Originally published in the PERCIS, Autumn 2011
At the outset of reading this article you may be questioning the connection between Russia and Guernsey.
You will need no introduction to the former, which straddles Europe and Asia, is the largest country in the world by area and has a population of more than 140 million. By contrast, the latter is an island between the United Kingdom and France, 65 square kilometres in size and with just 62,000 inhabitants.
Here is the connection: Russia is quickly developing, particularly economically and therefore is accumulating increasing amounts of private and corporate wealth; Guernsey has, during the last 50 years, established itself as a leading international finance centre – the Island has a wide range of providers offering a diverse suite of financial products and services to clients from around the globe, including Russia and Eastern Europe more generally.
There are already a number of high net worth individuals utilising Guernsey's experience and expertise in providing private client services to maintain and indeed, enhance their wealth through trust and company structures. In the last few years, there have been a significant number of investment companies and funds established in Guernsey (with many listed on major stock exchanges) as vehicles for investing into Russia. Many of these are private equity related, which is a specialist and growing area for the Island.
Now Guernsey is looking to specifically increase the amount of private equity business touching Russia that deals with its finance industry. I was part of a delegation from the Island that visited Moscow in May of this year so that we could be on the ground to see for ourselves the potential for closer business links between Russia and Guernsey.
A developing Russian economy
The most recent edition of 'Doing Business in Russia, 2011' by Baker & McKenzie highlights how during the last decade "prudent macroeconomic policies and renewed government efforts to advance structural reforms, have raised business and investor confidence" in the country.
It admits that "Russia was severely hit by the international financial crisis" and in 2009, GDP contracted nearly 8%. However, "the government has increased its efforts to safeguard the economy" and it did appear to stabilise during 2010. In fact, GDP recovered by 4% in 2010 and grew 4.1% year on year in the first quarter of 2011.
It is evident that Russia's economic growth and development means the country offers a lot of potential but there are also hurdles to overcome in terms of the perception of doing business in Russia. Indeed, senior representatives from Pictet Asset Management have been quoted within an article on www.thewealthnet.com that Russia is one of the cheapest markets in the global emerging market sector but it has a poor reputation and is therefore over-penalised for risk.
There is evidence to suggest that this is, to an extent, misplaced and reforms are slowly but surely coming through which will increase transparency and corporate governance standards. For example, Russia's President, Dmitry Medvedev, has recently recognised that the Russian business environment is in need of change and set a 1 July deadline for Prime Minister Vladimir Putin to oust ministers from the boards of large public companies, historically famous for their poor governance and lack of transparency, which has largely been successful.
This sort of thinking is a growing trend in Russia and as this evolves then doing business with Guernsey becomes an even better fit. In fact, one of the fund managers that already has Guernsey as home to its structures remarked that it chose the Island specifically due to our strong reputation for being well regulated and transparent.
The Guernsey-Russia connection
Guernsey has a unique environment:
- Situated in Europe between the United Kingdom (UK) and France.
- A British Crown Dependency
- A special relationship with the European Union (EU)
- English speaking
- Currency: British pound Sterling (GBP)
- Same time zone as the UK
- Links to both London and Europe
This environment has attracted several hundred financial services firms so that the Island's finance industry comprises a balanced range of providers, broadly comprising:
- Investment funds
- Asset management and stockbroking
- Fiduciary services (trust and company administration)
- Professional support services, such as multi-jurisdictional law firms and the 'big four' accountancy firms, as well as:
- the Channel Islands Stock Exchange (CISX)
- a Guernsey Registry for company incorporation and Intellectual Property (IP) and
- a bespoke professional development facility, the Guernsey Training Agency (GTA) University Centre.
There is a team spirit amongst these providers who work within the regime of an independent regulator, the Guernsey Financial Services Commission (GFSC).
Then there is Guernsey Finance, which is the joint government and industry agency responsible for promoting the Island's finance industry internationally. We work closely with the sector associations such as the Guernsey Investment Fund Association (GIFA) and also specifically-orientated organisations such as the Guernsey Russian and Eastern European Financial Forum (GREEFF).
Stuart Phillips, Chairman of GREEFF, has said: "The level of private equity interest in Russia is growing once again, as its economy forges ahead and the domestic investment climate matures. As conditions improve, more and more Russian companies are seeking additional capital to develop. Historically, internal cash flow was the primary source of finance for investment but improved market access now means that Russian assets, which remain priced at comparatively low levels, are attracting a lot of attention, particularly when you consider that target companies have limited alternatives to expand.
