It is time to make plans, the clocks are ticking

UCITS, AIFMD, Private Placement rules in Europe are very topical subject at the moment. And many people find it quite a daunting task to try to understand what the options are, what the implications are and quite simply which path to follow in the mine field of ever changing regulations.

Bottom line is it is going to be extremely difficult to avoid all kind of regulation in Europe; this is if the fund intends to be distributed in Europe. The good news is that it will clarify the limbo in which many funds stand at the moment, and which distribution capabilities relay in pretty obscure and imprecise private placement rules. So give or take, in 2 to 3 years, every single fund in Europe will be regulated. And if it has found a way not to be, it will in any case have a very hard time being distributed; so very likely, AUM will suffer.

Some might think that there is quite some time before decisions have to be made.

It might be so. But the trend is for regulations to be tighter, not more accommodating. So waiting for new ones to come into force is a decision which is not free of consequences in itself. Take for example the case of UCITS regulations. We are now under the regime of UCITS III. Coming in the near future is UCITS IV; value July 1^st. From July first, any new UCITS fund will need to be structured and launched according to the UCITS IV rules; pre-existing funds will have 2 years grace period to comply. So just in case you had in mind to launch one, it would be advisable to speed up the process and focus on it now.

Regardless, it is advisable to take a view as to the kind of status you want your fund to have in the coming years and prepare for it. The points to consider are numerous and decisions have to be taken carefully but the bottom line is going to be distribution. Who are your investors, what are they allowed to invest in and what are the regulatory consequences/impacts on them?  And further than that, which type of products are they going to be willing to invest in? UCITS is a piece of regulation that has been put in place to allow for retail distribution of investment products across Europe. Nevertheless, research indicates that institutions are the largest buyers by far of such products and this phenomenon extends to Asia, due to the “brand” appeal of UCITS funds. So it might be the case that you should consider it regardless.

In a similar vein, consideration needs to be given to the impact if solvency 2 on Insurance Companies and rippling effects on Pensions Funds. Having the appropriate structure might avoid being allocated to the “wrong” Equity Investment bucket…

Any choice will have its constraints and it is advisable to start drawing plans sooner rather than later.

Points to consider range from service providers, using a platform or going “on your own”, legal structure, investments regulatory constraints and limits monitoring, distribution channels…

But the rewards should be there for those who get it right.

Whatever your plans, bear firmly in mind the very limited time available. This is not something to be tackled at the last minute.

It is no surprise really that CP10/19 has received more attention than the FSA’s other eighteen consultation papers this year put together. Remuneration is a big issue and a political hot potato into which the FSA risks being drawn in and melted. By now everyone will be familiar with the main features – deferral and payment in shares – but most will not yet have given serious thought to the practicalities of implementation.

This is a consultation that shows further signs of the Regulator’s growing europeanisation. Not only is the process absurdly rushed, thanks to the European timetable for CRD III, but its wording is obscure and its implementation vague. Appealing as it may be to experience such flexibility in regulation, it is bad regulation and results in uncertainty, subjective assessment and resentment. As europeanisation progresses, we can look forward to much more of the same.

Generally firms expect to be able to be able to hold their fire until they can see the whites of the eyes of the new regulations. Not so this time. The European officials have again demonstrated their disdain for facilitating national consultation, leaving the FSA the task of dragooning the industry to meet the deadline of 1^st January. The flexibility that they proposed is little short of fudge, for which we should grateful even if we don’t like the taste. The use of proportionality as a smoke screen for staggered implementation with key elements held over to after the legal time-limit.

Nevertheless, at least partial implementation is required by 1 Jan. Few firms will find it realistic to wait for the confirmed rules in November before starting the necessary programme of implementation of the “appropriate governance arrangements”.  Some will be lucky or prescient enough to find that they already meet the obligations; most will not. Immediate attention is needed to remuneration policies, to record-keeping, to the remuneration committee, to the involvement of Risk and Compliance, to employment contracts. All of this is the home work prior to the main test of full compliance by 1^st July 2011.

Hidden challenge

But the real challenge lies not in the tight timeframe and not in the volume to activity required, tiresome enough as they may be, but in the judgement call on who is to be covered by the Code. Many will be tempted by the simple approach of rough justice for all. But for quite a large number of firms the de minimis rule will exempt so many of those otherwise caught as to require at least a careful review to ensure that remuneration arrangements are not being unnecessarily complicated at cost to the firm and cost to the recipients.

The prize for the least well sign-posted rule change must surely go to the FSA’s work on the Stewardship Code. Indeed so obscure was the FSA’s publication of the new rule, that the probability must be that only a small minority of the firms affected will have complied by the now-passed deadline of 6^th December. Rule changes sneaked out through anonymous consultations and without any policy statement beg many questions, the most interesting of which is why is the FSA indifferent to mass non-compliance with this requirement?

