EXCLUSIVE INTERVIEW: Insuring Asset Managers After EU Regulatory Tsunami

Tom Burroughes

20 May 2014

Apsley is an underwriting firm that is focused only on the asset management sector, particularly in alternative sectors such as hedge funds and private equity. With the advent of the European Union’s Alternative Investment Fund Managers Directive, the issue of insuring firms becomes ever more important and complicated. This publication recently interviewed James Lawrie, who is head of asset management underwriting at Apsley, about its business, the AIFMD, and the regulatory climate in which this firm operates.

Could you explain the requirement of the AIFMD as it applies to insurance? What must fund managers do?
The new regulation sets out that AIFMs must decide either to buy professional indemnity insurance or retain additional own funds in order to provide a buffer against potential liabilities. The deadline is 22 July 2014, by which time asset managers will have to have submitted a variation of permission form to their national regulator. Should a manager wish to use insurance in order to comply with the directive they should ensure that they have an AIFMD compliant policy in place ahead of the deadline.

How much liability risk insurance must managers have, at least at the minimum?
As well as setting out that AIFM’s must either buy insurance or hold additional own funds, the directive also enshrines as mechanism for calculating how much insurance an AIFM must buy in order to be compliant. The requirement is that an AIFM buys a limit of liability equal to 0.7 per cent of the total asset value of the AIF for individual claims, and 0.9 per cent of the total asset value of the AIF in aggregate per year.

What sort of liabilities are we talking about ?
The potential liabilities tend to fall into one of three categories; operational, legal and regulatory. We see these risks as having different characteristics in terms of frequency and severity. In reality operational risk is a catch all term which encompasses all those non-investment risks which an asset manager assumes. These are the risks for which end investors are not compensated for taking and which the asset manager could transfer with insurance.

How large, potentially, are the liabilities to which managers are prone?
This is difficult to quantify as liabilities are not capped. Given the nature of these types of losses they rarely make it in to the public arena. We have seen some large losses as well as some very significant levels of defence costs incurred in seeking to repudiate a potential liability.

What used to be the situation before AIFMD? Are there examples of things going wrong? What prompted EU legislators to make the change?
Prior to the implantation of AIFMD there was no requirement for alternative asset managers to buy professional indemnity insurance. This is in contrast to various other professions where requirements are imposed either by a regulatory body or professional trade association. AIFMD as a whole is a reaction to the events of 2008 and the perception that there was a regulatory gap for alternative asset managers which needed to be plugged. Whilst events post-Lehman saw many hedge funds suffer poor performance, redemptions and ultimately closure, it is difficult to point to a specific catalyst that prompted regulatory change.

Where does this new requirement leave the end-client in terms of likely returns and fees?
The requirement is for the AIFM to pay a premium for insurance cover would ordinarily come out of management fees and general expenses of the firm. It is clear that increased regulatory cost is a reality for AIFMs and they will have to assess how they absorb these. Generally there is downward fee pressure on managers and we don’t expect to see them rise as a result of insurance nor do we expect a drag on performance in terms of increased expense ratios. We do, however, see end investors becoming increasingly interested in what insurance an AIFM has in place to protect investor assets in the event of a loss.

What sort of business interest has your firm seen? What sort of managers are you dealing with? Any indication as to the size of business ?
We have dealt with a range of managers, from start-ups to well established multi-billion dollar firms. In terms of which managers will choose insurance versus own funds, this is still somewhat unknown until we get to the deadline on 22 July.

Certainly most managers we have spoken to are fully cognisant of the decision they are going to have to make in the run-up to the July deadline. We have seen some larger managers elect to hold additional own funds as the size of insurance limit they would have to buy is very large and can be difficult to attain.

When did your firm first notice the opportunity?
AIFMD itself has had a long gestation period, stemming as it does from the events of 2008. The directive as a whole has been heavily debated by all sides as it made its passage through the European legislative process and has certainly brought a greater spotlight on insurance. It does not, necessarily, mean that the market size will increase markedly as many managers already buy insurance and those that don’t may chose to hold additional own funds.

How does this area of business fit with the rest of what the firm does? Will you need to take on added staff, or deploy more resources, or switch from other areas?
Our sole focus is the asset management sector, with a particular emphasis on alternative asset managers. So we have been fully prepared for the increased attention the directive has brought on to the provision of insurance.

Can you give me a broad overview of how this sort of regulatory activity is driving your business and that of your peers?
Clearly there has been a surge in interest, and asset managers are much more aware of the possibility of using insurance as an important risk transfer device. This is also beginning to filter down to the end investors who are recognising that insurance can serve to protect their assets and are increasingly making insurance an important part of their due diligence process.