Markets Prime Finance Monthly Hedge Fund Trends 2012, 2011, …€¦ · The Hedge Fund Capital...

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Mar

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L/S

C

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Mac

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All

Fun

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-5.00%

-4.00%

-3.00%

-2.00%

-1.00%

0.00%

1.00%

2.00%

75th Median Average 25th MSCI World

For further information on any of the issues discussed in this newsletter, please contact the Markets Prime Finance team: email: [email protected]

July 2013Executive summary*

Deutsche Bank Research Highlights: “Deutsche Bank Markets Research: DB SYNDEX – Thematic Ideas - Trading DB’s Equity View via Synthetic Instruments” and “Investor Positioning and Flows – Buffer in Risk, Not Rates”Given turbulent market conditions particularly in Emerging Markets (EM), the Deutsche Bank Markets Research team discusses one potential option to gain EM low-risk exposure through MSCI Minimum Volatility indices. In the second piece, our team explains that the increased short interest in credit ETFs and the continued underweight positioning in US equities should provide a buffer for risk assets. On the other hand, rates positioning remains neutral.

Investor Sentiment The Hedge Fund Capital Group met with investors in Canada, Virginia and Europe last month. Large Canadian pensions indicated that they continue to allocate opportunistically with a focus on macro and market neutral strategies. In Virginia, investors are resisting taking a market view and looking at investments from a bottom up perspective. PerformanceThe median fund lost 1.04% last month, taking global median performance down to 3.80% through the end of June. Globally, distressed funds continue to extend their gains to 8.72% YTD. Equity l/s strategies also continue to perform globally (6.02% YTD) and regionally with Japan l/s funds posting an impressive 16.71% YTD.

Global dispersion of returns across funds remains high with funds in the 75th percentile gaining .35% and funds in the 25th percentile returning -2.61%.

LeverageThe MSCI World 30-day volatility rose 69% this month ending June at 14.64. Gross fundamental equity exposure increased 1% last month (ending at 2.51) while net fundamental equity exposure decreased, ending the month at 0.63 (down 4%).

The percentage of funds in the higher (1 – 2) net equity leverage bands have increased since April. However, the percentage of funds in lower (-1 – 1) net equity leverage band has decreased.

Securities Lending Last month, short sellers continued to target individual companies including Research In Motion and Molycorp Inc. Borrowing of Japanese equities has been on the rise, even as the benchmark Nikkei has been sliding lower. Chinese banks were a short interest focus with rising concerns about the lack of transparency in the shadow banking systems, non-performing loans and rising systemic risk.

Regulatory As the Alternative Investment Fund Managers Directive (AIFMD) enters into force this month, we have included a special feature on key considerations for the fund’s depository function. The regulatory team also dicusses the compromise reached on EU rules governing trading and investor protection, new EU regulation on credit rating agencies, the EU Market Abuse Directive, updates to the UCITS 5 position, as well as US derivatives and money market fund reform.

June 2013 Cumulative Median Performance by Strategy

Global performance

June 2013 Performance Dispersion

-0.59%

1.07%

2.05%

2.94%

3.29%

3.36%

3.80%

4.00%

4.64%

4.93%

6.02%

7.10%

8.72%

0.00%-2.00% 2.00% 4.00% 6.00% 8.00% 10.00%

Market Neutral

Macro

Emerging Markets Equity

Multi-Strategy

CB & Vol Arb

Equity L/S

Fixed Income

Distressed

Credit

CTA / Managed Futures

Event Driven

MSCI World

All Funds

Source: Hedge Fund Intelligence (HFI), July 2013


5 Time Voted No. 1 Prime BrokerGlobal Custodian Prime Brokerage Survey

2012, 2011, 2010, 2009, 2008

Marketing material - For institutional investors only

Markets Prime Finance Monthly Hedge Fund Trends

Deutsche Bank

Median

Distressed 0.01% All Funds -1.04%

Market Neutral -0.03% Event Driven -1.11%

Credit -0.48% Multi-Strategy -1.13%

Equity L/S -0.56% Fixed Income -1.45%

CB & Vol Arb -0.64% CTA / Managed Futures -1.53%

Macro -0.99% Emerging Markets Equity -2.93%

* This document contains extracts and opinions from various departments and business areas within Deutsche Bank, including extracts from Research Reports, as well as from external reports specifically referenced herein. It is not, however, a research piece and has been produced by a front office function. Also, please refer to the body of the document for a more detailed description of and proper references to the topics covered in the Executive Summary section.

mailto:MPF.Trends%40list.db.com?subject=

2


Monthly Hedge Fund Trends - Deutsche Bank Research Highlights


DB SYNDEX: Thematic Ideas - Trading DB’s Equity View via Synthetic Instruments 1

Translating DB’s top equity ideas into actionable tradesEach month, Deutsche Bank’s Equity View curates the highest-conviction ideas from our Strategists – this companion note helps to translate a selection of these views into actionable trades. We provide implementation suggestions through equity baskets, ETFs and futures to help investors efficiently access our best ideas.

