In or Out: You Decide - April 2019
International eyes are on London as the UK government seeks to find a path forward on Brexit. Meanwhile, life goes on in the asset management industry, and against a backdrop of uncertainty fund managers still have to decide where they wish to establish their operations and where to form their investment funds. Leaders of our European funds team have worked together to provide a brief comparative overview of each of the European jurisdictions in which we are licensed to form and administer investment funds, three in the EU (Cyprus, Luxembourg and Malta) and one outside it (Guernsey).
Trident Trust provides its fund administration services to non-retail alternative investment funds, so this article is aimed at private equity, real estate, debt and hedge fund managers, as well as traditional non-UCITS liquid investment strategies.
The key point at which to start is "where does your fund need to be located to satisfy your investors?" If you have a key investor who will not commit capital to a non-EU incorporated vehicle, then clearly an EU incorporated vehicle will be required, and the reverse is also true. A particular challenge occurs if potential investors include some institutions unable or unwilling to invest into a non-EU incorporated vehicle, alongside others who do not wish to invest in an EU incorporated vehicle. In these instances, it may then be necessary to launch parallel fund structures with different entry points: for example, one for marketing to EU investors, another for those investors who prefer a non-EU vehicle, such as Middle Eastern or Asian investors, and maybe another for US investors. The introduction of the Luxembourg limited partnership as a replicate of the traditional Anglo-Saxon partnership significantly simplified the life of global managers and their lawyers by making it very easy to incorporate an EU arm to a larger private equity structure.
Some good news for Guernsey is that, as a result of the confirmation from the European Council of Finance Ministers (ECOFIN), the island is considered a transparent and cooperative jurisdiction by the European Union. The European Investment Fund is therefore permitted to invest into Guernsey funds.
If the potential investors are not yet known, then the more pertinent question is: “Where do you intend to market the fund?” If the answer is across the EU, then it would seem logical that the fund be incorporated in the EU and benefit from the EU passport by appointing a full AIFMD licensed manager (AIFM). Luxembourg, and on a smaller scale Malta, have been experiencing significantly increased inflows of new business as a result of the uncertainty over Brexit and the attraction of the EU marketing passport. The new lighter RAIF/NAIF regimes (available in Cyprus, Luxembourg and Malta) have helped reduce the time to market of EU passported funds by focusing the regulatory oversight at the manager level and removing the additional regulatory oversight at the fund level.
However, Guernsey funds can also be marketed into a number of jurisdictions within the EU through national private placement rules. As only 3% of EU domiciled AIFs are registered for sale in more than three EU Member States, the benefit of having an EU-wide marketing passport may be of limited value for many funds. One of the largest pools of capital in Europe remains the UK, which is very much open for business from a Guernsey perspective, irrespective of the outcome of Brexit negotiations.
If a fund manager knows who the investors in a new fund are likely to be and where they intend to market their proposed new fund, the manager’s next consideration is perhaps: “Where will the fund invest?” At this phase of decision making, withholding taxation considerations may have a significant impact, especially for those funds which will invest in income generating assets, such as real estate and debt. For those asset classes, jurisdictions with double taxation agreements with the countries where the underlying assets are going to be situated will be of particular interest. For this reason, Luxembourg is a preferred jurisdiction for Western European real estate, while Cyprus is favoured for Eastern Europe real estate investment. In some instances, the fund vehicle is incorporated in a specialist fund jurisdiction for ease and simplicity, and underlying holding companies or special purpose vehicles are formed for the purposes of holding each asset and to ensure that there is not a second layer of taxation incurred in the fund.
A note on taxation: funds are nearly always tax exempt irrespective of where the fund is formed, whether "onshore" or "offshore", in the EU or outside the EU. The investors in the funds must pay taxation in their home countries if they make gains or receive income from their investments. Taxation at the investment fund level is therefore not a key differentiator between the various investment fund domiciles available, other than as mentioned above if investing through a non-treaty jurisdiction would incur taxation unintentionally.
Choice of Vehicle
The investment vehicle of choice may also make certain jurisdictions of greater interest than others. In the private equity industry, for example, the investment vehicle of choice is the limited partnership. English, Scottish, Guernsey, Cayman and Jersey Limited Partnerships have been very popular historically. Luxembourg now with its own limited partnership law has begun to capture market share. Guernsey’s claim to fame is the invention of the protected cell company, variants of which have been introduced in Cayman, BVI and Jersey, sometimes using the name “segregated portfolio company”. In UK real estate, the property unit trust has been very popular in the Channel Islands, especially in Jersey, where the acronym “JPUT” has become an everyday expression.
Certain jurisdictions have also developed a reputation for understanding certain asset classes better than others and having service providers that specialise in different asset classes. For example, Guernsey is best known for private equity, while Jersey is well known for real estate structures and Cayman is renowned as a hedge fund domicile. But in reality, each of those asset classes can be administered in each of the three jurisdictions. In the EU, Luxembourg has taken the lion’s share of the private equity/real estate funds, while Ireland focused more on hedge funds/UCITS, with Malta and Cyprus attracting smaller size hedge fund managers across strategies.
Accessing investors in the UK can also be achieved through a London Stock Exchange (LSE) listing and Guernsey has developed a strong leadership position in the niche described as “LSE listed funds”: this is not a specific asset class but a unique type of closed ended fund with a listing on the LSE, which is primarily of interest to UK-based wealth managers who utilise this structure to access illiquid assets for their private clients.
The Regulator in any jurisdiction also has a major part to play. The responsiveness of regulators to commercial pressures, like speed of turnaround on applications and responsiveness to emerging industry trends, can provide smaller jurisdictions with a competitive advantage. For example, Guernsey’s Private Investment Fund regime has a one-day approval for both the manager and the fund itself to be registered by the regulator and Malta’s regulator has responded very quickly and positively to the emergence of crypto currencies as an asset class. This has meant that Maltese-based service providers such as Trident Trust are developing expertise in this new asset class.
Further factors to consider may be cost, speed to market, language and culture. Each jurisdiction has its own regulatory requirements and processes, and these may provide fast track approval processes for funds for certain categories of investors.
While it currently remains uncertain when or indeed if the UK will actually leave the EU, we can be sure that the EU and its regulatory regime, including the Alternative Investment Fund Managers Directive, will continue to exist and that those funds formed in the EU will still be required to comply with it, while those outside the EU will not. Alternative Investment Fund managers have a wide range of choices available to them with respect to fund domiciles in the same or similar time zones to them. Pools of capital exist both inside and outside of the EU.
Trident Trust can assist managers wherever they and their potential investors are located and in whatever asset class they intend to invest. For further information and to discuss your needs, please contact your preferred Trident Trust funds contact.