Paul Scrivener, partner with Cayman law firm, Solomon Harris, explores the interaction between the two jurisdictions when it comes to funds of hedge funds
Switzerland is a particularly interesting jurisdiction when it comes to the alternative investments industry. In 2007 the Swiss Federal Banking Commission (SFBC) issued a report on hedge funds which revealed that approximately 5 per cent of all assets invested in Switzerland are invested in hedge funds. Other statistics show that some US$200 billion is invested through Switzerland into funds of hedge funds (FOHFs) representing around one third of total global assets invested in FOHFs. Only the United States is larger in terms of investment into this segment of the alternative investments industry.
Whilst Switzerland is clearly a major buyer of hedge fund products, surprisingly, it has been less successful, compared to London, in attracting hedge funds managers to set up in Geneva, Zurich or Zug. However, that could be changing as Switzerland sees the advantages for its huge financial industry of offering itself as an attractive location for hedge fund managers to live and work. Over the past twelve months or so there have been definite murmurings in this direction with the Swiss finance minister having held a series of meetings with bankers to discuss possible tax incentives for the hedge fund industry and the SFBC recommending changes to both the tax and regulatory regimes with a view to luring European hedge fund managers away from London.
We will have to wait and see whether there is the political will to carry through the necessary changes. However, even if hedge fund managers do not ultimately swap Mayfair for the shores of Lake Geneva or Lake Zurich, one thing is clear: Switzerland's appetite for FOHFs is as strong as ever. On the back of Switzerland's role as a huge purchaser of hedge fund products, it seems that large, medium and even small players in the Swiss financial industry are setting up FOHFs. There is no doubt that this sub-set of the overall hedge fund industry is keeping Cayman lawyers very busy and my own firm is no exception in that respect.
Why are these FOHFs being set up in the Cayman Islands? Legal and regulatory constraints largely prevent Swiss-based sponsors of FOHFs from setting up the fund within Switzerland. They therefore typically turn to the Cayman Islands as the jurisdiction to establish the fund vehicle, which will generally be a Cayman Islands company. It is the usual factors which attract these sponsors to the Cayman Islands – well-established legal regime, an absence of burdensome regulation, political stability and a speedy and efficient set up process by highly experienced professionals.
So, who are these sponsors and why is there such a need for FOHFs in Switzerland? The type of sponsor and their objectives can be quite diverse. In Geneva there is a significant pool of independent asset managers many of whom have left private banks to start up on their own with seed capital from clients of the bank. This might be called entrepreneurial start ups and a key component in the start up will be the establishment of an offshore FOHF through which the manager will manage the assets of his clients. Typically, these managers will require significant assistance from their Cayman counsel in the set up process because, for most, whilst managing money is second nature, running an investment management company and the intricacies of setting up and operating a fund, are not.
Another sub-set is the family office for whom a FOHF can be a very convenient structure to place assets under one convenient umbrella providing not only privacy but also access to the markets at a wholesale level.
A different type of FOHF sponsor would be a Swiss bank looking to "package" their investment management offering to high net worth individuals in a cost effective manner without burdensome regulation. This will particularly be the case for clients of the bank whose net worth may not be of a size where a managed account is practicable. Again, for these sponsors, the Cayman Islands is, by far, the domicile of choice for their fund vehicle and most Cayman counsel have significant experience in guiding them through the entire process from start to finish, not to mention offering ongoing support as legal issues arise during the life of the fund.
In Zurich, the FOHF industry is much more focused on an institutional client base and, in particular, Swiss-based pension funds and large corporations. In these cases, the sponsor will often be an investment advisor guiding large institutions who may be looking at alternative investments for the first time or who may be increasing an existing modest allocation to hedge fund products. Again, a FOHF is a very convenient vehicle to allow such institutions to "test the waters" beyond the long-only world. Zurich-based, Harcourt Investment Consulting AG is a good example of this type of sponsor.
An interesting development in recent years, is the growth in Switzerland of what might be called "incubators" for fund of hedge fund managers. There are financial firms that can see the distinct advantage of offering a "ready-made" fund structure to fledgling managers allowing those managers to focus their efforts on managing assets rather than worrying about set-up and regulatory issues. In these circumstances, the fund is not infrequently set up as a Cayman Islands segregated portfolio company, a specific type of company which can establish cells which are statutorily ring-fenced from each other thus ensuring that the liabilities of one cell do not diminish the assets of another cell.
Whatever the type of Swiss sponsor coming forward to set up an offshore FOHF, a frequently seen feature of the structure is the establishment of an offshore (typically, Cayman Islands) asset management company that will enter into an investment management agreement with the Cayman Islands FOHF. The sponsor will generally wish to have limited or no involvement in the offshore asset management company and the board of directors will frequently comprise independent directors residing offshore. The offshore asset management company will then engage the sponsor, or an affiliate company of the sponsor, as its investment adviser and so it is at this level that the sponsor plays a role in the operation of the fund. This type of structuring is generally tax advantageous for the sponsor and may offer regulatory advantages.
It is a very positive to see Switzerland's aspirations to attract hedge fund managers. Solomon Harris is the first Cayman Islands law firm to have set up an office in Switzerland with a view to further developing our Swiss and European funds practice, and therefore it will come as no surprise, that we are very supportive of the initiative. Whether or not there is an influx of new hedge fund managers into Switzerland, we certainly do not see any let up in the formation of FOHFs by players in the Swiss financial industry and there is no reason why the Cayman Islands should not remain as the domicile of choice for such funds.
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