Setting the scene: Navigating turbulent marketsEquity markets have been fairly turbulent since our last publication, with the recent indication of QE tapering by the US Federal Reserve and amid liquidity concerns impacting China. The unwind of Emerging Markets (EM) positions signified by USD 6.5 billion of outflows from iShares Emerging Markets ETF over the last month (these outflows represented over 15% of the EEM fund’s AuM) indicate investor concerns, particularly in the EM space. The Developed Markets over Emerging Markets story has gathered momentum, as shown in Figure 1 below. We show a snapshot of month-to date and year-to-date performances of major markets across the globe.

World equity index performance

Developed versus emergingThe MSCI Developed Markets index (MSCI World) has outperformed the MSCI Emerging Markets index by c.21% year to date. However over the last ten years, MSCI EM has outperformed MSCI World by over 100%. Deutsche Bank’s equity strategists expect the reversion to continue in favor of DM as Europe recovers, the US grows and China leads EM into slower growth. For more on the theme, long developed / short emerging markets and instruments to express the theme, please refer to our recent report- “The Synthesis – Developed over Emerging”, 19-Jun-2013.

Key themes in focusIn this issue we focus on two key macro themes and offer trading ideas in line with DB’s Equity View:

— EM Exposure with lower risk - The more turbulent market conditions with concerns on the path for Emerging Markets may lead investors to seek more cautious investments in EM. MSCI Minimum Volatility indices offer investors with EM mandates the opportunity maintain exposure with lower risk.

— The impact of higher bond yields on Financial sub-sectors - Expected QE tapering which subsequently leads to steepening of the interest rate curve will have an impact on financial sub-sectors. We highlight the US banks that will be positively (and negatively) affected by rising bond yields and European Insurers which are also expected to benefit from rising yields.

Deutsche Bank Markets Research: Investor Positioning and Flows - Buffer in Risk, Not Rates 2

After a furious cross-asset selloff that has paralleled the 1994 Fed-hike rout, markets showed signs of firming last week. With rates, credit and equity drawdowns about ¾ through the 1994 scenario, we find that high short interest in credit ETFs and underweight US equity positioning, among other factors, point to a buffer for risk assets. Rates positioning on the other hand is still neutral compared to notably short as is typical at the end of rates spikes.

Rates positioning still not short while credit and equity unwind is further alongDespite the 100bp rise in the 10y, rates positioning is only back to neutral; the end of rate spikes has historically coincided with a large net short (-5% of open int) implying further capacity for rates to rise. On the other hand, extremely high short interest in HY ETFs suggests investors are hedging credit risk, which is expensive particularly if the market turns. Equity positioning has remained underweight after being cut in late May while the spike in equity skew indicates notable hedging in the options space. EM exposure has been cut dramatically across currencies (MXN long unwound), credit (surge in EM bond ETF short interest) and equities (rise in skew). Similarly, commodity positions have been cut toward post-crisis lows except in oil which are near a peak.

Slowing in bond outflows key for bottomingBond funds had a record $58b of outflows in June (2% of AUM) but 14% of AUM left bond funds in 1994 suggesting more to come. HY bond outflows have already exceeded the level of 1994 while govt and world/EM outflows have been much less than 1994. Although bond outflows are likely to weigh on performance, we would point out that bond returns have tracked the change in flows; less negative flows in mid 1994, early 2000 and late 2003 coincided with a bottoming in the bond market. So a slower pace of bond outflows is likely to see bond markets stabilize.

Bond stabilizers: high liquidity ratios, slowing issuance, coupon reinvestmentWhile the potential for large and continued bond outflows is daunting, there are a few factors that can help offset a bond-equity reallocation. To meet redemptions, bond funds are holding $250b of cash (7% of AUM), much higher liquidity than they had in 1994, 1999 and 2003. As was the case this month, rising rates historically led to a notable drop off in issuance, relieving pressure on the bond market. US fiscal improvement will also reduce some of the overhang as QE ends. Finally, there is roughly $1tr of coupon payments that needs to be reinvested in bond markets annually which dwarfs fund flows.

US equity flows resilient as large EM equity outflows continueUS equities have actually had modest inflows in June ($1.3b) despite thetumult. Inflows to Japan have also continued. EM equity outflows on the other hand were $20b in June; of the $66b that went into EM equities since QE3, about 40% has come out. With EM mutual fund beta above average, continued outflows are likely to have a larger relative impact. The US mutual fund underweight and spike in US option skew imply higher relative support for US equities from a positioning perspective.

