Holy Directives


All politicians blindly accused the deregulation they themselves undertook as the main cause, with fat bankers’ bonuses, of the 2008 financial crisis. They therefore had to act to prove how rightful they are. Enemies were to be punished, banned, put off once for all. They will prevail. Propelled by their newly found crusade against evil finance, they embarked on a mission to re-regulate finances with the well-known zeal of fresh new converts.

One of the fruits of such undertakings is the Alternative Investment Fund Management Directive approved in 2011 with a level 2 regulation fine tuned by late December 2012.

The objective is holy: protect investors, increase transparency and reinforce due diligence requirements. The target is the cohort of hedge and private equity funds that tended to favour offshore or more complacent jurisdictions to carry their prosperous businesses in light-touched, if any, regulated manners. To ensure the room for escape is extremely limited, all service providers such as administrators and custodians fall under the scope of the AIFMD requirements. As such, a custodian is legally required to ensure that all funds and instruments are subject to a thorough due diligence. Their ex ante control function is thus reinforced: they can turn down investments external fund managers may decide to opt for.

Within that environment, jurisdictions that were viewed as too flexible, too business-minded or tolerant have to prove their bona fide as to become les “Premiers de la Classe”. Especially if they have ever been implied in hosting some “Madofferies” in not such a distant past…

So let us see how it may impact a European SFO as an example. For reputation purposes, its principals want their assets held onshore i.e. in Europe. Nonetheless, as a family with members under different international regimes, they need a jurisdiction that exhibits a strong, internationally known tradition, not to mention respectability. Since this family is sophisticated, it also has very clear financial objectives requiring that this jurisdiction be able to cater for its willingness to manage its assets flexibly “entre-nous”. This is why many SFOs opted until then for the Luxembourg nicknamed SICAV or FCP-SIP, a lightly-regulated onshore vehicle local authorities developed in the mid-2000s to attract the lucrative alternative investment funds business.

Such a vehicle now falls under the now enforced AIFMD with a few exemptions based on either the unlevered assets’ size or its relationships with group- related entities. So, good news for SFOs?

Yes, but not really because, despite the delays to become compliant with the AIFMD granted to SIFs constituted before 2013, their local custodians have just become über-wary of being good schoolboys. Regardless, the level and quality of due diligence performed by any SFO on any investment, local custodians (also referred to as the depository agent and local fund directors, have decided to impose their own due diligence requirements such as independent legal due diligence… just to make sure au passage, that they will not be trapped in unforeseen frauds.

Therefore, as experience showed, a SFO using a Luxembourg SIF vehicle will find itself forced to pay for a custodian-ordered lawyer to legal due diligence an onshore, Luxembourg-domiciled venture capital fund backed by the local European Investment Fund to deploy capital in British SMEs!

Worse, instead of establishing the laudable transparency, new informative asymmetries are created. Investments will rather flow into plain vanilla products at the expense of more efficient long term allocation such as very needed European VC.

What a waste of time lengthening investment executions. This example can be extended to managed accounts with local state banks etc. Furthermore, as most of those depository service providers are better known for their back office capabilities rather than their investment selection skills, they will opt for outsourced services whose costs are born by the investors! So here is the bulk of the problem: in times of very low yields with systemic cracks still left unrepaired, end- investors are faced with not only still relatively high uncertainties but also substantially increased execution costs that will feed an armada of new, operationally imposed consultants.

Inefficiently deployed capital inhibits mid to long opportunities for economic growth and welfare. Shameful externalities! Ways to hell are clearly paved with good intentions. Mercifully, there still exist adequate onshore vehicles to avoid such contradictions. For how long?