What impact could the European Union Alternative Investment Fund Management Directive (AIFMD) have on the location of hedge fund and their fees? Currently in draft form, the rules came under fire last autumn from alternative investment managers and trade bodies representing the hedge fund industry. The directive is planned for adoption in 2012 and aims to cover EU-based managers of alternative funds and non-UCITS investments of over €100m.

The draft proposes that EU hedge fund managers be charged 2bps on the value of their assets under management in excess of €250m, register with regulators in their home country and adhere to leverage limits. Approved managers are supposed to receive a passport to market their investments across EU member states. The alternative is for hedge funds not to change domicile which would close off access to EU investors. Critics of the draft have argued that the hedge fund sector would suffer greatly if the draft is adopted in its current form with an estimated 40% of hedge funds not eligible for sale in the EU. Changing domicile also comes with costs. Charles River Associates estimates compliance costs of €1.4bn associated to a change of legal structures to bring hedge funds into line with the directive.

We asked 28 single hedge fund managers and 68 FoHFs, with €674bn in AUM, what impact the changes anticipated by the directive would have on their organisation. The directive is more likely to impact funds domiciled offshore as the draft in its current form has not made a secret of its anti-tax haven sentiment. The largest group of hedge funds and FoHFs in our survey fall in the offshore category. Thirty-three are domiciled in the Cayman Islands, 32% in multiple locations, 8% in Luxemburg, 6% in the US, 4% in Guernsey, 4% in Canada, 4% in France, 4% in Ireland, 3% in Bermuda,1% in the UK and 1% in Finland. We also asked where the portfolio managers of the funds are actually located. Twenty-eight percent are in the US, followed by the UK (24%), multiple locations (15%), Canada (6%), France (6%), Switzerland (6%), Guernsey (2%), with the rest in 11 countries.

“We recently completed a domicile change from Guernsey to Luxemburg in order to increase operation efficiency and transparency. The key motivation was to make all of our hedge funds, or specialist portfolios as we now call them, UCITS III compliant,” notes Roman Knipprath, who oversees RFPs at Wegelin Asset Management. “This enhancement is now complete and we are comfortable with any change in legislation such as the EU AIFMD.” A number of offshore-based hedge funds anticipate an increase in fees: “We expect a modest increase in expected costs and fees with a move of the management company to the EU,” reports a Cayman Islands based hedge fund. A Guernsey-domiciled fund notes: “If adopted in its current form, we would likely need to move our business from Guernsey to within the EU. This will undoubtedly increase costs, although I think we would have to bear these as I do not think investors will accept managers passing on costs.”

Other offshore funds point out that if adopted in its current form the directive could drive away investors into UCITs-compliant funds. “It will drive our investors to our UCITS funds where there are additional costs so the fund manager himself takes less of the fee,” notes Dan Mannix, Head of Business Development at RWC Partners, which is based in the Caymans but has managers in the UK. The directive also raises difficult questions for FoHFs with a large universe of underlying hedge funds. “As an American-based manager, the AIMD should have minimal impact on our location, costs or fees,” notes a US-based manager. “However, the directive may have effects on managers who we hire for our FoHF portfolios.”

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