EU managers fleeing to UCITS funds

UCITS-compliant funds are becoming an increasingly popular vehicle for fund managers looking to get around the strict regulatory burdens and resulting compliance costs of a new EU directive due to be voted on in Parliament by the end of the year.

Cheyne Capital Management and the Man Group recently became the latest firms to launch UCITS-compliant funds, but they will likely not be the last as more fund managers are preparing for potentially strict new regulations coming up for debate in the European Parliament.

The controversial “Directive on Alternative Investment Fund Managers” – which if approved could be implemented in 2012 — would subject EU managers to new annual reporting requirements to investors and regulators, as well as additional offering memorandum disclosure requirements and regulatory reporting about assets in which funds are invested. In order to get around these regulations, a number of hedge funds are taking advantage of the fact that the directive will not apply to UCITS funds.

UCITS, or Undertakings for Collective Investments in Transferable Securities, is the regulatory framework for European funds which comply with standards relating to transparency, valuation and risk. Cheyne announced late last week that it is rolling out series of UCITS-compliant funds next year, while Man said that next month it will launch Man AHL Diversity, which will charge investors more than a usual fund – a 70-basis-point structural fee on top of the traditional 2-and-20.

Adam Levin, a partner at Dechert, said more managers are quietly making the move to UCITS-compliant funds in part to give themselves some “practice” on the regulation. “The regulation for UCITS – which are effectively consumer products – is a lot less prohibitive in some respects than under the AIFM Directive,” he said. “What they are doing is very smart, which is preparing themselves for the possibility of regulation by going to an existing regulated product.”

UCITS funds will also be able to be marketed to individual investors across Europe, whereas under the EU directive European- and non-European-authorised managers will be limited to only being able to market to professional investors. But to qualify as a professional investor one must demonstrate that they have done a number of transactions in the relevant asset space within a certain period.

Passage of the EU proposals is still far from certain, and recent pushback from the US and UK governments – as well as statements by the new chair of the European Parliament’s economic and monetary affairs committee – have indicated that the directive will be substantially amended at some point in the process. Even so, the switch to UCITS-compliant funds can help provide some certainty to managers amid an uncertain time.

“It’s not easy in some places as [managers] can’t do exactly what they want, but at least they’ve got certainty on the regulation, because it has been there for years,” Levin said. “It will mean that if the directive does come into force they can switch entirely over to UCITS-based fundraising and won’t miss a beat.”

More managers may be persuaded to make such a switch following a recent survey of hedge and private equity managers by London-based research organisation Open Europe which estimated that the compliance costs of the proposed regulations in the first year for the managers alone would be between €1.3 billion and €1.9 billion. The survey also noted that on average, compliance costs would increase by 31.51 percent, but added that these estimates exclude the costs of the custodians, valuators, administrators, portfolio companies and the regulators that more funds will have to take on.

“I’m sure that EU fund managers are shocked at the costs that will have to be paid,” Levin said. “Third parties will have a role to play as a consequence of the Directive and they will want their share to cover their own liabilities. My guess is that fees will be relatively high for both valuations and custody due to the liabilities and limited market participants. So, who will bear the risks for that? Essentially, it will be borne by the investors, with annual costs rising. Does that mean to say that the 2 percent annual fee and 20 percent carry are going to have to adjust upwards to 2.5 or 3 percent for the annual fee for EU funds, and does the 20 percent carry then come down as a consequence? I don’t know, but something will have to give because the economics are being made different from what we have now.”