility is absolutely critical to be able to meet the requirements of the market.”

Advent’s vice president of business development Thomas Zdon added: “We’re seeing actually from a technology spin where we’re getting the most attraction is people are pressing us for more independent valuations of derivatives and sources of that information. The fund administration space which was traditional T + 3, T + 5, T + 7 is now moving into a T + 0 environment. The pressure is on in appliance tools and risk tools to meet the requirements both of the UCITS and AIFMD.”

The pressures on the valuation function will therefore stem from the need to: support more frequent NAV calculations; prove independence when valuations have been internally calculated; and buy in independent third party pricing sources.

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