"Investors in this region benefit greatly from the services offered by Guernsey's private equity specialists throughout the lifecycle of their investments. Practitioners in the Island have been working in this sector for well over a decade and have developed platforms and technology tailored to the needs of private equity. Together with the independent regulator, international accounting and law firms based in the Island complete the service offering to private equity.
"As important as all this though, are the strong personal relationships that the Island has built over the years with key players in the private equity industry. These are what really stand Guernsey apart as the jurisdiction of choice for private equity."
GREEFF was formed by a group of firms and their associated practitioners who are already, or who are interested in, conducting business in the region and want to bring further business flows to Guernsey. Representatives from this group, including Stuart Phillips, the Chairman of GREEFF, were part of the delegation to Moscow earlier this year to speak face-to-face with existing contacts and develop new leads.
The group had a wide range of meetings which were very productive. They reinforced our thoughts about how the region's development means there is considerable potential for servicing the needs of private and corporate clients; and in addition, there was significant interest from those in Moscow about what Guernsey can offer in terms of financial services.
Our visit indicated that there are three principal areas where Guernsey can offer services to clients with Russian-related business: overseas investment into Russia via 'offshore' fund vehicles; Russian institutions seeking an overseas structure for investment back into Russia; and the allocation of Russian wealth outside of Russia.
The allocation of Russian wealth outside of Russia
A significant number of high net worth individuals in Russia use 'offshore' trusts, foundations or other structures as asset protection and yet, beyond this, much of the wealth remains within the country. This is partly due to the 'spend now' mentality but also due to the structure of the pension and insurance markets, Reforms appear to be in the pipeline but even if they are introduced, it will be some time before they have an impact and will also need to be accompanied by a change in mindset if they are to lead to increased investment in non-Russian products, such as Guernsey-domiciled funds.
Russian institutions seeking overseas structures for investment back into Russia
Many successful Russian businesses are now looking to source further investment from overseas. Many domestic institutions in Russia, such as a number of banks, have links with the state or are part owned by the state. As such, there has been a growing appetite for stock market flotation, of a business as a whole or just a minority stake. Guernsey can offer a stable environment for structuring tax efficient vehicles which can be listed on a variety of exchanges providing for inward investment into these Russian institutions from the European capital markets.
Overseas investment into Russia via 'offshore' fund vehicles
'Offshore' fund vehicles can be established to provide overseas investment into Russia. These are often driven by the will of overseas investors but tend to be most successful where the manager has a presence in Russia and therefore a familiarity with the business environment. Guernsey is already home to several successful examples of such structures:
- Aurora Russia Limited is a Guernsey registered investment company. It was established as a Guernsey authorised closed-ended investment scheme regulated by the GFSC. From March 2006 it has been listed on the Alternative Investment Market (AIM) of the London Stock Exchange (LSE). A total of £73.9m has been successfully invested to date into a diversified portfolio of companies in Russia. Aurora Russia adopts a group structure typically employed by overseas owners of Russian investments; the investments of the company may be owned directly or through a special purpose company incorporated in a jurisdiction which enjoys a favourable double tax treaty with Russia, such as Cyprus. For more information visit www.aurorarussia.com
- Baring Vostok Capital Partners is one of the leading private equity firms operating in Russia and the CIS. The Baring Vostok Private Equity Funds include the Guernsey authorised closed-ended investment scheme, Baring Vostok Private Equity Fund IV. This was raised in February 2007 with total committed capital of US$1.1bn and at that time was the largest private equity fund in Central and Eastern Europe. For more information visit www.bvcp.ru/en
- PPF Partners Limited is a Guernsey-based private equity firm investing in Emerging Europe. The company believes there is significant value to be unlocked in companies throughout Central and Eastern Europe and the former CIS countries. PPF Partners' first fund PPF Partners 1 Fund LP was launched as a UK domiciled Limited Partnership in December 2008 with commitments of €615 million provided by three Limited Partners. The fund is represented by the Guernsey-domiciled PPF Partners 1 GP Limited, as the General Partner, and is managed by PPF Partners Limited from its Guernsey office. For more information visit www.ppfpartners.com
- Raven Russia Limited is a Guernsey registered property investment company specialising in commercial real estate in Russia. The ordinary share and warrants of the company are listed on the Main Market of the London Stock Exchange (LSE), with the preference shares of the Company trading on the Alternative Investment Market (AIM) of the LSE. The basic group structure includes the Guernsey investment company, a Cyprus holding company and a Russian subsidiary holding the underlying investments. For more information visit www.ravenrussia.com
Other examples of managers with Guernsey domiciled funds investing into Russia include Ashmore Investment Management and Prosperity Capital Management. Speaking to these sorts of players, we hear that they are attracted by Guernsey's political and economic stability, experience in the investment fund sector, specific expertise in private equity and in particular, the fact that we are considered a well regulated and transparent international finance centre.
