Originally published in HFM Week, Guernsey Special Report, June 2010
With fund managers having to make difficult decisions after the global economic downturn, Barney Lee of Appleby explains why Guernsey's sensible regulatory systems can give managers all the support they need.
It is a difficult time for fund managers at the moment. European sovereign debt problems, uncertain markets and troubling fundamentals in many of the world's major economies make things difficult enough without the need to reconsider what is an appropriate level of regulation for fund products. However, all of these factors (and others) are making investors nervous which means managers are reviewing their domicile of choice.
A side effect of the global financial crisis was the flurry of distressed fund activity brought about by plummeting asset values, illiquidity, investor fear and, in some cases, fraud. These issues created sound bites for the mainstream media which in turn lead to hedge fund regulation becoming a daily news item and, consequently, a political issue.
Importantly, the key regulatory failings, to the extent there were any, existed onshore rather than offshore. However, the media frenzy, combined with government balance sheets moving into the red, meant that the mythical tax windfall which could be captured by clamping down on the offshore world lured policymakers into focusing their attention offshore (as well as onshore). While it is a well trodden path to state that certain regulatory responses are populist and do not understand the fundamentals behind the problems to have struck the global finance industry, the question for fund managers is how to identify jurisdictions for their products in light of all that has happened.
The current negotiations between the European Commission, European Parliament and European Council to reconcile the differing versions of the alternative investment fund managers directive (the AIFM directive) is a case in point. Analysis of the AIFM directive has been done to death but it is expected negotiations will continue until July or August, when a text will be agreed and put to a vote.
Guernsey, as the major non-EU offshore hedge fund jurisdiction, is clearly concerned as to these developments. Notwithstanding this uncertainty, Guernsey funds under management (both open-ended and closed-ended) have increased 12.2% over the past 12 months.
Guernsey has also seen a number of major fund players, the most recent being Bluecrest, move operations to the island. Clearly there is some confidence in the offshore world and Guernsey in particular. The question is, what is the source of this confidence?
There is obviously some political game-playing underway between the three EU bodies and it is rumoured that certain parts of the AIFM directive that were required to reach this stage for political reasons may fall away. However, speculating on such machinations is not a sensible way to do business and the managers who are putting their faith in Guernsey have not got to where they are without more concrete grounds for making decisions.
Guernsey's appeal lies more in its long-term game. It has always positioned itself as a sensibly regulated offshore jurisdiction. It has avoided the light touch regulation of the likes of the Cayman Islands and has sought a middle ground between that and the more heavily regulated onshore jurisdictions and onshore/offshore jurisdictions such as Luxembourg. In recent times, it has also stolen the march on its like-for-like competitors with there being a perception that the Guernsey regulator is more flexible than counterparts elsewhere and that Guernsey is a more cost-effective place to do business.
Further, the introduction in 2008 of the fast-track registered fund regime, which has now been adapted to include open-ended funds, has resulted in a lighter front end regulatory burden while still maintaining sufficient regulatory oversight via Guernsey-licensed service providers. Guernsey is also the home of the protected cell company (PCC), introducing the first such legislation in 1997 and continuing to develop the concept. PCCs, and their hybrid, the incorporated cell company, are a particular favourite for Guernsey hedge fund products allowing reduced administrative costs while providing the flexibility of multiple products in the same vehicle.
Over the past two years this sensible but flexible regulatory approach has borne dividends. While Guernsey hedge funds have experienced the same issues as elsewhere in respect of gating, illiquid assets and redemptions, these problems were market-driven and the level of hedge fund litigation in Guernsey has been proportionately lower than, for example, Cayman. This reflects positively on Guernsey's fund infrastructure, its service providers and, importantly, the sensible regulatory regime Guernsey has adopted.
Guernsey is aggressively looking to new markets. Cayman in particular has long had a significant advantage in Asia and the Middle East in terms of market awareness. This is partly due to the commendable foresight of various Caribbean service providers who were able to break into those markets early. Given the same structures can be established in Guernsey, it provides the option of a product with additional regulatory safeguards, together with the convenience of a far more compatible time zone. Geographical proximity allows board meetings to be held in person as well as access to service providers when required. Market awareness and, consequently, business derived from these areas is increasing. The Latin American market is another which is proving to be more aware of Guernsey than in the past.
In these times investors are increasingly looking for comfort from the regulatory regime in which a fund is domiciled. Managers must balance this investor demand with the compliance obligations imposed by the jurisdiction. Guernsey is able to provide investors with a jurisdiction that is known to be well regulated while still providing the fund manager with regulatory and operating costs that are reasonable in the circumstances.
The AIFM will almost certainly introduce additional hurdles to offshore funds. However, it is expected that Guernsey's sensible regulatory regime will be able to easily adapt to the proposed equivalence regimes. Guernsey is also cementing its reputation for providing services to non-Guernsey vehicles. The Channel Islands Stock Exchange, which is based in Guernsey, is a good example of this but there are also almost 300 non-Guernsey funds that use Guernsey licensed entities, such as managers, administrators or custodians. While a large proportion of these funds are Cayman Island funds, there are also a number from Luxembourg, the US, Mauritius, Ireland and even Australia.
It is probably fair to say that regardless of the form the AIFM takes, Guernsey will have a role to play in the offshore world in respect of funds. If trends continue, Guernsey's sensible level of regulation, sitting neatly between the jurisdictions that are not as well regulated and those that are heavily regulated, is likely to prove increasingly attractive.
The AIFM directive may prove to be advantageous to Guernsey in some respects as it is quite possible that many more non-Guernsey schemes will move to Guernsey to take advantage of its sensible regulatory regime.
For more information about Guernsey's finance industry please visit www.guernseyfinance.com
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