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According to leading market pundits, 2024’s market volatility roller coaster ride will continue, so keep those seat belts fastened.
Welcome to 2024, a year of potential market volatility due to general elections happening in key countries around the world, including the USA and potentially the UK (by 2025). Across the globe, markets have already experienced several years of volatility due to the COVID pandemic, lockdowns and fears of high inflation leading to economic recessions.
Many AIFMs and Asset Managers confirm that general elections typically can cause market volatility due to the level of uncertainty in the market generated by political outcomes. Investor’s investment performance can experience roller-coaster like “highs and lows”.
What does 2024’s election-driven market volatility mean to AIFMs and Asset Managers?
AIFMs and Asset Managers potentially face Portfolio Investment Risk AND the 5-Key Distribution Risks. The latter is prevalent if the manager does not have robust cross-border compliance infrastructure.
This is the “Double Risk Whammy”: It’s hard enough to deal with Investment Risk during times of marketing volatility when markets have dropped and your clients are losing money and becoming disgruntled. But did you know that you may also have to deal with Distribution Risk in addition to Investment Risk (in a double-risk sucker punch)?
In this blog, we explore the impact of market volatility resulting in “Double Whammy Risk” and how this can potentially have a negative effect on AIFMs and Asset Managers.
The risk “domino effect”
Risk factors are all interconnected. As a result, you can get the risk “(falling) domino effect”. General elections across the globe could cause higher market volatility, which in turn leads to potential portfolio investment performance (Investment) risk. That means investors’ performance could suffer, which in turn could trigger Distribution Risk for the AIFMs/Asset Managers who don’t have robust marketing compliance programs in place.
Think of the Double Risk Whammy like sea tides: 2024 could be the year that the tide (representing uncertainty and market volatility) goes out, exposing anyone without a swimsuit (representing exposing the AIFM/Asset Manager’s lack of robust compliance infrastructure).
Risk Whammy #1: Fund Investment Risk
Market Volatility is some AIFM/Asset Managers’ friend and others’ foe. Traders that specifically trade on market volatility welcome volatility and are prepared for it. Other AIFM/Asset Managers generally prefer to manage their investment funds during times of predictable market performance.
When general investment market performance is positive, when everyone is making money, both fund managers and investors are happy. But what happens when markets drop (or crash), your fund performance suffers and your investors lose money in your fund?
You could be open to the 5-Key Distribution Risks if you are non-compliant with the investor’s country’s laws in marketing and selling your fund to investors.
Risk Whammy #2: Distribution Risk
Marketing of AIFM/Asset Managers’ funds in any country could potentially incur 5-Key Distribution Risks including: sanctions, investor litigation, investor rescission rights, business franchise and reputation risks. Read our blog, 5-Key Distribution Risks for Cross-Border Marketing.
- Sanctions Risk: The country regulator could impose sanctions for unlawful activity carried out in their jurisdiction. Many AIFMs/Asset Managers don’t realise there are criminal sanctions including imprisonment as well as administrative sanctions (fines) in many jurisdictions for breaches of fund marketing and/or licensing rules. Read more about enforcement in our Blog, Punitive Fund Marketing Regulations Sanctions: Enforcement indicator? (the 10-year imprisonment club)
- Litigation Risk: Investors can sue the AIFM/Asset Manager on the basis that the AIFM/Asset Manager broke local laws and regulations for the marketing of funds to the investor in their country.
- Investor Rescission Rights Risk: Litigation and investor rescission rights risks frequently go together. The result: Investors will want their money back. If you breached country fund marketing laws when you marketed and sold the fund to the investor, in effect, you are handing out free put calls (“free puts”) to the investor – “free” to the investor but very expensive to the AIFM/Asset Manager, of course. Read our Blog, Trifecta of Trouble & Free Put 101: What happens when investors sue Case Study: FRANCE
- Business Franchise Risk: Breaches of local marketing regulations can subject the AIFM/Asset Manager to potential business franchise risk. Why would fund managers want to subject their precious and growing business franchise to excessive risk of failure?
- Reputation Risk: Reputations are hard-earned, so why would the AIFM/Asset Manager want to be landed with a bad reputation for their own breaches of local regulations, which could in turn negatively impact their ability to fundraise from investors overseas?
Is the 2nd Risk Whammy – Distribution Risk – inevitable during times of market volatility?
Possibly. It depends on whether you have a robust cross-border compliance program in place. If you have complied with all country’s marketing laws when you marketed and sold your fund to investors and have a robust set of compliance books and records to prove it, then you may not have to deal with Distribution Risk.
If you don’t have any cross-border marketing compliance program in place, did not comply with country fund marketing regulations and have no books and records in place, you may very likely have to deal with Distribution Risk.
And the most likely risks out of the 5-Key Distribution Risks which will be triggered during market volatility are litigation and rescission rights risks. These risks can hit you hard, where it really hurts.
Litigation Risk: What is a fund manager’s “Trifecta of Trouble” when investors sue?
While each investor lawsuit filed against fund managers is based on the specific fact set of each investor, there are 3 key arguments used in court by investors which could represent a “Trifecta of Trouble” for fund managers if they were not compliant with local fund marketing regulations when they marketed and sold their fund to the investor.
Investor Argument #1: “You (the fund manager) marketed your fund to me in breach of my country’s fund marketing regulations. You breached my country’s private placement/fund passporting/notification/prospectus registration rules; therefore, all our fund contracts are null and void.”
Investor Argument #2: “You (the fund manager) marketed your fund to me in breach of my country’s licensing regulations governing the marketing of funds. You did not have a license to solicit your fund to me in my country; therefore, all our fund contracts are null and void.”
Investor Argument #3: “You (the fund manager) mis-sold your fund to me. You misrepresented the risks and did not provide me with key information and did not disclose it in your fund offering documentation and contracts; therefore, all our fund contracts are null and void.”
Summary
Managing Investment Risk during times of market volatility is hard enough for AIFMs/Asset Managers. Market pundits predict 2024 will be another markets roller coaster ride. But don’t make your life even harder by dealing with the Double Risk Whammy: Investment Risk AND Distribution Risk.
The way AIFM/Asset Managers can mitigate their 5-Key Distribution Risks when fundraising overseas, especially during times of market volatility (such as what we'll experience because of 2024 national elections worldwide) is to comply with country marketing rules at all times. Put in place a cross-border marketing compliance platform and document it with robust books and records to prove it.
Don’t give investors a valid reason to seek legal redress and rescission rights claims because you broke the laws in their jurisdiction when marketing and selling your fund to the investor. Cross-border compliance infrastructure can help you sleep well at night and curtail the Double Risk Whammy.
And don’t forget to wear that swimsuit when the tide goes out….
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