Fiona Le Poidevin, Chief Executive of Guernsey Finance – the promotional agency for the Island's finance industry, explains why Guernsey remains an attractive fund domicile amidst the introduction of AIFMD.
In October, the Alternative Investment Management Association (AIMA), together with EY, published the results of a survey which showed the inconsistency in approach from national regulators in how they are implementing the Alternative Investment Fund Managers Directive (AIFMD).
It followed a previous AIMA and EY report published in late July last year which showed that only 12 out of 31 European Union (EU) and European Economic Area (EEA) Member States had completed full legislative transposition of AIFMD by the 'deadline' of 22 July 2013. The conclusion we can draw from these reports is that, despite AIFMD being in effect for more than six months, it remains very much in its infancy and it is only during the coming year that its impact will become clearer.
However, some trends are beginning to emerge, including the fact that the Guernsey regulator approved 33 new funds in the third quarter of 2013 (also see box 1). The Guernsey Financial Services Commission (GFSC) approved five open-ended funds, 19 closed-ended funds and nine non-Guernsey schemes between the start of June and the end of September last year. These are investing across a wide range of asset classes and include two notable listed renewable energy funds, Bluefield Solar Income Fund and The Renewables Infrastructure Group, with city sources quoting the latter as the largest IPO of a clean energy firm in London.
Since then, we have continued to see new launches from Guernsey, including another listed energy investment vehicle in the form of the US$1.2 billion Riverstone Energy Limited, which in October became the largest cross-border IPO since November 2012. This shows that managers and investors remain attracted to what Guernsey has to offer at a time when there is so much uncertainty, not least as a result of AIFMD. Indeed, it is a major vote of confidence in Guernsey and in particular, the dual regulatory regime which Guernsey has put in place in response to AIFMD.
AIFMD seeks to regulate EU-based Alternative Investment Fund Managers (AIFMs), managers of EU established Alternative Investment Funds (AIFs) and managers that market AIFs into the EU. So, in essence, if either the manager or the fund has a relationship with the EU then the Directive comes into play. Guernsey is not in the EU (although it is in the European time zone) and therefore, is not required to implement AIFMD.
However, with Europe still one of our biggest markets, a large proportion of business relates to the EU in some form. Yet, we also have a substantial amount of funds business which originates outside of Europe and does not touch the EU at all. As such, the Island has introduced a dual regulatory regime so that it is possible to continue to distribute Guernsey funds into both EU and non-EU countries: the existing regime remains for those investors and managers not requiring an AIFMD fund, including those using EU National Private Placement (NPP) regimes and those marketing to non-EU investors; and there is an opt-in regime which is fully AIFMD compliant.
The first thing to note is that this means managers and funds with no connection to the EU continue to be able to use the existing regulatory regime which is completely free from the requirements associated with AIFMD and as such, will have significant operational and cost benefits. Secondly, Guernsey's position as a third country means our managers and funds who want to access Europe continue to be able to use NPP regimes, which it is expected will remain until 2018. GFSC has signed bilateral cooperation agreements with 27 securities regulators from the EU and the EEA, including the UK, Germany and France. Having these agreements in place means that Guernsey funds continue to be able to market to appropriately qualified investors in these European countries through their NPP regimes.
Thirdly, it is expected that a full passporting regime for non-EU AIFMs will be implemented from July 2015. Guernsey intends to ensure that our AIFMs will be ideally placed to take advantage of being able to market AIFs on a pan-European basis with a single authorisation, as passporting is currently envisaged to operate. Indeed, Guernsey introduced an opt-in AIFMD equivalent regime with effect from 2 January this year.
Optionality The attraction of Guernsey for fund managers wishing to market into Europe is that it can provide a European platform but one which is not actually in the EU and therefore can offer optionality. For those marketing into Europe, the NPP route will likely be favoured by many due to the depth and breadth of requirements that fund managers will have to satisfy under AIFMD. Indeed, it is expected that full-blown AIFMD compliance will only be sought if there are particular reasons to do so.
For example, it makes commercial sense for a fund manager marketing almost exclusively to Europe to have a fully AIFMD compliant platform. However, this does not have to be based in a mainland European domicile and indeed, it could be a Guernsey platform because the Island has also introduced a fully equivalent, opt-in AIFMD route to market. However, managers should look carefully at whether the pan-European passport offered is relevant to their investor base.
