19/08/2009 Author: Tony Griffiths

The investor response

Of all the sources of objection to the EC’s draft AIFM Directive, it is the voice of investors, whose interests the draft aims to protect, that will have the most sway with EC lawmakers. HFMWeek looks at the threats to investor choice that the proposals represent, and how opposition is gathering pace

The AIFM Directive, as the European Commission (EC) has so often stated, is designed not only to regulate markets but to protect investors. All well and good, but by proclaiming the legislation as a tool for investor protection, the jarring provisions within – those that limit investor choice and add unnecessarily to the cost burden – look increasingly ill-conceived and add weight to Brussels-focused accusations of politicking. The impact for pension funds, endowment mangers and insurers is clear.
Inadvertently, the EC has rattled the investor cage, and what began as a murmur of discontent has, following weeks of impact assessment, swelled into a united roar of disbelief. The investment animal, so readily considered a docile beast, has some of the sharpest teeth in the financial kingdom – and now its territory just so happens to include hedge funds.
Says Peter Montagnon of the Association of British Insurers (ABI), a prominent Directive lobbyist: “We’re not trying to defend our market – we’re trying to defend choice for the people’s money that we’re trying to invest.” This, at a time when many European politicians still view hedge funds with baseless suspicion, may provide the basis for the one truly effective argument.
Lest the EC forget, the path from hedge fund to pensioner (and, indeed, the public sector in general) is one with fewer steps than ever. In recent years, institutional inflows have supplied the hedge fund industry with a somewhat timely backbone of long-term money, and, in the process, provided institutional investors with a significant interest in the sector’s well-being.   
According to the Alternative Investment Management Association (Aima), pension funds within the EU have approximately €1trn ($1.42trn) exposed to non-Ucits alternative assets. Not only that, Aima estimates the provisions within the Directive could lead to a performance-related loss in revenue of €25bn ($35.6bn) (based on the approximation that alternative investments offer a 2.5% return premium on standard assets).
The €25bn figure has been contested, but few investors seem to doubt that, were the Directive to be enacted in anything like its current form, the entire investment industry would be hit hard. Investors of all types and sizes have begun to act in unison, with their statements, interviews and lobbying letters providing sustenance for the hedge fund industry, battered and bruised from the early fight.    
The ABI was one of the first investor groups to lobby the EC, via a letter co-signed by Dutch insurance association Eumedion back in mid-June. “As a large investor we have a broad interest in this Directive,” says Montagnon, the association’s director of investment affairs. “We want regulation that adds to market confidence, not regulation that creates a compliance burden with few benefits. I don’t feel that we’re getting much out of this other than the passport.
“In the process of sending that letter we helped set up a bit of debate. I hope through this debate that we can get the right change”
The ABI’s letter, Montagnon notes, includes two important elements. Firstly, it offers a cross-border perspective by showcasing both British and Dutch concerns; and secondly, it comes from the end-investor. Critics of the hedge fund fight have argued that the sector’s own campaign has felt, at times, too London-centric. It seems unlikely that Brussels-based industry sceptics – impervious to managers’ cries, it would seem, no matter how strong the case made – are going to be swayed by calls from the UK hedge fund industry alone.
According to Montagnon, the emotion needs to be taken out of discussions. “We don’t want to be associated with any tantrums – that ‘this will be the end of the City of London’, Some of those voices haven’t been helpful.”  
Robin Clark, global head of lobbying at Axa Investment Managers, agrees. “I don’t think it’s productive to our interest to be seen to be arguing as London-based or as asset managers,” he says. “We’re all part of the financial services industry.” French insurer Axa has been actively contributing to the Directive debate via a number of trade associations at national and pan-European level, Clark reveals.

