Some alternative managers have pro-actively adapted their business strategy and practices to minimise exposure to the emergence of heavyweight regulations such as MiFID II.
However, it is not always desirable or easy to segment your business this way. With the introduction of Solvency II, we saw that the intended target of the regulation (insurers) is not always the one that bears the brunt of the workload (the fund management community). The same issues play out with MiFID II: there are aspects of the regulation that are difficult to dodge if you are an alternative manager that wants to leverage MiFID II licensed distributors.
No matter what you are managing or where you are investing, the market is porous, meaning that eventually, your investments may end up being sold where you do not expect them to be. Specifically, in this case, we think it is illogical for hedge funds not to engage fully with the wealth management community in Europe, an industry facing the full rigour of MiFID II.
Why is the wealth management and private banking industry so important? Firstly, it is a vast market. Through measuring the risks of it’s individual clients, and spreading the risk of investments across a wide range of securities, the industry allows hedge funds access to a much wider range of clientele than they would typically be able to tap.
If a non-MiFID II licensed AIFM wants to leverage a 3rd party MiFID II distributor , the AIFM needs to be aware that the distributor is legally obliged to repaper their distribution agreements with all product manufacturers to ensure those distributors, MiFID II licensed or not, adhere to the product governance and investor disclosures (e.g. costs and charges) aspects of the directive. As MiFID II distributors are required to demonstrate end-to-end MiFID II product governance, they need to manage data flows with many disparate firms, and to that end, they are engaging only in standardised exchanges of target market specifications/costs and charge information via the industry endorsed EMT template. If they are not able to access the right information, they will be obliged to ditch the respective investment and pull it from their models, buy-lists and platform lists.
In the end, this matters because of the perceptions of hedge funds. As complex investments, they are going to attract the attention of the regulator, so there will be no question of a hedge fund being able to have any involvement with the MiFID II environment without being fully compliant in product governance terms. As it happens, some regulators are even adopting MiFID II product governance rules as best practice, which would imply that this will affect a firm irrespective of whether the rules govern them directly or not.
In summary, complying with MiFID II product governance regulations is a pre-requisite for selling into a huge market for the hedge fund industry. Moreover, even without that incentive, regulators will value the initiative of the hedge funds that take the trouble to embrace this new environment.