On July 1, final amendments were passed on a new incarnation of pan-European legislation that will make it easier and faster for fund managers to set up shop in different countries and market their funds in more locations. The changes will take effect in July 2011.
That’s the good news. The bad news: to reap the benefits of the third completed round of UCITS, or Undertakings for Collective Investments in Transferable Securities. Now, under the latest set of directives, known as UCITS IV, new opportunities and challenges arise.
For the first time, fund managers can also unify the management of multiple funds in a single location, through the creation of a so-called master-feeder fund. Instead of launching separate management companies in each European country to abide by local requirements, firms now have the option of creating a single master fund and multiple-feeder funds in different countries. The caveat: Each local feeder fund must invest at least 85% of its net asset value into the master UCITS fund.
"Such a consolidation of fund management locations reduces administrative costs for the fund manager but will require the master parent to provide [each of] the feeder funds with its daily net asset value so the feeder funds can calculate their own net asset values for investors in their home markets," says Aaron Overy, vice president at Northern Trust in London. "The master feeder fund may also opt to send daily information on its trading strategies to the feeder funds in the home market."
Northern Trust, as the custodian and fund accountant for a master fund, has adapted its custody and fund accounting platforms to create a "tax-transparent" pooling vehicle for investment funds under Irish law. Such a vehicle allows investment fund managers to be taxed by the authority in the country of the feeder fund on the basis of the location of the securities in which they invest.
Northern Trust will also be responsible for electronically processing orders and redemptions by feeder funds into the master feeder fund.
Under UCITS IV, fund managers trading in OTC derivatives will no longer be allowed to rely only on their broker-dealers or trading desks for valuations; that means they will have to develop new consistent front-middle and back office procedures and rely on third-party data vendors. Fund managers will also likely adapt Value at Risk (VAR) methodology for calculating how much of their funds each day are at risk of being lost, from market movements. That is because it will be more difficult for fund managers to comply with the so-called "commitment" approach to measuring risk, which prohibits them from having a total market exposure greater than two times their net asset value.
Fund managers must also back-test their models on a daily basis and report to local regulators if the back-testing shows that their VAR model has failed. "In case the back-testing fails, the fund manager may be compelled to multiply its value at risk figure by a number predetermined by the local regulator and indicate the higher value at risk in their offering documents," says
Hedge funds-of-funds managers will need to better monitor their exposure to different underlying single manager funds, keep track of their orders and redemptions and calculate their net asset values on a daily rather than weekly or monthly basis. "Such a change means that the fund of hedge funds manager will also need to calculate and forecast its liquidity requirements on a daily rather than monthly basis," says Richard Koppel, managing director of London software vendor YouDevise, a web service that electronically calculates NAVs and monitors liquidity requirements.
UCITS IV will also require fund managers to collect information and manage the workflow necessary to accommodate improved disclosure requirements. In providing investors with an annual two-page key information document, fund managers must not only calculate any risk metrics but explain them in layman’s terms. "It means that fund managers must gather narrative data from their portfolio managers, operations department, and legal department to pass by compliance for approval," says Ronand Brennan, chief technology officer of Money Mate in Dublin.