Given that many alternative investment fund managers have now applied for their licence under the Alternative Investment Fund Manager Directive (AIFMD), efforts are shifting towards the practical implementation of the regulation and the first hurdle of Annexe IV regulatory reporting is currently the hot topic for much of the industry.
Given that many alternative investment fund managers have now applied for their licence under the Alternative Investment Fund Manager Directive (AIFMD), efforts are shifting towards the practical implementation of the regulation and the first hurdle of Annexe IV regulatory reporting is currently the hot topic for much of the industry.
While it is understandable that the immediate focus is on ensuring that transparency reports are completed in time for the first deadline in October, alternative investment fund managers should also think about how they can turn the transparency requirements—and how they use their data—into a real competitive advantage.
So what are practical challenges for Annexe IV reporting? Alternative investment fund managers tackling the issue have undoubtedly found that there is not necessarily a straightforward method. The reporting touches on a multitude of areas and therefore requires a cross-departmental approach to managing its implementation.
Following a thorough analysis of where the data needs to be extracted from, it may become apparent that certain data is not readily available in any of their systems or has not been calculated, as per the European Securities and Markets Authority (ESMA) guidelines. The data management challenge should not be underestimated.
Most commonly, the challenges will arise from risk calculations and market allocation (such as market identifier code (MIC) attribution), sub-asset type allocation as per ESMA codes, and assets under management (AUM) calculations. AUM must be calculated based on absolute value, while some derivatives need to be valuated at notional value. To that end, in many instances the AUM will need to be recalculated accordingly.
Furthermore, the consolidation of AUM at the alternative investment fund manager level can be a tricky exercise for those using several administrators—especially for cross investments between funds of the same manager. All of this makes the AUM monitoring used to determine the reporting frequency a very challenging task. For the ranking of the major markets, an allocation of an MIC code level for many instruments is required.
Very often, when instruments have been traded on several markets, the breakdown of the MIC allocation is not available. In this instance, it becomes necessary to decide on alternative scenarios, while understanding the limits of those methods.
Counterpart grouping poses another challenge for alternative investment fund managers. The grouping of brokers, banks and issuers under one common heading is not always very clear. As non-EU alternative investment fund manager reporting requires a country specific approach, the consolidation and related frequency determination leads to an additional layer of complexity. And in certain circumstances, ESMA requires reporting on new codes such as legal entity identifier and alternative investment identifier.
However, as yet, such codes are not fully recognised by the industry. In addition, risk elements such as investor liquidity profile and unsecured borrowing amount are very often not readily available in the fund’s systems.
Due to ESMA’s specific sub-asset type coding, mapping becomes necessary between internal codes used by fund houses and those used by ESMA. This exercise is not a simple one, with the reconciliation of both sets of codes being far from a one-to-one comparison.
Given that the above points do not form an exhaustive list, an alternative investment fund manager shouldn’t expect to receive all of the required information from its service providers or internal departments at the push of a button. Indeed, it becomes necessary to discuss and agree with each data provider a set of common, pragmatic methods and best practices to ensure correct reporting.
At the end of the day, the Pandora’s Box doesn’t need to become a nightmare if fund managers can delegate the gathering of data, and the production and filing of the reports to teams that are equipped to handle the complexity.
In fact, alternative investment fund managers should think about how they can use dealing with Annexe IV reporting as a useful exercise to turn their use of data into a positive differentiator for investors. Instead of being just a cost centre and a matter of regulatory compliance, data management can be used to add value and allow the fund manager to compete more effectively.
The first advantage created by data management is one of efficiency. A tremendous amount of time at alternative investment fund managers is spent collecting, replicating, reproducing and merging information. Making the process more efficient therefore allows more time to be spent doing their day job of serving their clients and managing their portfolios.
Second, investors themselves now expect greater use of data. As a result, any alternative investment fund manager that can demonstrate how and why it makes the decisions it does is likely to be more successful in raising capital. A fund that has good data is more likely to make good decisions and can use its data management practices to demonstrate its efficiency, transparency and security credentials.
For many alternative investment fund managers, the roadblock to achieving these positive points is that they cannot easily share data and do not have complete faith in the data that they have.
A key reason for this is that despite the numerous technological advances made in financial services, current data-sharing processes used by alternative investment fund managers tend to be antiquated.
The majority of alternative investment fund managers still transmit data by using Excel spreadsheets that are sent and received via email. This means that data collection and sharing takes a significant amount of time and requires the replication of data, which in turn can result in errors that reduce the integrity of data.
A further consequence of the use of Excel and email in data management is that it becomes costly for asset managers and their counterparties to audit their own information. There is no easy way of knowing what information has been sent, if or when it has been changed and why, or when it has last been validated for accuracy.
Without dedicated technology that makes it easier and more secure to collected, verify and share information, data management can therefore become a very costly one. The solution is for alternative investment fund managers to think about how technology can be used to turn these negative issues associated with data into positives for their business.
Alternative investment fund managers currently focusing on Annexe IV reporting now should therefore start looking at how to implement new systems for future benefits beyond the first reporting deadline. Those that do will be well positioned in the long-term to not just meet the requirements of AIFMD, but also gain a competitive advantage over their peers.
