Custodians warn of regulatory risk to hedge fund services

Hedge fund managers and clients will lose out if Brussels acts too strictly on the custodianship of fund assets, service providers suggest.

Service providers warn their work for European hedge funds could be adversely affected if Brussels adopts the inflexible proposals currently being discussed around the custodianship of fund assets.

The providers say it will be European funds and investors who will suffer as a result.

Dealing with regulation is a pressing issue for hedge managers and service providers.

A recent survey of offshore fund managers by RBC Dexia Investor Services found about half had not moved any funds onshore, as many did not see any “significant benefits in more regulated hedge funds,” said Jean-Michel Loehr, RBC Investor Services’ chief for industry and government relations.

Hedging reshaping

Chris Adams (pictured), head of hedge fund solutions at BNP Paribas Securities Services, says: “There is no doubt regulations are driving the industry.”

He cites bodies of law such as Dodd-Frank in the US and Europe’s AIFM directive.

The publication this month of AIFM’s Level 2 measures will clarify how far custodians must assume liability for guarding hedge client assets.

If it forces custodians to assume full liability, the ­providers could simply stop servicing in markets where this entails most risk – chiefly emerging markets, for which manager and investor appetite is strong.

Emerging markets hedge managers took in enough new money this year to breach previous peak assets, and run $122bn.

Adams says: “I hope common sense will prevail and regulators will not move the major players out of the market, because that would not help anyone. Regulation can drive concentration into an ever smaller number of participants, which can create systemic risk.”

David Aldrich, managing director at BNY Mellon, says if a strict ruling comes in the AIFM directive, ultimately investors and hedge funds will lose out.

Responsibilities of custodians have been diluted in redrafts of the directive already. But Aldrich says:

“If ­Brussels takes a prescriptive approach upfront on the ­legislation, it makes it very difficult to work as a hedge fund custodian for European-domiciled collective ­investment schemes.”

In some scenarios, a custodian could do its job properly but still suffer if there is a loss event; particularly in emerging markets, he says.

A large part of the issue around the liability relates to segregation of client assets, and how – or if – the ­concept of segregation is understood in developing markets.

 

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