AIFM Reporting : which challenges?

MichelRothilde_IMG_1351_propalMichel Rothilde
Senior Manager | Enterprise Risk Services
Deloitte Tax & Consulting

Speaker at the IFE Conference Reporting sous AIFM, 3rd of July Luxembourg

The roots for transparency
After the global financial crisis of 2007-2008, political pressure as well in Europe and in the USA called for more transparency from the financial sector, especially from alternative investment funds. Failure to monitor and manage the build-up of a shadow banking system and level of interdependence within the financial industry, its potentially disastrous consequences on the system itself and on people triggered major concern within the opinion. These are the roots of the current regulatory wave calling for more transparency in the financial sector globally.

In 2009, the G20 committee agreed on clearing obligations for OTC transactions as they were pointed out to be source of hidden risks. As discussed later, this translates into the European Market Infrastructure Regulation (EMIR). In the USA, the Dodd Frank act was the major financial reform with wide spreading impacts, followed within the European Union (EU) by the Capital Requirement Directive (CRD 4), EMIR and the Alternative Investment Managers Directive (AIFMD). For regulators and policy makers, the new reporting obligations was an effort required to enable the monitoring and mitigation of the systemic risk, as quoted by the European Commission in its recital “The increased transparency and consistency through provisions on reporting and disclosing relevant information as outlined in the implementing measures should make it possible for competent authorities to detect and respond to risks in the financial markets”1.

We can see a clear direction, pushed by public opinion, for future financial regulations towards more reporting requirements as this is the rational expressed in regulations recitals and often mentioned in political speeches. Finally, we will also see later in this paper that financial institutions might also be forced to more transparency not only by regulators but also to meet their investor demands. As such, being able to rely on a streamlined and automated data system that can on top of regulatory reports generate customized reports on clients request will be a competitive edge.

Reporting requirements, to start with a tryptic…
Since June 2012 in the USA, the Rule 204(b)-1 require SEC-registered investment advisers who manage private funds to periodically report risk exposure information as per the template named Form PF. The content of the Form PF is vast and ranges from static data linked to the identification of the fund, investment strategy and counterparty exposure to information on clearing mechanism and risk sensitivity measures.

Under the European framework, the requirements for the reporting to authorities are set in the Article 3(3)(d), Article 24(1),24(2) and 24(4) of the AIFMD, the content of the report is, for the least inspired by a large extend from the American Form PF.

The EMIR requires reporting and transparency effort for OTC derivatives instruments from many financial sector actors. Several triggers require new reports for OTC derivatives (new contract, modification of a contract, cancellation of a wrong report, termination of a contract, portfolio compression, valuation update including collateral, and others). Moreover, under EMIR the responsibility falls on both counterparties of a transaction, although counterparties can delegate reporting to a third party including CCPs, in any case, records must be retained for all derivative contracts (and modifications) for at least 5 years.

Under the three frameworks, fields and formats of reporting are defined in technical standards which cover data types, instruments classifications and IT requirements. From both a content and format standpoint, they display many overlaps as they request fairly similar data to be reported. Such overlaps include instruments and products taxonomy (Interest Rates, Foreign Exchange, Commodities, Options ) and breakdown, standardised identifier (LEI, Broker ID, Clearing member ID, CCP LEI, product identifier, venue of execution, etc.), valuation of products (market and model). With such overlapping from the three regulations, we understand there is room to take advantage from economy of scales opting for an integrated solution.

Financial institutions in charge of producing and reporting such data face many challenges, both from an IT and operational standpoint. Data collection and enrichment for instance, as sourcing data is stored in various systems (e.g. one system per product) and various sources (e.g. various service providers), while some data is not existing yet and thus is to be created. Once the initial sourcing challenge is solved, report generation is the next step, yet not seamless since it might require standardisation from sources and formatting along with enrichment with market data and computation of risk measurement and figures.

The IT infrastructure necessary to successfully meet reporting requirements will need to be robust enough to manage and store huge volume of data and also have to conduct to smooth report distribution. This will need to manage confidential clients’ data, different Trade Repositories (for EMIR) and match tight deadline for production stressing operational process efficiency and putting cyclical pressure on staff.

The journey only begins
When comparing EMIR and AIMFD reporting requirements, one could realise that standardised identifier (LEI, Broker ID, Clearing member ID, CCP LEI, product identifier, venue of execution, etc.), valuation requirements, clearing information and Product taxonomy (interest rates, foreign exchange, commodities, options) are similar. As per our analysis, roughly 40% of required information in EMIR and AIFMD reports are the same, between AIFMD and Form PF more than 75% is in common, hence players should thoroughly consider regulatory reporting globally and not by isolated regulation and should definitively have a strategic view for their data management and report production.

As mentioned in the introduction, the call for transparency also finds its origin with the investors themselves. Indeed, more and more investors, specifically professional one, do not see alternative fund as a separate asset class but rather apply a top down approach breaking down each alternative fund into its underlying risks, so they have a holistic management of their risks. For those investors it is then crucial to obtain customized reports with the granularity required to perform properly risk and performance attribution. For those financial institution being able to produce customized reports, it will be a competitive edge not to say that it will be a “must have” in the future.

In this context, we believe that two main approaches are most likely to turn out to be the most efficient. On the one hand, centralised in-house development for international groups willing to invest in training staff and IT infrastructure and data warehouse. On the other hand, financial institution may want to focus on their core business and rely for reporting on an external provider. Many outsourcing possibilities are available on the market, but how many of them do really offer a flexible and integrated solution?

 1 COMMISSION DELEGATED REGULATION (EU) No …/.. of 19.12.2012 supplementing Directive 2011/61/EU of the European Parliament and of the Council with regard to exemptions, general operating conditions, depositaries, leverage, transparency and supervision. Recital 123

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