AIF segregation rules to hit pension funds’ collateral management

Proposed sub-custody segregation rules for AIF (alternative investment fund) assets could have a significant impact on pension funds’ and insurance companies’ collateral management and securities lending, according to BNY Mellon’s Ross Whitehill.

Under Europe’s Alternative Investment Fund Management Directive (AIFMD), it requires a delegate of the depositary bank to hold AIF assets separately from any other accounts.

According to Whitehill, head of Strategic Regulatory Office, Global Collateral Solutions, the proposed rules will deplete participation amongst pension funds and insurance companies in the securities lending because it removes the tri-party collateral manager for their repo transactions.

“They [pension funds] will no longer be attracted to the market because people wishing to do either lending or repo transactions with AIFs will have to relate to bilateral collateral management, which none of these are ready to support,” says Whitehill. 

As a result, not only could there be a significant impact on funding and liquidity in Europe, but unintended consequences on the performance of AIFs could occur. 

“When you segregate at the fund level, the broker-dealer will no longer want to deal with the segregated AIF, so there is going to be a massive impact on liquidity, on funding, and securities lending will not be possible on a tri-party basis. This will have unintended consequences on base-performance for AIFs and ultimately UCITS that won’t be an attractive securities lending proposition to the broker-dealer community,” he adds.

“There is a recognition that segregation at the sub-custodian level is fine for pure custody, but it is not for collateral management.

Many of Europe’s fund managers are concerned with the requirement to establish segregated account at the sub-custody level as they may have to devote significant resources to maintain multiple accounts with potentially costly controls and reconciliations risks. 

In response to the consultation on the rules in February, both the Association of the Luxembourg Fund Association (ALFI) and the European Fund and Asset Management Association (EFAMA) have called for a omnibus account structure, arguing “considerations should be given to, at least, commingle assets that are collectively managed such as assets of AIF, UCITS or any other regulated fund.”