Montagnon and Clark are not alone in seeing flaws in some of the early, industry-led complaints. Lord Myners – the UK’s city minister, who called investors to arms in HFMWeek, early July (issue 153) – has stated on a number of occasions that threats made by London-based hedge funds to leave the capital on account of the Directive are detrimental to the cause; a view that has been seconded by Aima chief executive Andrew Baker.   
Aima‘s latest lobbying efforts have revolved, largely, around the impact on investors. In mid-July, HFMWeek obtained a copy of a draft letter, created by Aima, through which investors could voice their concerns. Most recently, of course, the trade body has provided us with the €25bn pensions-impact figure mentioned earlier, which may not have had quite the desired impact, but remains, as Baker puts it, “a possible illustrative number”.              
Few are arguing that the damage to pension funds – the biggest hedge fund investors in the public sector – is potentially significant. In a recent Penrose Financial survey, almost half (47%) the pension sector luminaries polled felt that tougher European regulation would “drastically” reduce the number of hedge funds.
The UK’s National Association of Pension Funds (NAPF), whose incoming chairman, Lindsay Tomlinson, came out against the Directive last month, held the first meeting of its Directive-focused working group last Friday; its aim being to finalise a letter to the EC. Present at the meeting were the UK’s two biggest pension funds: The BT pension fund, represented by fund manager Hermes, and second on the list, the £23bn ($38bn) Universities Superannuation Scheme (USS).
Kathryn Graham, director at Hermes Pension Fund Management, explains her concerns. “We have no issue with an increase in regulation if it’s appropriate, and we don’t mind paying for it if it’s appropriate, but we also want to know that we can continue to receive information from, meet with and invest in, the best managers, wherever they’re based,” she says. Hermes, Graham adds, is involved in “a lot” of discussions regarding the EC’s proposed regulations, but was unwilling to go into detail at the point of interview.
“I’ve spoken to a number of my contemporaries in other pension schemes and foundations, in the UK, Europe and beyond, and we’re pretty much of the same opinion, that the directive is aiming to achieve some admirable goals but there seems to be some unintended consequences that do concern us,” she continues. “We very strongly want to be part of the consultation process to ensure that it doesn’t have any impact on our portfolio allocation decisions.”
Last month, USS’s Emily Porter admitted her team’s fund – on a global search for new managers after launching its new hedge fund allocation programme in the summer – was worried the Directive could limit its access to non-EU managers. “It could have a severe impact really,” she said.
Amid what is already a reassuring level of support from hedge fund investors, it is important to remember that the Directive covers a number of markets, thus offering greater scope for investor support. “They seem to be using a very large hammer to crack a very small nut, but that’s us looking at it from the private equity view,” says Kevin Dervey, a senior investment manager with the £6.4bn ($10.5bn) West Midlands Pension Fund, whose portfolio has an estimated 5% allocated to hedge funds.
The West Midlands director of pensions, Brian Bailey, was a signatory to a letter which appeared in UK newspaper The Times in July objecting to the new regulations on the grounds of its approach to private equity – still the majority holding for pension investors. A number of other local government schemes, such as Scotland’s £8bn ($13.2bn) Strathclyde Pension Fund, have registered similar, private-equity-based concerns.
“The type of hedge fund managers we look at tend to be based in London and domiciled in, perhaps, Luxembourg, so there is a big enough pool of people to look at without going further afield,” says Dervey. “Having said that, it could be a problem further down the line,” he concedes.

When it comes to the AIFM Directive, institutional investors, regardless of the type of alternative asset they covet, appear to agree on three matters: One, that its provisions are well-intended with some positive inclusions, such as the passport; two, that, in its current form, the Directive is unnecessarily damaging to investors; and three, that the current situation highlights the importance of public consultation.
“I suspect that all of us would like to feel like there was more of a debate,” says Hermes’ Graham. “There’s a debate happening in the press. There’s a debate happening between market participants. I don’t have any comfort that this is going to actually impact the legislation and that’s the sort of thing a proper consultation process would solve. My understanding from the advice we have been given is that these kinds of directives tend not to be written so quickly and without a consultation process, and if that is the case then it is clear that a consultation process is needed.”
AXA’s Clark adds: “There hasn’t been the full commission-level consultation, and maybe one thing that will come out of this is that that has caused a lot of problems and that they will do things differently in the future.” Clark believes that the September’s Eurofi conference will prove a timely grandstand. Eurofi, a think tank dedicated to financial services in Europe, chaired by Jacques de Larosière, has put the Directive on the agenda. AXA will be attending the Gothenburg event, which has been organised in conjunction with the Swedish EU presidency.
ABI, says Montagnon, will continue to lobby actively. “We’re very interested in building coalitions with other investor bodies.” However, ABI’s lobbying head, Carol Hall, stresses that until the Directive’s rapporteur is appointed the speed and intensity required of efforts cannot be established. Hall, like HFMWeek, believes French Europe People’s Party candidate Jean-Paul Gauzes to be the frontrunner for the position.   
However, the fact that the Directive includes provisions for a public consultation and review two years after enactment (Article 50) is, for Montagnon, one of a number of reasons to be hopeful. “I’m quite optimistic that if we get the right mood going we can address the key issues, he says. “With hard graft, good will and by stripping the emotion out of the debate, we can be successful. After all, the Commission must want a directive of which they can be proud.”