By Andrew Shrimpton, Chair, Regulatory and Compliance Solutions
The Financial Conduct Authority (FCA) launched a new five-year strategy on 25 March 2025 with a key priority to “support sustained economic growth, by enabling investment, innovation and ensuring the continued competitiveness of the UK’s world-leading financial services”. Third-party alternative investment fund managers (AIFMs) have a key role to play in this regard, operating as regulatory incubators for investment firms, allowing them to test new investment strategies and business models, thereby supporting innovation and the competitiveness of the UK asset management sector. But how do you make sure your AIFM host is doing their job properly?
Under the Alternative Investment Fund Managers Directive (AIFMD), funds are required to have a manager with the correct regulatory permissions. Firms can choose to do this themselves but some appoint a regulated third party as their AIFM host. While AIFMs must conduct a detailed risk assessment of every incoming fund during onboarding, responsible funds should also complete due diligence of their own when selecting an AIFM. Considering the increased regulatory scrutiny of the hosting sector, it’s in the interests of every fund to ask the right questions and ensure their AIFM isn’t cutting any corners.
Here, we share five key questions a current or prospective fund should ask its AIFM host to assess if they can meet the regulatory requirements and are likely to be able to provide services in the long term.
1. How are conflicts of interest managed?
It’s critical to assess how your host AIFM manages conflicts of interest. A key conflict arises because funds are paying for a service, so the firm may be incentivised to reduce its onboarding due diligence and its oversight to bring on and retain more business. There is a real risk that the firm’s senior management prioritises commercial goals ahead of adequate and robust oversight.
We recommend reviewing the FCA register to assess if the firm’s board and senior manager appointments are sufficiently experienced to provide adequate governance. It is particularly important to check if the CEO (SMF1) and the Compliance Officer (SMF16) roles are not held by one person. We believe that the conflict can only be effectively managed by appointing one person as SMF1, responsible for commercial targets, and a separate, suitability experienced and competent person as SMF16, responsible for compliance and able to challenge decisions made by the SMF1 when necessary. It might also be worth considering whether there is a suitably qualified independent Board chair.
2. Do you have sufficient expertise to oversee different asset classes and trading strategies?
It has always been important for AIFMs to understand the investment strategies of their funds, and increased expectation for robust oversight makes it doubly so. A firm needs expertise in different asset classes and investment strategies which could include both illiquid investment strategies such as private equity, real estate, venture capital and private credit as well as liquid strategies such as long-only equity, long/short equity, fixed income arbitrage, and managed futures.
For example, the AIFM cannot appropriately oversee a managed futures fund that invests in commodity futures without understanding that asset class and its associated complexities. A responsible firm should limit their activity to the investment strategies they thoroughly understand.
3. How do you ensure effective oversight of liquid and illiquid funds?
We recommend asking if, during onboarding, a thorough and detailed risk assessment is carried out to determine the level and type of fund oversight needed to mitigate risks.
For illiquid funds such as private equity and real estate, an FCA-authorised investment adviser (which can be an appointed representative of the AIFM host) sources deals and undertakes detailed due diligence on private assets, recommending investments and disposals to the AIFM’s Investment Committee. Periodic fund valuations are overseen by the AIFM’s Valuation Committee. It is key to have formal governance structures, detailed policies and procedures and sufficient expertise for the committees to provide robust oversight. The host should be able to demonstrate compliance with the recently released FCA guidance on private market valuation practices.
For liquid funds such as hedge funds, AIFMs can use the host model to employ staff on secondment from a third party to help manage the AIF. In this model, the seconded staff help the AIFM to carry out regulated tasks; for example, portfolio management of assets of the AIF, or investment and risk reporting to investors. The AIFM needs robust post-trade daily monitoring in place to review all fund-related trading activities and transactions conducted by secondees including meeting its responsibilities for “best execution” of transactions. The AIFM also needs to monitor investment and liquidity risk with clear escalation procedures when limits are breached.
For both illiquid and liquid funds, we recommend assessing if the operations and portfolio monitoring teams are adequately resourced to conduct structured and detailed oversight, with adequate reporting of findings to the internal portfolio monitoring and risk committees. This should include annual fund reviews covering “target market assessments” and “stress testing”, as required under the FCA PROD rules.
4. How is market abuse risk monitored?
The FCA highlighted the need for adequate market abuse risk monitoring in its May 2019 “Dear CEO” letter to regulatory hosts. We recommend asking if the AIFM has undertaken a comprehensive firm-level assessment to clearly identify its regulatory obligations under the FCA’s Market Abuse Regulation (MAR).
A fund-level assessment should inform the proactive daily monitoring of the trading activity of funds to detect and report suspicious transactions and orders. The FCA expects firms to adopt an automated trade surveillance system rather than rely on a manual approach.
5. How is AML and sanctions risk monitored?
Another reason to review the FCA register is to assess if the firm has appointed a dedicated MLRO (SMF17) responsible for financial crime oversight. A fund’s investors, UBOs of portfolio companies and secondees should all be subject to daily screening for sanctions, politically exposed persons (PEPs) and adverse media, and any positive matches should be effectively assessed, escalated and remediated. With the current levels of elevated sanctions risk, we further recommend checking if the firm has invested in technology that allows automated daily screening of sanctions lists so that new additions can be identified and remediated promptly to mitigate the risk of providing AIFM services to sanctioned individuals or entities. For illiquid funds, investment or transactional KYC needs to be undertaken on the sellers of a private asset when the fund is acquiring it and the buyers of a private asset when the fund is selling it.
IQ-EQ is the leading provider of regulatory hosting solutions and AIFM and depositary services in the UK. We have well-established expertise and a strong track record in helping global asset managers access European investors, with regulated third-party AIFM platforms not only in the UK but also Luxembourg, France and Ireland. Find out more about our comprehensive regulatory compliance offering and get in touch today.
