Getting to grips with regulatory reporting
Regulatory reporting has become a critical component of running an alternative investment fund. This requires well-developed data sourcing and data management processes to help ensure that fund managers remain compliant.
Until a few years ago, there were no formal regulatory reporting requirements on the part of alternative investment managers. Following the financial crisis in 2008, the European Union tried to figure out a reporting mechanism to obtain a clear handle on the size of the alternative investments industry, and the degree of counterparty exposure that exists.
The European Union subsequently introduced the AIFM Directive, within which Annex IV reporting can be found.
Determining the frequency of reporting requires a decision tree methodology based on whether the manager is EU based or non-EU based. The total assets of the manager will be considered – referred to as regulatory AuM – as well as the size of the AIF, the manager's status (EU or non-EU), whether they are employing leverage or not in the fund (invariably an AIF will be employing leverage) and the type of assets being held in the fund.
In most situations, the frequency of reporting can be broken down as follows:
• RAuM is EUR100 million – EUR500 million (unleveraged): Semi-annual
• RAuM is more than EUR1 billion: Quarterly
• Any single AIF exceeds RAuM EUR500 million – Quarterly
UK-based AIFMs are required to file Annex IV reports electronically via its GABRIEL system using ESMA's Annex IV reporting template, which is implemented in an XML file format.
Whereas Annex IV, for most start-up managers, many of whom will have less than EUR100 million in AUM, will only be an annual filing, what is of more concern is the transaction level reporting, which is due to come into effect under MiFID II on 3rd January 2018.
Regardless of the size of the manager, they will be required to transaction report on a daily basis. The MiFID II requirements on transaction reporting are set out in article 26 of MiFIR.
"Many clients' prime brokers already do filings on their behalf, under MiFID I, but there is a concern that this will not exist forever, and as such they are having to think about alternative options," explains Charles Gillanders, chief technology officer at Quintillion Limited, a European-based affiliate of US Bancorp Fund Services. "Under MiFID II, transaction reporting will contain much more detailed information, including personally identifiable information, which the sell-side will not necessarily be happy to report on."
As a result, investment firms are more closely considering which Approved Reporting Mechanism (ARM) they work with to comply with their reporting obligations.
"We have just completed a comprehensive RFP process to select a regulatory reporting partner. We have selected someone who will, as an ARM, provide us with a robust MiFID II reporting solution for our clients," confirms Gillanders.
For context, MiFID I has 30 reportable fields whereas MiFID II has close to 80 reportable fields.
Even if a prime broker were to continue doing transaction reporting for their clients, they would have to invest significantly in technology to extract the additional information.
Alan Doyle, head of strategy, alternative investment fund services at Quintillion, confirms that the fintech firm that Quintillion has selected as its trusted partner will combine the administration capabilities they have in identifying the data sources, with their ability to take all of that data, aggregate and file it on behalf of clients to the relevant regulatory authorities.
"Phase one of working with this partner will include providing a solution for Annex IV, Form-PF and CPO-PQR reporting. That is for the retrospective annual, semi-annual or quarterly reporting requirements. Phase two will support more detailed periodic reporting and end-of-day reporting: EMIR, Solvency II reporting, etc," confirms Doyle.
"We've spoken to clients who have attempted to do regulatory filings themselves, or have been using an outsourced technology partner or fund administrator, and really there are pros and cons to every approach."
Some managers find that they struggle with the onboarding process when getting set up with a technology provider. Regulatory technology, or `Regtech', has quickly become a growth area and several technology providers are jumping on the gravy train. The problem with this is that they lack the knowledge that is needed to handle the nuances of regulatory filings.
"They need to meet particular file format demands and use different reporting systems. It quickly becomes quite a large undertaking for some technologists," says Gillanders.
The other option is for managers to take on the reporting responsibilities in-house. Many soon find that while they might have the expertise and data management capabilities, they struggle to keep everything up-to-date.
"The regulators constantly update things, there are regular updates on filing requirements. It becomes a maintenance burden on managers," says Doyle.
"We think we are able to help resolve the two problems simultaneously. We live and breathe the underlying information streams of our clients' funds and know the data very well. We have the internal resources to conduct data mapping, make sure the data is going to the technology provider in the correct format and confirm everything works as it should.
"At the same time, the technology provider we have chosen is committed to remaining up-to-date at all times with the regulators; whether it be the latest Q&A released by the ESMA, the SEC or the NFA. They have that expertise to maintain the regulatory filings despite the ongoing changes that might occur. It is an effective, solution for our clients."
Gillanders explains that with Annex IV reporting clients are required to report static and portfolio data. Some 38 questions relate to the AIFM, most of which require static data, while 295 questions relate to the AIF.
Static data includes information on the investment manager, the fund strategy, its risk profile and so on.
"One of the high-level objectives of the regulator is to pick up outliers or changes that indicate a change in the risk profile. Investor data also needs to be reported based on country, investor type (professional, retail) and the degree of investor concentration, or otherwise, as well as the redemption terms, notice period and exposure to side pockets where applicable.
"The regulators also want to look at month-end portfolio data, which outlines the market value of each of the fund's open positions. If on any given quarterly basis there are found to be material movements compared to what was reported the previous quarter, it will get picked up. Exposure levels based on counterparties, currencies and countries are also reported," explains Gillanders.
All of the funds overseen by the investment manager are reported on in one filing to the local regulator under the banner of the AIFM. If one is outsourcing this function, as several managers opt to do, it will be the responsibility of the third party AIFM.
Doyle does not think there is materially significant difference in regulatory filing requirements for European managers relative to US managers.
"There is quite a bit of crossover in terms of the questions being asked and the underlying data which will comprise the answers. Making sure that you know where the data is going to come from is vital. There are always going to be some firms that want to maintain everything in-house but it comes with maintenance requirements.
"If you are going to outsource at all, selecting the right partner who has both the data source responsibilities and the expertise to adapt to changing regulations is highly important."