1 http://pull.db-gmresearch.com/cgi-bin/pull/DocPull/1647-A3F3/53424332/28Jun2013_Trading_DB’s_House_View_via_Synthetic_Instruments.pdf

2 http://pull.db-gmresearch.com/cgi-bin/pull/DocPull/1629-54AF/53525941/0900b8c086f7de15.pdf

-30%

-20%

-10%

0%

10%

20%

30%

Japan

Nikkei

US

S&

P 500

UK

FTSE

100

France C

AC

Sp

ain IB

EX

Italy FTSE

MIB

Ind

ia NIFTY

Greece A

SE

Ch

ina S

hag

hai C

om

p

MS

CI E

M

Brazil IB

OV

YTD performance Last 1m performance

DM DM DM DM

DM DM EM EM EM EMEM

Source: Deutsche Bank, MSCI has announced the reclassification of Greece from DM to EM, effective from November 2013


http://pull.db-gmresearch.com/cgi-bin/pull/DocPull/1647-A3F3/53424332/28Jun2013_Trading_DB%E2%80%99s_House_View_via_Synthetic_Instruments.pdf

http://pull.db-gmresearch.com/cgi-bin/pull/DocPull/1647-A3F3/53424332/28Jun2013_Trading_DB%E2%80%99s_House_View_via_Synthetic_Instruments.pdf

http://pull.db-gmresearch.com/cgi-bin/pull/DocPull/1629-54AF/53525941/0900b8c086f7de15.pdf

3


Monthly Hedge Fund Trends - Investor Sentiment 3


Macro and market neutral strategies popular with Canadian investorsOur team was in Canada last month and met with several of the institutional investors in Toronto and Montreal, including pension, endowment, foundation, consultant, and fund of fund investors. This is a sophisticated allocator group, and many of the large Canadian pensions run a significant portion of assets in-house. Thus any external managers to which they allocate will be considered within the context of their broader portfolio with regards to strategy fit and costs. While many of the Canadian allocators have mature portfolios, they can allocate opportunistically and are open to potential upgrades in their portfolios. Our meeting revealed that macro and market neutral strategies continue to be popular strategies with Canadian investors.

Virginia investors maintaining portfoliosIn our recent trip to Virginia, we observed light activity in hedge fund allocations from a variety of investor types. While investors in the region are constantly looking to upgrade the portfolio, they also mentioned that they are allocating on an opportunistic basis. Both an endowment and an outsourced CIO mentioned that they are generally maintaining their portfolios at this point in time. It seems that investors are not necessarily taking a specific market view, but rather looking at investments selectively from a bottoms up approach.

No one-size-fits all approach to European investorsIn Europe, the culture and mindset of family offices can differ significantly amongst the key players. However, those that continue to allocate to hedge funds offer an attractive investor base due to their sticky, long-term capital and their ability to allocate quickly. Indeed in our 2013 Alternative Investment Survey, 80% of European family offices stated that they could complete due diligence in less than 6 months.4

The most sought after strategies amongst the European family offices are equity l/s, global macro and emerging markets. We also frequently see interest for managers with niche offerings that provide exposure to particular markets, sectors or regions, particularly from the London-based family offices. Several allocators have also mentioned that they would be willing to participate in interesting co-investments with hedge fund managers.

The UK pension market reached a record high of $2.7 trillion in 2012, growing 5% during the year and more than doubling in the last decade.5 It is encouraging that the UK pension funds have become increasingly active in alternatives, including hedge funds, with a number of the larger pension funds enhancing their internal investment teams to support their growing alternative allocations. However, it should be noted that this has been at a slower pace than their US, Nordic and Dutch peers. Average allocations to alternatives has increased from 3% to 17% in the past decade, and overall exposure to hedge funds grew from 1.8% to 4.1% between 2009 and 2011.4,6

The UK pensions rely heavily on consultants, therefore developing a good relationship with these financial intermediaries is paramount. Strategy-wise, the pension funds are looking for diversification from their equity investments, where they have significant exposure to beta, as well as their fixed income exposure. As a result, any strategy with low volatility and low correlation that will contribute positively to the overall portfolio returns may offer an attractive proposition for UK pensions. In general, however, appetite for equity hedge strategies among UK pensions remains fairly low.

A recent trip to Munich indicates that the demand for hedge funds remains somewhat muted amid regulatory uncertainty. There are, however, some allocators who remain committed to growing their hedge fund allocations. German investors tend to require a three year track record and a minimum of $500 million in assets, with a strong manager pedigree. Liquidity continues to be important, with quarterly being the longest that they are able to accept.

Two new trends in the German market for 2013 are demand for absolute return oriented bond products and an increased focus on ESG (Environmental, Social, and Governance) investing.

New allocation plans announced for Government Pension Investment Fund (GPIF) of JapanOn June 7th, Government Pension Investment Fund of Japan, the world’s biggest manager of retirement savings, announced new asset allocation plans. It said it will reduce its holding of JGBs and increase equity exposure. There is no plan to allocate to hedge funds at this stage. GPIF manages $1.2 trillion.

The proportion of assets held in Japanese bonds will be cut to 60% from 67%, the health ministry said at a briefing to announce changes to the mid-term plan of the GPIF. The weighting of Japanese stocks will be increased to 12% from 11% currently and international stocks will increase to 12% from 9%.

They do not plan to allocate to hedge funds or any alternative assets for now. In February, GPIF President Takehiro Mitani mentioned the fund may have to buy alternative assets to cope with a higher interest rate under Abenomics. However at this stage, there is no plan for GPIF to start hedge fund investments. Tokihiko Shimizu, Director-General of the Research Department of GPIF explained at the AIMA Japan Hedge Fund Forum 2013 on June 27th that they have done some research on hedge funds already and at some point they will announce their view on hedge funds.

