AIFMD: hedge funds reported to be struggling with reporting

Custodians and administrators say hedge funds, particularly smaller and emerging managers, are poorly equipped to meet the rigour of reporting standards under AIFMD

Hedge funds are poorly equipped to meet AIFMD's reporting standards

Many hedge funds will struggle with submitting their first Annex IV reports to regulators which are due today (October 31) under the Alternative Investment Fund Managers Directive (AIFMD) with custodians and administrators predicting managers opting for in-house reporting will likely need to re-examine that decision.

At a minimum, the reporting requires data to be collected both internally and externally from the fund administrator, transfer agent and other counterparties including prime brokers, legal counsel, and risk and compliance firms. It is for this reason that many alternative investment fund managers (AIFMs) have chosen to outsource regulatory reporting to their fund administrator as it will house much of the data that must be included in the report, although ultimately the fund management company is responsible for reporting in the eyes of the law.

Mark Mannion, head of business development and relationship management Emea for alternative investment services at BNY Mellon, says many managers will "undoubtedly" struggle with reporting, finding the requirement to build interfaces with multiple parties challenging.

Pete Townsend, COO Ireland and head of hedge fund solutions, BNP Paribas, agrees some managers do not realise how hard the reports will be to execute. He says many managers have decided to run the first set of reports in-house in order to understand the process before choosing an outsourcing provider. He adds: "We expect some providers will run the process in-house and will only then realise exactly how complicated and onerous it is. We expect to see many such providers turn to outsourcing when the next reports are due."

Phil Christianson, associate director of product management at Eze Software Group, says he has seen teams of anywhere from two to 10 people working for between one and two months leading up to the filing deadline, with many running mock filings in advance populated with previous quarter-end information.

A second round of reporting follows in January and the process will be repeated every quarter for players who manage assets in excess of €500 million. AIFMD requires reports for every fund, including new data on risks, counterparties, liabilities and leverage. This entails collecting information from a multitude of sources, putting it in the required XML format and managing discussions with regulators.

Many outsourced reporting services have sprung up but they differ in their range of offerings.

BNP Paribas's reporting service involves collecting data from its own systems and from the AIFM, performing the necessary transformations of that data such as classification, various calculations, consolidation across funds, and specific formatting. This gives the AIFM the ability to review and validate the report, before BNP Paribas submits it to the regulator.

In its AIFMD Trilogie offer, Societe Generale Securities Services (SGSS) provides modular reporting. The first service level consists of providing clients with the data SGSS has regarding their funds - such as information on assets, unit holders and risks - in a format that can be directly incorporated within the final reports they have chosen to draft internally. The roles are reversed for the second service level where it is the asset manager who sends SGSS the fund data that is only available in its systems, and SGSS is then responsible for all reporting tasks. The third service level is aimed at fund management companies that use a number of custodians. SGSS could draft reports for the funds entrusted to it, leaving the fund manager responsible for drafting the consolidated reports, or SGSS could collect the data received from other custodians and carry out all tasks associated with AIFMD reporting, including for non-SGSS funds.

SGSS is currently serving 35 European asset managers with AIFMD reporting services, although several AIFMs in its client base have decided to build reports in-house. Laurent Plumet, SGSS head of product development for fund administration services, says: "Though the regulator is favouring estimated front-office data as opposed to back-office audited information, most of the AIFMs we've been approached by took the option to mainly rely on fund administrators' data and complement these with risk numbers."

He says the rationale behind this is that custodians are in a better position to process huge volumes within an aggressive timeline. In addition, some required data fields are AIFMD-specific, such as European Securities and Markets Authority-defined asset types and sub-types, with no need for AIFMs to have them administered in their platforms.

Fund administrators and service providers have to collect 400–800 data items from different legal entities and then put them through a series of transformations to fill the 340 fields in the reports that are sent to regulators. Ralf Menegatti, product owner, asset management, at regulatory reporting firm AxiomSL, believes roughly 30% of the required items will not have been integrated into the systems fund managers use and this will "turn the alternative investment funds industry on its head".

While larger AIFMs may find challenges connecting different in-house platforms to gather the data, mid and small-sized AIFMs may not be best equipped to industrialise data feeds. Smaller funds and offshore funds that only market their products in Europe will struggle the most to meet their reporting obligations, according to AxiomSL, because they have overlooked the structural and process changes in operational services that must be made before they can start reporting.

It is also entirely possible that there are questions within AIFMD that funds will not previously have calculated answers to. Eze Software's Christianson says risk may be an example, since AIFMD requires stress testing.

Smaller managers may take advantage of 'ManCo' advisory services as the effort involved in integrating reporting procedures internally may be feasible only for funds with large-scale operational infrastructures.

Jeff Rhodenizer, project office manager at Canada-based Admiral Administration, says: "The operational infrastructure required to meet the AIFMD requirements is vast and may prove difficult or even impossible for emerging managers. The administration cost alone may be crippling to a small fund operation. Although these costs may be charged to the fund entity, it will impact the net asset value performance numbers and may lead to further challenges in raising capital."

Others foresee equally far-reaching consequences. Ultimately, Menegatti predicts that AIFMD will force fund managers and directors to abandon multi-jurisdictional organizational structures. He says: "Requirements for greater transparency mean it is no longer possible for a fund manager in Jersey to use the services of a sub-custodian bank in London and a depository bank in Paris, for example."