But first the facts. The new rule (COBS 2.2.3R) requires all managers of institutional money to publish a statement setting out how and to what extent they comply with the Financial Reporting Council’s Stewardship Code. As the FSA announced just three weeks ago, this should have been done by 6^th December. If you did not know that, join the club.

Not a daunting task… yet a task

The good news – apart from the fact that the FSA obviously does not care – is that stuffing a one pager onto your website is not a labour that would have tested Hercules. The bad news is that this document, even if of no interest to FSA, may well become a hostage to fortune. The theory is that the information will inform the decisions of potential clients over who should manage their money. The reality may well be that these statements are surveyed and scrutinised by investigative journalists, government departments, company management and political agitators. Control of public companies will always be a hot potato and now the rod with which to beat the shareholders and their agents, the investment managers, is being crafted.

The temptation must be simply to construct an innocuous and disdainfully vague statement, adequate for public consumption even if insufficient to guide the potential clients for whom it is primarily intended. As a holding position this may work, but it seems unlikely to survive for long as the scrutineers begin to press for better particulars. Most importantly, though, the policy and the actions have got to be consistent. Anything less will emerge before long and prove indefensible.

Looks reasonable and easy, but…

The essential requirements of the Code look, at first glance, reasonable enough. Having a policy on stewardship is hardly inappropriate. Working with other investors, where permissible, seems eminently sensible if one wishes to magnify the impact of one’s vote. Liaising with company management and knowing how to escalate issues sounds useful. But when it comes to an obligation to tell the world how you have voted shares that belong not to you but to your clients, it is beginning to sound intrusive. And not just intrusive but actually creates a conflict of interest that was not there before. If fund managers go the whole way, they will be breaching client confidentiality and simultaneously opening themselves up to pressures to act in a way that may not be in the best interests of their client.

Public disclosure of voting should not be undertaken lightly. It will not be long before pressure groups use this information to cajole fund managers into casting votes which reflect the views of the pressure group but do not reflect the interests of the fund managers’ clients. With the experience of the tactics used to damage the legitimate business of Huntingdon Life Sciences, it is not difficult to see how publication of voting records could introduce significant conflicts of interest for fund managers. It is to be hoped that firms will make clear that they consider the voting of shares that belong to their clients to be a matter of client confidentiality and therefore interpret the Code, wherein much ambiguity lies, as requiring nothing more than statistical summaries.

With time very pressing, firms will need to draft, adopt and publish quickly. OWL will be happy to advise on process and articulation.

Reasons for the markets instability witnessed over the past 18 months have been debated and discussed a number of times. It seems therefore reasonable to assume that they are well known and relatively well understood. However, the market – and more worryingly its regulators- seem taken of guard every time a new casualty appears, generating some suspicion as to how much awareness and understanding there is globally. Let us therefore attempt to draw a framework that will put some structure around the chaos currently unfolding.

How did it all got started?

All started with the subprime crisis. A segment of the mortgage market became out of favour, on the premises that delinquency rated were on the way up due to an expected slowdown in the world’s growth rate. This became quite suddenly an evidence to finance industry although the theme had been herald by a number of market participants for a number of months; some had even built significant positions ahead of the events, generating at the time at best incredulous reactions.  Overnight, every institution faced the difficult task of evaluating the exposure they had to this segment, and the likely resulting loss. They started to look into their balance sheet to find out. What they found out took them by surprise and this was that they could not really say. The Structured Bonds they held would not allow them to understand exactly what kind of risk they were exposed to; or at least not in sufficient detail. The loss of granularity was such that they could neither determine the scale of their exposure, nor the pain they should expect to take. They could not really estimate the value or the risk of significant part of their balance sheet.  They then turned to the market to find the answer; many of them; at the same time. The resulting unbalance triggered the events and the rest of the story is known. Before exploring the contamination mechanism, let us spend a moment on what happened then and why, more importantly. A Brief History of Recent Times

With many ‘star names’ in the hedge fund industry being able to use their clout to lock up investor assets for lengthy periods, the notion that illiquidity is a price worth paying for better performance should be scrutinized. This paper will analyse how the performance of ‘long lock up’ funds compares to the performance of their cousins who do not impose such punitive conditions on investors whilst assessing comparative performance in difficult market conditions.

Funds examined

For the purpose of the paper, the definition of long lock up fund applies to hedge fund holdings with a liquidity of greater than 2 years. Since data on long lock up funds is not so widely available, we could only use 8 long lock up funds held by our clients for the paper. Details of the funds are listed below with the fund names withheld to preserve confidentiality agreements Analysis long lockup performance