3 From Deutsche Bank’s Hedge Fund Capital Group4 2013 Deutsche Bank Alternative Investment Survey5 Towers Watson Global Pension Asset Study 20136 National Association of Pension Funds, 2011


4


Monthly Hedge Fund Trends - Performance


Americas

2013 Year to date median performance

Europe


Asia


Americas

June 2013 Performance dispersion of returns

Europe


Asia


CTA

/ M

anag

ed F

utu

res

D

istr

esse

d

US

L/S

Cre

dit

Glo

bal

L/S

Mac

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All

Fun

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Mu

lti-S

trat

egy

E

ven

t D

rive

n

Fi

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Inco

me

75th Median Average 25th S&P 5004.00%

3.00%

2.00%

1.00%

0.00%

1.00%

2.00%


Mu

lti-S

trat

egy

Eve

nt

Dri

ven

Mar

ket

Neu

tral

Cre

dit

G

lob

al L

/S

Eu

rop

ean

L/S

Fi

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Inco

me

All

Fun

ds

Mac

ro

CTA

/ M

anag

ed F

utu

res

Em

erg

ing

Mar

kets

Eq

uity

-5.00%

-6.00%

-4.00%

-3.00%

-2.00%

-1.00%

0.00%

1.00%

2.00%

75th Median Average 25th Stoxx 600


Mac

ro

Jap

an L

/S

Mu

lti-S

trat

egy

All

Fun

ds

P

an-A

sia

L/S

Ch

ina

L/S

Asi

a ex

-Jap

an L

/S

-6.00%

-8.00%

-10.00%

-4.00%

-2.00%

0.00%

2.00%

4.00%

75th Median Average 25th MSCI AsiaPac incl Japan


8.42%

12.63%

5.89%

5.50%

3.88%

5.41%

3.39%

2.15%

0.16%

0.12%

6.00% 8.00% 10.00% 12.00% 14.00%4.00%2.00%0.00%

Distressed

6.54%

Credit

Fixed Income

CTA / ManagedFutures

Global L/S

All Funds

Multi-Strategy

Event Driven

S&P 500

US L/S

Macro


0.45%

0.48%

1.38%

1.56%

2.45%

2.93%

3.08%

3.11%

3.16%

4.08%

4.52%

5.49%

0.00% 1.00% 2.00% 3.00% 4.00% 5.00% 6.00%

CTA / Managed Futures

Market Neutral

Emerging Markets Equity

All Funds

Fixed Income

Event Driven

Stoxx 600

Multi-Strategy

Macro

Credit

Global L/S

European L/S


0.90%

3.24%

3.76%

4.07%

4.53%

5.68%

8.78%

16.71%

0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00% 14.00% 16.00% 18.00%

China L/S

MSCI AsiaPac incl Japan

Pan-Asia L/S

Multi-Strategy

Macro

Japan L/S

All Funds

Asia ex-Japan L/S



5


Monthly Hedge Fund Trends - Leverage 7


Global — The MSCI World 30 day volatility rose 69% this month ending June 25, 2013 at 14.64. Gross fundamental equity exposure increased 1% last month (ending at 2.51) while net fundamental equity exposure decreased, ending the month at 0.63 (down 4%).

— The percentage of funds in the higher (1 – 2) net equity leverage bands have increased since April. However, the percentage of funds in lower (-1 – 1) net equity leverage band has decreased.

Global net & gross equity leverage vs. volatility

Global – June 2013 Quarterly change in net equity leverage distribution across funds

2.42.52.6

2.32.22.12.01.91.81.71.61.51.41.31.21.11.00.90.80.70.60.5

0.30.4

40

30

35

25

20

10

15

5

25 Jun 12

25 Aug 12

25 Sep 12

25 Oct 12

25 Nov 12

25 Dec 12

25 Jan13

25 Feb 13

25 Mar 13

25 Apr 13

25 May 13

25 Jun 13

25 Jul 12

MSCI World 30d Vol

MC

SI W

orl

d 3

0 d

ay H

isto

rica

l Vol

Leve

rag

e

Gross Leverage Net Leverage

Source: Deutsche Bank Global Prime Finance Risk, July 2013

16%

8%

0%

-2%

12%

4%

14%

6%

18%

10%

2%

-1 - -0.75

-0.75 - -0.5

-0.5 - -0.25

-0.25 - 00 - 0

.25

0.25 - 0.5

0.5 - 0.75

0.75 - 11 - 1

.25

1.25 - 1.5

1.5 - 1.75

1.75 - 2

01 July 13

% o

f fu

nd

s (D

euts

che

Ban

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01 April 13

Source: Deutsche Bank Global Prime Finance Risk, July 2013

7 Deutsche Bank Global Prime Finance Risk, July 2013


6


Monthly Hedge Fund Trends - Securities Lending


Global 8

US % short interest sector change - June 2013

Research in Motion and Molycorp Inc. targeted despite market volatilityRecent volatility in the markets appeared to be triggered when Fed Chairman Ben Bernanke suggested that the Fed could soon begin to taper its quantitative easing.9

Short interest in Research In Motion (BBRY) increased leading into their June earnings release. Total short interest topped out at almost 185 million shares vs the 442 million share float (42%) as the phone and tablet maker reported weak numbers. Shorts began pressing the name with the limited remaining supply available leading into this print and have been craving more stock. For reference, short interest a year ago at this time was inside 75 million shares. Unfortunately recall pressure, which began the third week in June, prevented funds from adding in size. Spot rates for borrow initially spiked as high as 18% but the significant price decline in the stock ultimately led to short covering which helped offset the needs from long sales.

