Alternative asset managers have a toolkit of regulated and unregulated fund frameworks to build scale, and should benefit from a year of policies that aim to spur growth in the global economy.
The implementation of MiFID 2 brings the tail-end of a swathe of regulations aimed at increasing the financial sector's resilience. Policymakers are now shifting their focus to improving the flow of capital to key segments of the global economy. Several regulatory measures are underway that aim to improve access to both investors and investments, and reduce red tape for the Alternatives industry. Cooperation between alternative managers and regulators will be vital to converting policy changes into viable opportunities.
Access to Investors
The alternatives industry is ripe for further growth, despite (and perhaps because) it is becoming increasingly regulated. Alternative strategies grew up in unregulated environments using flexible fund structures for endowment funds, family offices, and high net worth individuals.
Now, managers are increasingly choosing to focus on more highly regulated onshore jurisdictions to capture demand from institutional investors. Institutional investors have been flocking to alternative strategies and their interest shows no sign of abating. A recent investor survey found institutional investors plan to increase allocations to private debt (62%), infrastructure (50%), private equity (39%) and real estate (36%)1. Regulatory changes in Europe aim to make highly regulated jurisdictions, such as Luxembourg and Ireland, a more attractive landing spot for alternative funds. Managers setting up under the Alternative Investment Fund Managers Directive (AIFMD) framework can benefit from cross-border European marketing, giving them broader access to the booming institutional investor markets across Europe.
The European Securities and Markets Authority (ESMA) has also made changes to encourage socially responsible investment strategies. As part of the Capital Markets Union (CMU) framework, ESMA revamped the rules around certain European venture capital, social entrepreneurship, and long-term investment funds so that alternative managers of any size can benefit from the AIFMD marketing passport across the EU. ESMA also expanded the asset classes that are eligible for these fund types making them a more attractive proposition to product manufacturers. While the majority of alternative fund vehicles are aimed at and purchased by institutional investors, these EU passportable fund vehicles can be sold to retail investors should alternative managers wish to expand their target audience.
Local changes in Luxembourg to support the alternatives space have been successful. The re-vamped limited partnership regime incorporates the most attractive features of limited partnership vehicles for private equity, venture capital, and real estate transactions to give asset managers greater legal flexibility. New rules for semi-regulated fund vehicles can shorten the time to market for alternative investment funds that can be marketed quickly throughout the EU.
In Ireland, proposed tweaks to the investment limited partnership fund structure should increase options for global alternative asset managers who want to expand in Europe.
More Investment Options
Expansion in Non-Bank Financing
The highly ambitious CMU framework aims to improve the flow of capital across Europe and make non-bank funding more accessible to small and medium-sized enterprises (SMEs). The CMU includes initiatives to harmonize EU insolvency and tax laws, to reduce complexity and cost for cross-border financing. The potential for this market is substantial – in Europe, SMEs source 70% of their funding from banks,2 whereas the trend is roughly inverse in the US.
The trend towards non-bank financing should also be reinforced by proposed changes to Basel 3. Basel 3 promotes stability within the international banking system, limiting the ability of banks to damage the economy through excessive risk taking. To ensure systemic banking resilience, these rules impose constraints on lending that banks can provide, allowing for growth in non-bank lending in the EU in 2018 and beyond.
Investor appetites for illiquid strategies, such as private debt, private equity, and real estate have grown faster than the number of high-quality deals available. Uninvested commitments (dry powder levels) are rising; investment valuations are high for private equity; and real estate and private debt deals are seeing a dilution of investment terms in an intensely competitive deal environment. Policies which encourage new areas of investment can provide some release for this pent-up demand.
The 2016 Paris Agreement to limit the rise in the global average temperature creates myriad opportunities for asset managers. The agreement creates a framework to facilitate private investments in climate solutions, with several countries identifying renewable energy and energy efficiency projects as top priorities. Policymakers are looking to allow more diverse private funding of such projects, particularly in the EU and Asia.
Cutting Red Tape
Regulations for specific industries, such as Solvency 2 for insurance companies in Europe and cost transparency for pension funds in the US, have increased the burden on asset managers to provide bespoke and detailed reporting to investors. In 2018, the European Commission will embark on a “fitness check" of supervisory reporting requirements aimed at reducing red tape and inconsistent regulatory reporting for fund managers.
A Way Forward
There is a clear desire to make the alternative investment environment work better for everyone through positive, growth-focused initiatives. These changes could open up a new wave of investment opportunities in 2018 and beyond, but cooperation between alternative managers and regulators will be essential to convert policy changes into tangible, viable opportunities.
Alternative asset managers will need to find ways to broaden their liquid and illiquid product strategies to break down structural inefficiencies across the spectrum of private equity, real estate, infrastructure, private debt, syndicated loans, and hedge fund deals.
Some already have.
1 Preqin Investor Outlook Alternative Assets H2 2017, June 2017
2 European Commission survey on the access to finance of enterprises (SAFE), 2014
This article was originally published in the 2018 Regulatory Field Guide. The guide features insights from a number of our experts on key regulatory developments that will have the greatest impact for asset managers in the year ahead – and beyond. Visit bbh.com/regulatoryfieldguide to explore the guide.
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