In September 2018, Intertrust hosted a fund structuring panelled discussion and networking breakfast in São Paolo for our Brazilian clients and business partners. The panelists discussed various structuring issues and topical challenges and how these industry shifts support the use of key offshore fund jurisdictions of Cayman, BVI and the Bahamas.
The panel opened by tackling the elephant in the room: the pace of regulatory reform. While it was noted that the key offshore jurisdictions remain some of the easiest and appealing places to establish funds businesses, the industry has recently suffered as the market participants assimilated the requirements and inevitable cost.
Positive prevailing conditions but headwinds begin to blow
The panel and audience generally agreed the regulatory changes are positive—they've improved upon existing framework and increased transparency during the longest bull market in US history. But concerns remain around the practical implementation, especially around the most recent AML changes in Cayman.
This period of low volatility is creating a difficult market for start-up managers to differentiate themselves from lower-cost, less actively managed investments. The panel felt existing large managers were more likely to have necessary infrastructure and service provider contacts to manage and afford implementation, while continuing to attract capital. Smaller managers will continue to be challenged.
On regulation, the panelists agreed that clients and their local advisors are experiencing pain from the inconvenience and cost of addressing the regulatory initiatives. In addition to the AML reforms in Cayman, a beneficial ownership regime, GDPR compliance, FATCA and Common Reporting Standards tax reporting have been instated. These changes were implemented at a time when the Cayman Islands Monetary Authority (CIMA) was also rolling out its penalties and enforcement regime, essentially providing the regulator with teeth to address instances of non-compliance.
As a counterpoint, it was noted that part of the attraction of Cayman as a favoured jurisdiction is the very fact that it is considered safe and well regulated. When the audience asked whether this was the time to move business away from Cayman to other funds jurisdictions where the regulatory regime was currently less onerous, the panel suggested that Cayman is actually at the vanguard of implementing these requirements and that other jurisdictions would be following suit shortly; re-domiciling or establishing funds elsewhere for this reason alone was considered myopic.
With the upcoming elections in Brazil there is a level of uncertainty in the market, and investors are delaying capital deployment pending clarity on the next administration. Doubt over the future tax regime is exacerbating decision-making uncertainty. However, current favourable Real:US Dollar exchange rate combined with opportunities in private equity, distressed assets and infrastructure has led to further international investment, especially as local pensions were previously barred by regulatory restrictions. Within this context, the AUM of funds products managed locally has increased by 28% since 2015. This compares favourably to the 18% gain experienced in fixed income.
Our panelists focused on the offshore trends, including the full implementation of CIMA's enforcement and penalties regime, the introduction of the Cayman Islands version of GDPR (the Data Protection Law) and the expectation that the global trend for increased substance would be rolled out further.
The panel and audience agreed substance requirement headwinds would likely result in more back office functions performed locally. For example, Luxembourg's keeping of accounting books and records is considered integral to substance and Ireland requires directors to be residents. Clarity on this subject will develop following the forthcoming Brazil elections when potential reforms will become known.
Larger managers will continue to attract more capital than emerging managers do. Additionally, managers are becoming more innovative, for example, with the use of separately managed accounts for clients seeking lower costs and better returns but also assuming higher operational risks. Similarly, it is expected there will be further consolidation among service providers as smaller administration players continue to be challenged to stay abreast of and provide solutions to their client's international regulatory and structuring requirements.
The key Caribbean funds jurisdictions of Cayman, BVI and the Bahamas remain the domiciles of choice for Brazilian investors. The advancements in regulation have further enhanced their reputations. That said, the pace of change and associated costs have left market participants looking twice before forging ahead with new deals.
The funds market has never been more complex with the increased cost of compliance and risk of non-compliance. From the uncertainty of Brazilian legislative change post elections, to the speed of offshore and onshore regulatory change, partnering with the right service providers was seen as critical for the ongoing integrity of any funds structure. Track record, reputation, size, quality of service and cost should all be considered when selecting professional services firms to partner with.
We look forward to continuing leading discussions around key issues impacting Brazilian fund managers and their service providers as the market continues to develop and grow.
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