The borrow picture on Molycorp Inc. (MCP) continues to deteriorate as well. The name had been quiet up until late May as both directional shorts and convert hedges looked to press the name. Spot rates have quickly risen to 99% and will likely persist for some time, as lenders look to re-rate and recall existing shorts. The name is popular with directional shorts and as a result, borrow rates have been quite high (has traded 70%+ in the past, for example). In late January, the company issued a secondary along with a new convert. We see current short interest north of 50 million shares, representing approximately 40% of the float. With all of the available supply currently utilized, borrow has stalled in the name.

Japanese equities borrowing still high despite Nikkei performanceJapanese stocks moved into bear market territory amid concerns the US Fed will begin to taper its bond buying program. In a traditional signal of concerns from the short side, borrowing of Japanese equities, the prerequisite to short sell them, has been on the increase even as the benchmark Nikkei has been sliding lower. While the Nikkei has lost around 21% of its value since May 23, data shows equity borrowing has increased 10%, hinting that those on the short side may still be expecting further declines in the Japanese market.

Despite this however, compared to borrowing levels over the past 12 months, the current volume still falls far short of previous peaks. Some hope that despite near-term concerns, comparatively speaking, the outlook may not be entirely gloomy.

8 This material has been produced by the Deutsche Bank Securities Lending Group and must not be regarded as research or investment advice.

9 http://www.bloomberg.com/news/2013-06-20/fed-seen-tapering-qe-to-65-billion-at-september-fomc-meeting.html

10 http://www.bloomberg.com/news/2013-06-24/pboc-opaque-stress-test-catches-funds-in-crossfire-china-credit.html

11 http://www.bloomberg.com/news/2013-06-20/china-said-to-seek-concessions-in-review-of-mediatek-deal.html

12 http://www.bloomberg.com/news/2013-06-21/spreadtrum-jumps-most-since-2009-on-1-5-billion-offer.html

13 http://www.markit.com/en/about/news/commentary/commentary-article.page?dcr=/en/securities-finance/2013/02-07

European % short interest sector change - June 2013

Chinese banks remain a major focus; flows dominated by liquidity concernsWe saw strong demand to short Hong Kong yield plays and ASEAN markets particularly. Chinese banks remain a major focus with rising concerns about the lack of transparency in the shadow banking system, non-performing loans (NPLs) and rising systemic risk. Concerns heightened when Bank of China denied reports that they had a capital default, investors were concerned of a liquidity crunch as repo rates touched record highs (SHIBOR touched record levels).10 China Minsheng was the prominent China bank short during the funding storm with over $180 million of executed shorts as the short base grew +25% to 15 days volume.

Macau gaming underperform broader marketsMacau gaming underperformed the broader markets due to concerns that the SHIBOR spike may impact junket liquidity. Galaxy was the stand out with short interest spiking +136% over the month. Deutsche Bank’s Karen Tang downgraded Galaxy, Melco Crown, Sands China & Wynn Macau to hold. We cut forecasted 2014 revenue growth to 8% from 11% primarily on lower VIP spend.

Mediatek MStar merger completion extendedThe long-winded Mediatek MStar merger took another twist this month when Mediatek extended the merger completion date to 1 Nov. from 1 Aug.11 Chinese regulatory approval of the merger is still in-progress. The spread fluctuated throughout the month expanding to as wide as 27%. New directional short activity resurfaced following Mediatek declines with fears that the proposed Spreadtrum privatization will lead to unlimited Chinese government financing and negative pricing pressure on chips.12 Meanwhile borrow levels continue to rise as onshore recalls for dividend record date approaches mid-July.

Strategic arbitrage opportunities in M&ACompared to pre-credit crunch trends, opportunities in the M&A market have dried-up as most companies focused more on fixing their core businesses. However, recent strategic purchases that presented arbitrage opportunities for funds include: Dell’s leverage buyout and challenge from Icahn, Liberty Media trying to buy Time Warner Cable through Charter Communications, and Softbank buying Sprint/Clearwire.13

In addition to these mergers, arbitragers were particularly interested in trading Pfizer (PFE)/Zoetis (ZTS) on the back of PFE’s tender offer. Arbitragers looked to tender to receive as much ZTS as possible since there was a discount to receive shares via the tender offer.

-30.0% -20.0% -10.0% 0.0% 10.0%

Industrials

Materials

Energy

Info Tech

Cons Disc.

