The hedge fund industry continues to grapple with an environment of change and uncertainty. The trend towards increased institutionalization of the sector continues, bringing even greater focus onto the due diligence, risk management and transparency management processes of funds and their managers. At the same time, the regulatory environment has continued to shift which has created not only uncertainty and complexity, but also significant costs.
While the level of regulatory scrutiny and the complexity of regulatory compliance may be weighing down on the hedge fund industry, our survey clearly demonstrates that fund managers are committed to meeting their compliance requirements. But that’s not all: they are also absorbing the additional costs rather than passing them on to their clients.
Responses to our survey seem to demonstrate that most hedge fund managers have already made significant investments into building their compliance capability and processes. Almost two thirds (64 percent) of respondents reported that they were spending upwards of 5 percent of their total operating costs on meeting their compliance requirements while more than a fifth (21 percent) said they were spending more than 10 percent of their operating costs.
The data suggests that, as an industry, hedge funds are spending more than USD2.98 billion on regulatory compliance, including technology, headcount and third-party vendors.
In particular, respondents noted the high costs of AIFMD authorization and reporting. SEC registration and reporting was identified as the second most costly regulatory requirement to comply with’.
The industry has already invested significant capital, time and resources towards achieving regulatory compliance around the world. According to our survey, hedge fund managers are convinced that the costs and resources associated with regulatory compliance are only set to increase over the next five years. Almost nine out of ten respondents (89 percent) said that they expected their regulatory compliance-focused technology spend to increase, while only 10 percent suggested that it would stay the same.
Increased regulatory scrutiny and compliance costs are influencing the operating models. Two fairly equal camps are starting to emerge – those that will use regulatory change to proactively transform their operating models and those that would prefer to react to change as it happens.
Our research shows that the majority (56 percent) of fund managers would not consider exiting markets or lines of business due to increased regulatory pressure, nor have the majority (55 percent) considered moving their fund domicile, management company and/or center of main economic activity to an alternative jurisdiction in response to regulatory change.
Two exceptions exist, however: 52 percent of respondents from Europe said they had considered moving their fund domicile, management company and/or center of main economic activity; while 50 percent of the large fund managers said they had considered exiting markets or lines of business due to increased regulatory pressure.
The market for regulated absolute products seems to be gaining traction with more than one in five respondents saying they have an existing UCITS fund and one in ten reporting managing a “40 Act” fund.
The size of the firm’s AUM seems to have a direct correlation with the types of funds managed: those with larger AUMs (of more than USD5 billion) are three times as likely to have a UCITS fund as their small counterparts (those with less than USD250 million). And larger firms are more than six times more likely than those with AUMs of under USD1 billion to manage a “40 Act” fund. This likely reflects the increased infrastructure required to run onshore products versus offshore products.
However, according to most of the managers that we interviewed, client demand not regulation is the greatest force driving product design.
To review the take-aways for fund managers, regulators and investors, please read the The Cost of Compliance report.