Like any regulation, AIFMD creates opportunities for service providers looking to take advantage of mandated changes. This post presents some ideas we have had over the last few months. None of these are tested or robustly surveyed – we are simply putting them out to clients for consideration.
1) AIFMD requires hedge funds to have one master depositary, including a bank, CSD or prime broker that is willing to be the central supervisor of the hedge fund’s activities and assume the risk that this entails. This isn’t an easy job but it will be done by some organization for a fee. Besides each bank or vendor offering its own service, we see a few business combinations that might make sense:
– CSD partners with hedge fund administrator. The CSD provides the record keeping and the hedge fund administrator is the compliance arm.
– Custodian and insurance company. The custodian provides both record keeping and compliance and offloads its risk exposure to an insurance company. The insurance company has to approve and supervise each hedge fund.
There are several variations on this partnership theme that could be explored.
2) We see the opportunity for a “super subcustodian network” that assumes the risk portion of supervising a network of subcustodians. This would allow a custodian to outsource its liability risk for supervising subcustodians. Without some sort of risk diversification off of the primary custodian, either Citi, Standard Chartered and a few others are going to take every emerging markets client, European custodians will seek to build out their own subcustody networks, or somebody will have a lot of sleepless nights. A “super subcustodian network” would take over the supervision and alleviate the concerns of depositaries assuming the risk that their subcustodians could err.
3) While audits of hedge funds already occur, AIFMD is likely to produce a cottage industry of new auditors and specialist firms who can vouch for the integrity of the fund. We can see this becoming mandatory before a depositary would take on a client. But what happens if the fund commits fraud? The auditor is getting sued and fast. Time for some serious professional liability insurance.
4) We can see various technologies coming into play that help depositaries monitor the integrity of their AIFM clients. For example, a manager may need to fill out a weekly report or affidavit and sign it with a digital finger print reader. This would help ensure that the manager is paying close attention to fraud-related issues at the fund.
5) An increase in the importance of the depositary relationship may lead AIFM’s to look towards depositaries for securities loans and margin, presuming these exist in the AIFMD future once short selling bans, FTTs and the like are considered (tongue-in-cheek). Let us suppose though that there is still business here – the depositary has a new cross-selling opportunity and may want to beef up its staff to take advantage of new AIFM clients. These new revenues may offset compliance costs and may be a reason to fight for AIFM clients early on. If these clients are effectively captive and can be sold a bundled service, that may produce an unusual revenue opportunity for new entrants.
6) There may also be a new repo funding business matching up internal AIFM clients seeking funding with money market funds, corporate treasurers and other repo cash providers. Any credit intermediation would be welcome.
While these ideas are in no way fleshed out, they are a sample of some new opportunities we see emerging as a result of AIFMD.