UK-based fund managers looking to launch open-ended property funds are struggling to fulfil a key regulatory condition attached to the Alternative Investment Fund Managers Directive (AIFMD) in time for its compliance deadline this summer. According to industry experts, there is a potential shortage of banks or specialist firms that are willing, adequately capitalised or familiar enough with property to provide depositary services to such authorised investment funds.
Under the AIFMD, these open-ended funds, as well as property authorised investment funds (PAIFs), must engage a depositary to verify title, handle cash management and carry out general administrative tasks (see panel opposite.) However, concerns are growing about a bottleneck of existing funds unable to secure depositary services and, more importantly, an apparent impasse for smaller fund managers seeking to get new funds off the ground.
Tony Norris, chief executive of Gallium Fund Solutions, which provides professional services to property investment managers, says that in acting for six prospective funds, ranging in size from £20m to £100m, the firm has been turned down by the major banks that provide depositary services. Norris says: “There is a massive shortage of depositaries with a full licence prepared to accommodate what is a growing sector.” He adds: “The response we have had is that because of this directive these depositaries are bogged down, either with their own compliance and regulations or with assisting existing clients with these problems. Even the big guys are refusing to take up our business.”
Managers keen to launch funds
A director of one specialist depositary service provider, who declined to be named, says: “There are a lot of managers that would like to launch authorised property funds, particularly as the asset regulator has tightened up the kind of funds that can be sold to high net worth individuals.
“But there just seems to be an anomaly with the Financial Conduct Authority (FCA) saying that a depositary for an authorised fund needs £4m capital, which means the banks are the only people who can provide that service. “Banks, however, want to deal with the larger fund managers that they can cross sell other products to. “What they are not particularly interested in is acting for these smaller [open-ended property] funds.”
Norris believes the major depositaries would prefer to deal only with funds worth at least £100m – which is “misreading” the market. “Most of the appetite is for £20m up to £100m – boutique asset managers who have operated in the private sector in the past and now wish to raise money and have to go down the regulated route,” he says.
Firms such as Host Capital and Langham Hall provide depositary services to closed- ended funds and other non-authorised funds, which have much lower capital adequacy requirements. But these firms do not meet the FCA’s £4m capital adequacy requirements to provide such services for open-ended funds.
This remains the preserve of seven major banks and financial services groups – including Citibank, RBS/NatWest, HSBC and State Street – which are all members of the Depositary and Trustee Association (DATA). Those seven depositaries act for the entire authorised fund market – not just PAIFs. Karen Bowie, DATA’s company secretary, says they are “pulling out the stops” to be ready by the FCA’s 22 July AIFMD compliance date.
However, Langham Hall managing partner Rob Short claims: “The service is being offered [to property funds] but they are less familiar with the asset class. The bigger banks have a standard set of procedures that deals with all products, not just real estate. So they will struggle to take the procedures that exist for billions and sometimes trillions of assets and tailor procedures that are unique for real estate.”
Short adds: “Funds that are open-ended but with only quarterly liquidity need a ‘depositary light’ service based on a deep understanding of real estate, because the funds look much closer in nature to closed- ended funds. But their depositary options are limited mainly to the banks, which are currently servicing retail products.
Funds “caught in no-man’s land”
“So they’re caught in no-man’s land. We’ve had a number of these enquiries and have had to decline the opportunities, as the regulatory capital required would be prohibitive.”
It is understood that firms and advisers have expressed their latest fears to the FCA, which declined to comment. However, issues involving depositaries have dogged the AIFMD since it was first drafted in 2011 as the regulatory and supervisory framework for alternative investment fund managers in the European Union.
In a July 2012 survey, Deloitte found that 72% of fund managers viewed AIFMD as a business threat. The survey identified the cost of depositary services as the biggest concern for managers at that time and cost remains problematic.
Of the major bank depositaries, NatWest and HSBC dominate the property sector and the fear is that there will be no market pressure to bring down the cost of services to fund managers. “The really big fund managers have probably got enough traction with the bank depositaries to negotiate a good deal,” says one adviser.
“The issue is with the smaller players.”
Norris believes depositary fees would start at £100,000 a year, which would be a significant drag on the performance of smaller funds. He says: “There are not enough players out there. We believe the significant appetite is from the medium-sized funds and boutique managers, but that is below the radar of the existing depositaries. They are either setting their fees so high that a small fund manager cannot pay them or, quite frankly, it is just too small for them to bother with at the moment.”
According to Short at Langham Hall: “There will be two or three players, realistically, in the open-ended space. They will be the banks, and fund managers will have to accept a more rigid set of services and greater intrusion into their business. Fund managers will have less influence over the depositary’s ability to tailor the services.
“However, these depositaries are banks and they should be able to bring people in at short notice to at least get the manager over the line.” Norris believes the AIFMD as currently drafted is stifling the raising of capital for property and could force fund managers to go off-shore rather than go down the authorised route.
Capital barrier blocks new entrants
He also questions why there is a £4m capital adequacy requirement for property fund depositaries. “That £4m is such a barrier. We’ve got no new entrants,” says Norris. According to the specialist depositary adviser: “It is really important that the fund management industry provides choice for the consumer at the end of day and the world will be a far worse place if as a result of AIFMD it is difficult for boutique managers with niche investment strategies to survive.”
Short adds: “The successful fund managers are wise enough to understand that some regulations are beneficial as they serve a particular purpose. With this one, unfortunately, a scattergun approach has been taken and the regulation is not tailored enough to real estate to be particularly useful, partly because it has been rushed through. “There are too many issues that people have had to grapple with and there is a lot of uncertainty about its interpretation.”