Financials

Utilities

Cons. Stap

Healthcare

Telecom

-30.0% -20.0% -10.0% 0.0% 10.0% 20.0% 30.0%

Utilities

Financials

Energy

Healthcare

Info Tech

Industrials

Telecom

Cons. Stap

Cons Disc.

Materials

Source: Data Explorers & Deutsche Bank, July 2013 Source: Data Explorers & Deutsche Bank, July 2013


http://www.bloomberg.com/news/2013-06-20/fed-seen-tapering-qe-to-65-billion-at-september-fomc-meeting.html

http://www.bloomberg.com/news/2013-06-20/fed-seen-tapering-qe-to-65-billion-at-september-fomc-meeting.html

http://www.bloomberg.com/news/2013-06-24/pboc-opaque-stress-test-catches-funds-in-crossfire-china-credit.html

http://www.bloomberg.com/news/2013-06-24/pboc-opaque-stress-test-catches-funds-in-crossfire-china-credit.html

http://www.bloomberg.com/news/2013-06-20/china-said-to-seek-concessions-in-review-of-mediatek-deal.html

http://www.bloomberg.com/news/2013-06-20/china-said-to-seek-concessions-in-review-of-mediatek-deal.html

http://www.bloomberg.com/news/2013-06-21/spreadtrum-jumps-most-since-2009-on-1-5-billion-offer.html

http://www.bloomberg.com/news/2013-06-21/spreadtrum-jumps-most-since-2009-on-1-5-billion-offer.html

http://www.markit.com/en/about/news/commentary/commentary-article.page%3Fdcr%3D/en/securities-finance/2013/02-07

http://www.markit.com/en/about/news/commentary/commentary-article.page%3Fdcr%3D/en/securities-finance/2013/02-07

7


Monthly Hedge Fund Trends - Regulatory – Special Feature


Deutsche Bank Global Transaction Banking: Charting a smooth course through AIFMD implementation14

Designed to establish a harmonised regime across the EU for various forms of alternative investment fund (AIF) management, including hedge funds, fund of funds and private equity, the Alternative Investment Fund Managers Directive (AIFMD) is scheduled to come into effect on 22 July 2013. AIFMD will certainly impact responsibilities, liabilities and risk for EU AIF managers and their prime brokers, depositaries, administrators, and custodians.

AIF managers in the EU must therefore ensure they have a good understanding of the short and long-term effects of the Directive on their business and plan accordingly. They will need to appoint a depositary and make the changes needed to their systems to meet the reporting requirements of the Directive.

A subtle shift of power AIFMD brings AIFs under an unprecedented degree of regulatory scrutiny. One of the key requirements is that all AIF managers must appoint a depositary to be responsible for three things:

— safe keeping of assets (or, in the case of non-clearing assets, asset verification);

— monitoring the cash movements between the AIF manager, its underlying funds and all of its counterparties; and

— providing general oversight of the fund’s investment activities to ensure they adhere to its governing documents.

These provisions significantly increase the breadth and importance of the depositary’s role – a higher profile role that comes at a cost for depositaries since their work load, tracking, monitoring and risk increases accordingly. Indeed, a key point of AIFMD is the strict liability provisions that apply to the depositary of a European AIF. The depositary for a European AIF will be held liable for the loss of any financial instruments that they directly hold in custody on behalf of the AIF. It will also be held liable for the loss of financial instruments that are held in sub custody accounts with a third party. Typically, the depositary will treat the AIF’s prime broker as a sub custodian but the depositary retains the liability.

Although the fund manager continues to be responsible for appointing its own prime broker and fund administrator, the depositary’s oversight role – and the liability it assumes as a result – means that it is likely to want to exercise influence over those decisions. Certainly, the depositary will want to carefully consider operating models to ensure it has the control it needs and reassurance that the assets are properly segregated from non AIF assets. In simple terms, depositaries are going to want to work with prime brokers, fund administrators and custodians that they know, trust and have a solid financial backing.

With the implementation of AIFMD imminent, fund managers should be engaging with depositaries now. While there are about 10,000 alternative funds being managed in the EU today, there are only 28 depositaries. Since there is a practical limit to the number of funds that can be taken on in a relatively short period of time, managers should address their depositary needs with a real sense of urgency.

A practical look the depositary’s expanded role means The obvious impact is that depositaries, for the first time, will be underwriting potentially huge levels of risk – substantially more than under the current regulatory regime. As they will be required to delegate sub custody to prime brokers (for which they still retain liability), there will be increased scrutiny on the operational effectiveness of both the prime broker and the prime broker’s sub custodian network. As a result, it’s feasible that liability concerns may lead some to withdraw from certain geographical markets and / or asset classes. Only depositaries with sufficient size, geographic reach and capital will be able to make the necessary provision for their potential liabilities. Together, these factors are expected to fuel significant industry consolidation – an unintended, and perhaps undesirable, consequence of the Directive.

Those that remain will have to adapt to the operational demands integral to this more central role in the value chain. Almost all depositaries will need to upgrade – to varying degrees – their existing capabilities. As depositaries prepare to become responsible for the restitution of financial instruments in the event of a loss, such enhancements will need to focus on three key areas.

