The financial and economic crisis of 2008 led to a regulatory frenzy on both sides of the Atlantic.
The main regulatory initiatives set out to increase transparency, protect investors and to shield markets from possible systemic risks, most notably via imposing capital adequacy requirements.
Operational models and infrastructures have already been heavily impacted and the next wave of regulation will continue to impact these. In addition, multiple macroeconomic challenges will undoubtedly impact the regulatory landscape further: continued low interest rates and China’s sliding economy and share trading suspension are only two areas that look likely to carry further impacts. There are significant struggles specific to the European Union (EU) too.
Could we be entering an era of Japanese-style stagnation? Is the EU best equipped to deal with these forces in its current form? These are important questions to be asking, especially given that today’s crop of regulation looks unlikely to resist the impact of these wider economic trends.
Although some post-crisis regulations are still in their implementation phase, the private real estate market should nonetheless be ready for the next waveof regulatory initiatives.
Here are four such initiatives that are firmly in our sights.
1. Base Erosion and Profit Shifting
In a nutshell: This OECD led initiative is aimed at corporate tax optimization strategies used by multinational enterprises. The plan is laid out into
15 action items, which in turn are split into five groups: coherence, substance, transparency, digital economy, multi-lateral treaty.
The fallout: The opportunity will be for certain jurisdictions to enlarge certain substance requirements in servicing these structures to ensure that taxation occurs in these jurisdictions.
Indirectly, this could impact alternative investment vehicles, as they are cross-border investment structures. For asset managers, this could have an impact on
the operating models and thereby represent a significant costing impact as managers require an overall review of the operational model and structuring.
2. European Long Term Investment Fund
In a nutshell: This initiative allows channeling funds from both retail and institutional investors for long term investment projects. ELTIFS may be the beginning of a two-tiered Europe when it comes to alternative investments. From a practical perspective, AIFMs will need to gain approval to manage ELTIFs, and therefore to comply with requirements laid out in the AIFM and ELTIF directives.
The fallout: The hybrid structure will allow for non-bank funding of these projects, which in itself is one of the positive factors of the regulation.
We will have to wait to see how the market reacts to this vehicle and whether it will actually be seen as efficient in accomplishing the original goals. For custodians and administrators it will once more represent a certain operational burden and review process.
3. Solvency II
In a nutshell: Although not a new regulation, it only came into force in January 2016. The directive is aimed at insurance companies and sets out risk framework and liquidity requirements. It is based on three pillars, dealing with quantitative financial requirements; risk management; and information to be provided to supervisory authorities.
The fallout: Whereas increased transparency certainly is a positive thing. this regulation could inhibit investments into certain economic sectors. Meanwhile, allocation to debt investments should continue to increase, as the related ratios are favorable.
This drive for increased transparency will require insurance companies to invest in a solid infrastructure to produce the required data, and to work with providers that have put into place similar measures to ensure data delivery to their clients. Concurrently, from an alternatives perspective, it remains to be seen whether insurance companies will continue to allocate investments to both real estate and private equity, as they have in the past, or whether this regulation will dampen this trend by imposing certain liquidity ratios.
4. Reserved Alternative Investment Funds
In a nutshell: This new vehicle is intended to widen the available vehicles in terms of structuring alternative funds and hasten the speed in which they are established. Managed by an authorized AIFM, they will be indirectly subject to the AIFMD regime.
The fallout: The struggle amongst offshore centers will continue. This is beneficial for the sector overall, as it will imply a continued focus on providing the best-suited vehicles and structuring opportunities. It will be of crucial importance for certain jurisdictions to continue to demonstrate regulatory agility and market-leading initiatives going forward.
This new type of AIF will have the same characteristics as the regulated SIF, with the exception that these vehicles will be non-regulated. No prior CSSF authorization will be required, nor will any supervision be conducted by the CSSF. The supervision will be conducted indirectly via the AIFM supervisory authority. Ultimately, this vehicle will increase the time to market for managers in launching real estate or private equity funds.
In conclusion, drives to increase transparency and trying to stabilize risks are welcome, but overall regulatory success is a long term perspective and remains to be determined. In time, we will see if these current regulations achieve their original goals.
It should also be noted that regulations have a significant footprint on current operating models and therefore a significant financial impact. Nonetheless, they should also be seen as presenting opportunities. In a world where the outlook for alternatives is so upbeat, asset managers able to navigate the regulatory landscape efficiently stand to have the best chance of creating and preserving value.