The unintended consequences of the European Union Alternative Investment Management Fund Directive in its current form could mean severe financial consequences for Europe’s already beleaguered pension fund industry, thereby possibly cutting off the EU from significant pools of global capital. But what might be Europe’s loss could conversely be Cayman’s gain, writes Business Editor Lindsey Turnbull.
The total size of assets under management by the European pension fund industry is $7 trillion or €5 trillion. According to AIMA (the UK-based Alternative Investment Management Association) about 20 per cent of that is allocated to alternatives (hedge funds, private equity, real estate funds etc), or about €1 trillion.
Restrictions placed on European fund managers by the proposed European Union Alternative Investment Fund Directive by way of the imposition of strict trading restrictions could well reduce returns by 2.5 per cent for that €1 trillion, according to AIMA. 2.5 per cent (at least), AIMA says, is the approximate reduction in return which alternative investments would deliver under the directive due to leverage restrictions and increased compliance costs.
Andrew Baker, CEO of AIMA, said, “This is an estimated figure but it shows the potentially enormous impact that the directive could have on Europe’s pension funds and in the longer term, Europe’s pensioners.”
Baker says that European pension funds have been increasing their allocations to offshore funds over recent years because of the good returns, lower correlations with traditional asset classes and low volatility they provide.
“With Europe facing strong demographic pressures as a result of an ageing population, pension funds will need strong growth and reliable returns over the coming years in order to meet future demand. If they suffer lower returns as a result of the directive, it’s not only Europe’s pension funds but Europe’s pensioners of both today and tomorrow who will suffer,” he states.
AIMA is therefore calling for a full impact assessment to be conducted to determine whether the uncertain benefits of the directive justify the certainty of massive costs.
Baker states: “As it is currently drafted, the directive will result in a major reduction in choice for Europe’s institutional investors by limiting their investment to onshore EU-based hedge funds and fund managers and a big increase in costs and hence a significant reduction in returns. None of this is good for the competitiveness of the European financial services sector or indeed the economies of Europe as whole.”
AIMA produced the estimated figure based on the estimated assets under management of the European pension fund industry, the estimated allocation to alternative investments by European pension funds, and the estimated reduction in returns they could face if the directive went through in its current form.
The Chairman of the Cayman Islands Financial Services Society, Anthony Travers joins AIMA in criticising the proposed EUFD and states: “The criticism of the EUFD by AIMA is entirely justified and highlights one of the possible unintended consequences of what is a singularly ill-conceived attempt by the European Union at protectionist financial legislation in the guise of appropriate regulation.”
Travers says that, by requiring European Union resident fund managers to market and trade only on behalf of European Union situate funds, the EUFD proposes all current offshore funds with an EU situs fund manager (and, he confirms, there is no doubt here that the Cayman Islands is intentionally targeted) will be obliged to move to a European Union jurisdiction.
He says: “That would have been an achievable objective had it not become confused with a further misplaced intention, entirely driven by the political rhetoric, which has surrounded the debate, that has driven the framers of the EUFD to seek to highly regulate the EU resident fund manager in terms of trading activity, risk and liquidity.”
He continues: “The unintended consequence that may very well arise is that not only the offshore fund will remain offshore but the EU resident fund manager, and in so far as Cayman Islands hedge funds are concerned these are primarily based in London, will now be obliged to move out of the EU. The attractions to the fund manager in so doing are not only that it will avoid misconceived regulatory restrictions sought to be imposed by the EUFD on its trading activity, but will also avoid the recently introduced punitive levels of taxation and national insurance contribution in the United Kingdom.”
In this scenario, AIMA points out that the returns hitherto generated for the benefit of an EU-based pension fund will not be available, as the offshore fund and fund manager construct will be off limits to an EU-based investor. It follows also that in seeking to establish a regulatory “Fortress Europe”, and, as with all protectionist legislation, the possibility arises that it will cut off the EU from significant pools of global capital hitherto invested into Europe.
Travers furthers: “For geographical reasons, the logical beneficiary of the fund manager exodus is likely to be Switzerland-based in Europe, but outside the EU. But with revisions to its Immigration Law there is every reason to suppose that the Cayman Islands might also attract the high profile fund manager. At this early stage, it is difficult to comment definitively on the outcome because there is no doubt that alarm bells are now sounding in Europe as to the possible unintended consequences and as a result the EUFD may well undergo a significant revision.”
The Cayman Islands Financial Services Association is closely monitoring the position and has instructed advisors in London to undertake a detailed analysis of what would be required by way of amendments to the Cayman Islands law to conform with the requirements of the EUFD by providing an equivalent regulatory regime to that required in Europe by the EUFD in Cayman.
Travers cautions: “However, the cost of so doing and the lack of trading flexibility that would result to the fund manager will need to be carefully evaluated against the alternative position of maintaining our current regulatory regime, even assuming a loss of the Cayman hedge funds for which European Union based fund managers currently act.”
He says CIFSA’s current view is that the EUFD may very well represent an opportunity for Cayman to strengthen its current position.”
He says that CIFSA is supported in their approach by the findings of the Institute of Economic Advisors and the Turner Report, both of which indicate in the clearest possible terms that the Cayman Islands regulatory regime was not implicated in the recent and current financial meltdown. Accordingly the correct start position from the Cayman perspective is that the EUFD represents an inappropriate and disproportionate regulatory response.
“That at least provides an appropriate start point as we continue to monitor the situation,” Travers says.