1) Due diligence: Since depositaries must ensure that sub custodians (which, because of the existing model in which prime brokers hold the fund’s assets and use them for rehypothecation, might well be prime brokers and their sub custodians) are “fit for purpose”, regular market level due diligence will be required with the depositary reserving the right to demand a change if the custody risk is deemed too high with a market or a sub agent.

2) Cash monitoring: The ability to monitor all cash movements of AIF assets will be essential. Being able to accurately track and break down the movement of trillions of dollars of client monies potentially across thousands of bank accounts globally and pinpoint their precise position at any given time – will require superior overview positions powered by heavyweight technological capabilities.

3) Liability: Finally, depositaries may also want to offset liability – for example, by acquiring indemnifications from delegated parties (i.e. sub custodians or prime brokers). The industry’s model for doing this has yet to be decided – and once again, active and ongoing market dialogue is vital.

An integrated modelWhile the ideal model for AIFs might have to be developed individually with all parts of the chain, an integrated model – in which, depositary services, administration, cash management, corporate administration, sub custody and potentially one of the prime brokers (in a multi prime broker model) is provided by the same organisation – has several important advantages, not least that it leverages the efficiencies and cost-savings inherent in a larger, global providers’ domestic network and capabilities.

Models that split depositary and administration services will most likely result in higher costs. This is due to the replication of the processes, procedures and systems infrastructure required to ensure that AIFMD rules around cash management and asset safekeeping are met. Since this extra layer will no doubt be priced into the cost of services rendered, the AIF manager could effectively pay twice to have similar processes performed. The depositary has to have its own complete records therefore has an obligation to build the records based on its own policies and procedures. There is inherent inefficiency in splitting the roles.

An integrated model, meanwhile, can avoid such duplication and offer cost benefits while more effectively mitigating risks (by allowing the provider to retain tight control of the assets). This increases visibility – keeping everything in line-of-sight through internal systems and controls. In addition to being more secure, this reduces the administrative burden, and – through greater transparency – aids compliance.

Time for actionAs AIFMD’s July implementation date nears, one thing is clear: AIF managers must be aware of the urgency of preparing for the Directive’s implementation and discuss their individual needs with their depositaries immediately. An integrated model – one that mitigates risk, reduces costs, and maximises the advantages of these changes – will often be the best way of doing so.

14 http://www.gtb.db.com/docs/Deutsche-Bank-Global-Transaction-Banking-Whitepaper_AIFMD.pdf- Deutsche Bank Government & Regulatory Affairs Group


http://www.gtb.db.com/docs/Deutsche-Bank-Global-Transaction-Banking-Whitepaper_AIFMD.pdf-%20Deutsche%20Bank%20Government%20%26%20Regulatory%20Affairs%20Group%20

http://www.gtb.db.com/docs/Deutsche-Bank-Global-Transaction-Banking-Whitepaper_AIFMD.pdf-%20Deutsche%20Bank%20Government%20%26%20Regulatory%20Affairs%20Group%20

8


Monthly Hedge Fund Trends - Regulatory 15


European Parliament votes to remove 1:1 remuneration cap and performance fee restrictions on UCITSOn 3 July, in a vote on the updated Undertakings for Collective Investment in Transferable Securities Directive (UCITS V), the European Parliament removed proposals for a cap on variable remuneration and restrictions on performance fees.

This reverses the position adopted on 21 March by the European Parliament’s Economic and Monetary Affairs (ECON) Committee, which proposed a 1:1 cap on variable remuneration in relation to fixed remuneration and placed restrictions on performance fees. UCITS fund managers will now only be subject to restrictions on the cash element of bonuses and rules on clawbacks and deferrals as proposed by the EU Commission.

The final position on the revised UCITS V Directive will be subject to negotiation between the Council and Parliament, once the Council adopts its own amendments to the Commission proposal. It is not clear when Member States will adopt a position of their own on the Directive.

EU Finance Ministers reach compromise on rules governing trading and investor protection (MiFID 2)On June 21, the EU Finance Ministers agreed a compromise position on the Markets in Financial Instruments Directive (MiFID2) which needs next to be discussed with the European Parliament and EU Commission.

The proposal places stringent restrictions on dark trading taking place in equity markets and opens the possibility for venues and central counterparties (CCPs) to be required to allow access to alternative providers, though only in certain circumstances.

Further negotiations on EU level will focus on key political issues including: transparency in the equity markets, algorithmic/high frequency trading (including whether to require minimum order resting times), restrictions on OTC trading, access between venues and CCPs, investor protection issues (such as the obligations placed on investment advisors) and access to EU markets by non-EU firms providing MiFID services. The implementation is set to be two years after the proposal is finalized, but this may be subject to further discussion.

New EU regulation on credit rating agencies enters into force On June 20, the new EU regulatory package on credit rating agencies (CRAs) entered into force.

