AIFMD Implementation Challenges: Part 4
Since the Alternative Investment Fund Managers Directive (AIFMD) (2011/61/EC) went into effect on 21st July 2011, Alternative Investment Fund Managers (AIFMs) (i.e. hedge funds, private equity funds, real estate funds, and institutional funds) have faced a number of significant operational and implementation challenges. PART 1 of this blog identified appointment of a third party depositary and data management and Annex IV reporting challenges. PART 2 identified risk management and liquidity management challenges. PART 3 reviewed the significant challenges introduced by the new AIFMD valuation rules. PART 4 will review the challenges introduced by the new AIFMD leverage requirements.
Under Article 15(4) of the AIFMD, AIFMs are required to set a maximum level of leverage that they may use on behalf of each Alternative Investment Fund (AIF) they manage. Leverage is defined as meaning any method by which the AIFM increases the exposure of the AIF it manages, whether through (1) borrowing of cash or securities; (2) leverage that is embedded in derivative positions; or (3) by any other means. It is expressed as the ratio between the exposure of the AIF and its Net Asset Value (NAV).
AIFMD Implementation Challenges
AIFMs are also required to set the extent of the right to reuse collateral or guarantee that could be granted under the leveraging arrangement, but must take into account:
(1) the AIF type;
(2) the AIF investment strategy;
(3) the AIF’s sources of leverage;
(4) any other interlinkage or relevant relationships with other financial services institutions which could pose systemic risk;
(5) the need to limit the exposure to any single counterparty;
(6) the extent to which the leverage is collateralised;
(7) the asset-liability ratio; and
(8) the scale, nature, and extent of the AIFM’s activities on the markets concerned.
If there is any exposure contained in any legal or financial structures involving third parties controlled by the relevant AIF, then these must be included in the calculation of the exposure of an AIF where the structures have been specifically set up to directly or indirectly increase the exposure at the level of the AIF.
For AIFs that are managed in accordance with the ‘gross method’, they must follow the gross method for calculating the exposure of the AIF set out in Article 7 AIFMD. For AIFs that are managed in accordance with the ‘commitment method’, they must follow the commitment method for calculating the exposure of an AIF set out in Article 8 AIFMD.
Special requirements are applicable to AIFMs that employ leverage on a ‘substantial basis’ (i.e. average daily calculation of an exposure exceeds three times average daily calculation of the NAV) at the AIF level.
AIFMs will find it particularly challenging trying to put in place regulatory compliance frameworks that can accurately calculate the exposure of an AIF under the detailed and complex provisions of the gross and commitment methods. AIFMs will also have to put in place leverage limits, monitoring processes for those limits, they will have to disclose leverage figures to investors, and answer any investor queries in relation to those figures.
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