Many managers have increasingly geographically diverse investors and therefore it is essential to have a platform which suits all. European Directives – such as AIFMD but also the Undertakings for Collective Investment in Transferable Securities (UCITS) Directive – cater for European investors; as such, if you don't need UCITS/AIFMD or only need limited access to them for certain investors, then it is advisable (and possible) to structure in a way that will greatly reduce the compliance obligations and costs that come with those regimes.
For those managers with elements of EU and non-EU business, the potentially onerous administration burden and costly compliance with AIFMD will mean that parallel structures are likely to be given serious consideration. It will be possible to break the non-EU business away into a parallel or feeder structure for which AIFMD compliance would neither be required nor necessary.
Conversely, if a manager has a platform in a mainland European domicile then it will have to comply fully with AIFMD even if there were a large proportion of non-EU investors. European mainland platforms do not offer the ability to separate the reporting obligations away from non-EU investors, as with a Guernsey platform.
A June 2013 survey of European asset managers by fund software provider Multifonds showed that 77% of respondents were considering establishing AIFs for non-EU investors 'offshore' as a way to put them outside the scope of the Directive.
One option might be for a non-EU AIF to opt to be self-managed and therefore a non-EU AIFMD but this will be subject to proving sufficient substance to the arrangements. So called 'letter box' entities cannot claim to be managers and substance will be required in a jurisdiction where a manger is claiming to be domiciled. Similarly, the extent to which activities such as portfolio and risk management can be outsourced must be considered and care must be taken to ensure that the real decision making powers lie with the entity that is claiming to be the manager.
This might, in certain circumstances, encourage investment houses to build up their presence offshore and perhaps take back in-house some of the functions which have been previously outsourced. Guernsey has a huge advantage as a fund domicile in the existing standards we already employ regarding oversight and due to the substance which is already present in existing Guernsey domiciled structures. For example, Guernsey already plays host to a number of major managers, such as Apax, BC Partners, Man Group, Mid Europa,
Permira and Terra Firma which all have offices and staff in the Island.
Yet, there is a potential tension between the need for robust substance in third country arrangements (with the associated implications of possibly moving functions in-house) and capacity for investment houses to be able to deal with the increased requirements from AIFMD and other regulatory initiatives. There are also a range of fund administrators, ranging from major international names to boutique, independent operations, coupled with a significant pool of qualified Non-Executive Directors in Guernsey, who are experienced in providing management functions.
Guernsey's advantage is that it not only has experience of investment houses establishing operations in the Island but it has the infrastructure, such as fund administrators, which can not only provide support to in-house teams but also can provide third-party services. Quality of service is evidenced by the fact that Guernsey providers now not only administer or manage assets of Guernsey open and closed ended funds but also more than £90 billion worth of assets from open-ended funds which are domiciled in other jurisdictions, typically the Cayman Islands, where there may be local substance challenges.
Unlike many competitor jurisdictions, Guernsey also already has well-established custody businesses. They provide dealing and settlement and also offer services over and above traditional custody services to encompass robust support for corporate governance, often performing a fiduciary role. Yet, much of Guernsey's core business of closed-ended private equity and real estate funds will be able to access AIFMD's lighter touch regime for non-financial assets that permits a wider range of entities, such as lawyers and registrars, to carry out custody functions, thus benefitting from cost and operational advantages of not requiring a formal custodian.
We are already seeing some Guernsey based administrators setting up depositary functions. They are targeted at the likes of private equity and real estate clients who are new to the requirement for a depositary and may be most likely to favour a bespoke 'one-stop shop' for their third-party administration and depositary services. Having said that, there is also a need to consider the fact there are also established custodians who already provide a specialist service, including independent oversight. It should be emphasised that any arrangements also need to have sufficient substance to work not just from a regulatory perspective but also in terms of tax, for example corporate residence as well as the implications of VAT and transfer pricing.
Guernsey's position as a third country, its dual regulatory regime and its infrastructure and expertise mean that in light of AIFMD it offers a different proposition to those jurisdictions in the Caribbean and those in mainland Europe and one which we believe makes it more attractive for funds to (re)domicile or co-domicile in Guernsey.
Originally published in Clear Path Analysis' Re-domiciling and co-domiciling for fund managers 2014 report, January 2014.
For more information about Guernsey's finance industry please visit www.guernseyfinance.com.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.