With the introduction of the Alternative Investment Fund Managers Directive (AIFMD) regulation on 22nd July 2013, hedge fund managers and their advisors have had to adapt the way they operate. This is especially true for custodians; as the deadline approaches for all European alternative investment funds to be AIFMD compliant, there is greater responsibility placed on them than ever before.
Preqin’s Hedge Fund Analyst online service tracks 205 custodians who service a combined 14,500 hedge funds. According to the database, J.P. Morgan is the most widely used custodian, accounting for 16% of all hedge funds, followed by Goldman Sachs which holds the assets of 11% of funds. It is interesting to note that J.P. Morgan continues to increase its market share over its competitors and currently holds over double the amount of clients as Morgan Stanley, the third most used custodian.
Data from Preqin shows that as funds increase in size, there is less competition outside of the top 10 custodians; sixty-nine percent of funds with over $1bn in assets under management (AUM) are serviced by the top ten custodians. The market share of these firms significantly declines as the size of funds decreases; only 45% of funds with less than $50mn in AUM are serviced by one of the top ten largest custodians. This data indicates that there is little competition among the largest funds as these large fund managers are placing more importance on securing established investment banks to hold their assets. A good example to highlight this case is that of State Street Custody Services. State Street is placed tenth in terms of number of clients serviced, according to Preqin, but when it comes to total number of funds serviced they appear second in terms of market share of funds with over $1bn in AUM, representing 10% of these funds. This highlights the fact that fund managers are not taking chances as they look to go with the more established names, especially in light of the AIFMD regulations.
Under the AIFMD there are three main functions of a custodian: AIF asset safekeeping, cash flow monitoring and oversight duties. The latter responsibility has seen the most changes imposed on custodians as a result of the AIFMD. The standard of liability for the loss of financial instruments has increased substantially and poses a significant challenge for custodians going forward. This is not just in relation to fraud but also within the finer details of the funds – supervising issues, cancellation and redemption of shares/units and payments of dividends. The use of third parties has also come under heavy scrutiny with the AIFMD placing many restrictions on custodians’ ability to delegate.
Since the financial crisis in 2008, the hedge fund industry has experienced a changing landscape of hedge fund regulation. With the AIFMD one-year transitional period due to end on 22nd July 2014, the actions of custodians will be thrust under the spotlight as they prepare for the challenges ahead.