Regulation in the alternative investment space is an evolving beast with both foundational and emerging topics ramping up demands on fund managers' in-house teams, explains Mary Bruen, Regional Head of Fund Services - Jersey, Guernsey & Isle of Man. 

At both a domestic and foreign level, general partners (GPs) are now confronted with a dizzying array of compliance requirements and information requests from investors, advisers, and regulators.

Keeping on top of the myriad of regulations and implementing appropriate processes to accommodate these changes is stretching investment managers' in-house teams and increasing reliance on specialist third party providers. In our survey of 100 alternative investment managers conducted last year, an overwhelming 78% said they expect to outsource regulatory reporting in the next three years. 

Global regulations yet to show their teeth

Firstly, there are the blanket regulations such as the Foreign Account Tax Compliance Act (FATCA) and the Common Reporting Standards (CRS). We are still at the starting gates when it comes to these initiatives. Right now, they represent a data collection exercise for the jurisdictions concerned. 

It is prudent to keep abreast of future developments around their implementation. The Organisation for Economic Co-operation and Development (OECD) and the US' Internal Revenue Service introduce recommendations each year, many of which are then implemented by tax authorities. 

The next stage will be for countries to decide what they are going to do once that data is available to the authorities. There is a definite possibility of further regulation around data and for resolving potential conflicts with another blanket regulation, the General Data Protection Regulation.

What AIFMD II means for fund managers

Then, of course, there is the Alternative Investment Fund Managers Directive (AIFMD) II.

AIFMD's framework was always intended to be reviewed to ensure it was fit for purpose. That process kicked off in January 2019 and has taken longer than expect¬ed. However, with the publication of the European Commission's (EC) proposal in November 2021, AIFMD II is finally here.

Instead of remodelling the complete AIFMD framework, AIFMD II proposes targeted reforms to improve its functionality. In the preamble to the draft text, the EC acknowledged that the existing "...AIFMD standards for ensuring high levels of investor protection are mostly effective" and that "...AIFMD is generally meeting its objectives..." and this sets the tone for the scope of the proposed changes, none of which are seismic in nature.

Notably, non-EU AIFMs will be impacted in the main by:

  • a tightening of the delegation rules and as a consequence having less flexibility on how third-party appointments of non-core/ancillary activities are structured;
  • increased investor disclosures (including on direct and indirect fees of the AIF or its investments) when marketing cross-border using the national private placement regimes (NPPR); and
  • potentially problematic consequences of the ability for member state regulators to require an AIFM of an open-ended AIF to activate or deactivate a liquidity management tool.

AIFMD II is very much an evolution rather than a revolution and there may be some frustration that the proposals do not represent a stronger departure from existing provisions. 

Issues such as cross-border marketing (there is no reference to the third country passport); eliminating alleged barriers for sub-threshold AIFMs; and external valuer's liability under AIFMD are not considered. Addressing these could present further opportunities for market harmonisation across the EU.

There is not yet a firm implementation date for AIFMD II. Importantly there will be industry lobbying opportunities before the final version is published in the EU's official journal and subsequently implemented. 

How to interpret substance requirements

Base Erosion Profit Shifting (BEPS) standards and the impact of the European Union (EU) substance requirements on both EU and offshore jurisdictions could cause a fundamental shift in domiciliation patterns over this decade. 

BEPS may well be the most important development for the structure of alternative funds in a generation. COVID-19 has catalysed its pertinence by changing the way we work and impacting governance structures, with virtual board meetings expected to soon impact tax and regulation.

BEPS underpins substance requirements and underlies the OECD's forum on harmful tax practices. Rules on permanent establishment will have implications for directors, with competent directors anchoring a structure in the jurisdiction where it is domiciled. 

Investment managers are therefore considering their domicile options more closely, partly due to increasing costs and heavier regulatory burdens. We are also seeing new or amended fund structures being introduced to enable jurisdictions to compete with well-established fund domiciles. 

AIFMD defined risk and portfolio management as key indicators of substance and it an opportunity for jurisdictions, and therein service providers, to increase substance through the provision of new services which help GPs manage portfolio and operational risk.

The push towards sustainability

The momentum behind tackling climate change has enveloped the investing world in recent years. Investment managers are increasingly under pressure to deliver ESG-friendly products with a focus on sustainable practices.

The EU Sustainable Finance Disclosure Regulation (SFDR) which became effective in March 2021 was the first instance of imposing mandatory ESG disclosure obligations on asset managers. It seeks to ensure investors are better placed to assess the sustainability credentials of fund managers. The SFDR is predominantly aimed at funds with a sustainability agenda, with all other funds classified as neutral.

It will be interesting to see how the SFDR impacts capital flows into funds offering environmental credentials and the extent other fund managers will have to play catch up. The process of getting their operations and funds SFDR ready and compliant is no easy task and is another area where outsourcing is likely to increase.

Choosing the right outsourcing partner can enhance your competitive advantage

As regulations continue to evolve, managers need to have strong compliance functions to ensure they meet their ever-changing obligations and avoid falling foul of non-compliance.

At Ocorian, we have been investing in this area with the acquisition of two specialist compliance consultancies, Newgate Compliance in the UK and Platinum Compliance in Guernsey. 

Outsourcing your fund's administration and compliance requirements to our Global Funds team can help you stay in control of your operations whilst enabling you to focus on executing your investment strategy and maximising investor returns.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.