The new rules aim to reduce over-reliance on external credit ratings and promote competition between CRAs. The credit agencies are required to be more accountable for their ratings and more transparent when rating sovereign states. New rules require CRAs that have entered into a contract to issue credit ratings on re-securitizations cannot also issue credit ratings on new re-securitizations with underlying assets from the same originator for a period exceeding four years. At least two CRAs should be engaged to provide independent credit rating of structured finance instrument. The legislation requires enhanced public disclosure of information on the credit quality and performance of the individual underlying assets.

EU agrees an update to the EU Market Abuse DirectiveOn 26 June, the European Council approved a preliminary agreement with the European Parliament regarding the Regulation updating the 2003 Market Abuse Directive.

The scope of the rules has been broadened to include financial instruments traded on all venues, OTC-traded financial instruments and the manipulation of benchmarks. The rules are also strengthened to ensure market abuse cannot take place across commodities and their related derivatives. Competent authorities are given significant additional powers to pursue perpetrators of market abuse and the sanctions regime is strengthened to ensure it acts as an effective deterrent.

Negotiations on the accompanying criminal sanctions Directive, which had been frozen pending agreement on the Regulation, will now recommence. Implementation of the updated directive and Regulation is likely to take place towards the end of 2015.

SEC publishes Money Market Fund (MMF) reform proposalsOn June 5 the US Securities and Exchange Commission (SEC) unanimously approved proposed rules to reform MMF regulation. The SEC’s proposal outlines two alternatives that could be adopted separately or combined into a single reform package. The first alternative would require institutional prime funds – which invest in short-term corporate debt – to use a floating or variable net asset value (NAV). Retail MMFs, defined as those with $1 million-per-day redemption limits, would be exempt.

The second proposal requires non-government MMFs to impose a 2% liquidity fee if weekly liquid assets fall below 15% of total assets, and would allow the fund’s board to temporarily suspend redemptions for up to 30 days. The SEC also recommends other reforms including diversification requirements, disclosure requirements, stress testing and reporting. The comment period ends September 17, 2013.

US Derivatives Reform In June, the US Commodity Futures Trading Commission (CFTC) granted various forms of relief from derivatives requirements under Dodd-Frank. On June 3, the CFTC extended the time to comply with certain pre-trade screening requirements for bunched orders for futures, in order to provide additional time for market participants to coordinate on the communication of limits. On June 4, the CFTC granted relief from central clearing for swaps entered into by eligible treasury affiliates on behalf of non-financial affiliates, subject to certain conditions and requirements. To qualify for relief, the swap activity must meet several conditions, including that the eligible treasury affiliate enter into the swaps for the sole purpose of hedging or mitigating the commercial risk of one or more non-financial affiliates. In addition, certain information must be reported to a registered swap data repository (SDR).

The CFTC also extended the effective date of the inter-affiliate clearing exemption rule from June 10 to June 18, 2013, and they issued a time-limited, no-action letter granting relief from required clearing for certain swaps entered into by qualifying cooperatives, subject to certain conditions. In addition, the CFTC extended the compliance date for board approval of the end-user exception from clearing until July 10, 2013, subject to certain conditions. Lastly, the CFTC issued no-action relief to provide for transition to SEF registration, allowing swap trading facilities that were unregulated prior to Dodd-Frank to continue operating during the pendency of, and transition to compliance with, the swap execution facility (SEF) final rules.

Throughout the month several CFTC commissioners made public statements regarding the upcoming July 12 expiration of the cross-border relief from various Dodd-Frank requirements, and significant uncertainty remains given the lack of consensus within the CFTC. Of note, CFTC Commissioner O’Malia issued a statement advocating for extension of July 12 cross-border relief until December 31, 2013, and Commissioner Wetjen said in a speech that the CFTC should adopt interim final cross-border guidance prior to the July 12 deadline when the CFTC’s regulatory relief is set to expire.

CFTC Chairman Gensler has however expressed his intention to finalize the guidance shortly and not extend the cross-border relief beyond the July 12 deadline. On June 14, the European Commission and ESMA announced that it would apply to the CFTC for a substituted compliance assessment to be undertaken on EU rules in respect of the CFTC’s entity level and transaction level requirements.

15 Deutsche Bank Government & Regulatory Affairs Group This is a summary of some of the themes underlying recent regulatory developments affecting hedge funds and their managers. It does not purport to be legal or regulatory advice and must not be relied on for that purpose. Deutsche Bank is not acting and does not purport to act in any way as your advisor. We therefore strongly suggest that you seek your own independent advice in relation to any legal, tax, accounting and regulatory issues relating to the merits or otherwise of the products and services discussed.


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6/07

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9/09

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MiF

ID

take

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(exp

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d

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iFID

2: P

lenar

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te (0

8/10

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EM

IR: F

irst

pos

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le

clea

ring

ob

ligat

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(end

201

3)

EM

IR: D

eriv

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es c

lear

ing

ob

ligat

ion s

tart

s (Q

2 20

13)

2014

2013

2015

2016


10


Monthly Hedge Fund Trends


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Markets Prime Finance Monthly Hedge Fund Trends 2012, 2011, …€¦ · The Hedge Fund Capital...

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Transcript of Markets Prime Finance Monthly Hedge Fund Trends 2012, 2011, …€¦ · The Hedge Fund Capital...