Guernsey's private equity offering
Guernsey has an investment fund industry with a heritage that stretches back for over half a century. During the past two decades, the sector has seen a gradual yet sustained shift where the balance of business has moved from being largely retail, equity-traded/cash-based schemes to predominantly institutional, niche funds.
This period included significant growth, particularly of esoteric asset classes through the middle of the last decade. This experience means that the Island has built a wealth of expertise and first class infrastructure for the structuring, management, administration and custody of not just traditional funds but also alternatives, in particular private equity.
It could be argued though that the listing of the US$5bn Guernsey limited partnership KKR Private Equity Investors LP on the Amsterdam Euronext was so innovative that it has been the largest single contributor to the Island's recent success in this asset class. This highlighted that Guernsey was one of the few jurisdictions from which funds wishing to list on Euronext did not need to obtain a licence in the Netherlands because the Dutch AFM had ruled that there was already adequate 'home' supervision. It also put Guernsey on the map internationally, particularly in the US and is something from which the Island has never looked back as it has become – in the words of Bridget Barker, Partner at Macfarlanes in London – "the jurisdiction of choice for private equity."
Today, the net asset value of investment funds under management and administration in the Island stands at just over £274bn or US$422bn. The private equity and venture capital sector has seen especially strong growth during the last year, reaching a total net asset value of more than £75bn (US$115bn) at the end of June 2011. The Island's reputation for excellence in this asset class has been reaffirmed by a Private Equity News / State Street survey where more than three-fifths (61%) of Chief Financial Officers (CFOs) responding said that Guernsey was their preferred destination for private equity outsourcing.
Jon Moulton, Chairman of private equity firm Better Capital, gave a ringing endorsement of the Island's funds industry when speaking in front of more than 300 delegates at the Guernsey Funds Forum in London this May. Jon, who has a house in the Island and whose Guernsey-domiciled investment company is listed on the main market of the LSE , said: "Guernsey has a very good reputation; it works very well....Guernsey needs to carry on doing what it's doing into the future and it will prosper."
Another significant figure in the private equity industry is Guy Hands, Chairman of Terra Firma. As well as the private equity firm joining the likes of Permira and EQT by establishing an operation in Guernsey, Guy has also decided to buy a property and live in the Island. This reflects the fact that Guernsey is not just an ideal location for locating management companies but is also attractive as a residence for the managers themselves.
This is no doubt helped by the fact that Guernsey has a zero rate of corporate tax as standard, no withholding tax on dividends paid, no capital gains tax, no inheritance tax and no value added or general sales tax, and personal income tax remains levied at a maximum of 20%, with a cap of up to £100,000 on non-Guernsey source income or £200,000 on all income.
Our standing regarding private equity does not mean that we are in anyway a "one-trick pony". In fact, during the last year we have seen new investment structures launching across a range of niche asset classes, such as aircraft, classic cars, dispute resolution and movies which all add to the existing mix, which includes timber and renewable energy.
Our administrators and custodians do service non-Guernsey funds but a large proportion of their business relates to Guernsey open and closed-ended funds, which are now promoted and sponsored by leading institutions in more than 55 financial centres globally. These can be established through a range of flexible investment vehicles such as companies, unit trusts, the Guernsey-pioneered Protected Cell Companies (PCCs), Incorporated Cell Companies (ICCs) and limited partnerships.
There is a broad range of administrators in the Island, many of which have specific expertise and bespoke IT solutions for alternative assets. These include specialised private equity administrators such as Ipes, Augentius, International Administration Group (IAG) and Alter Domus, in addition to a list that includes globally recognised names such as HSBC, Northern Trust, RBC, State Street and JP Morgan who can also act as custodians.
Guernsey's funds industry can draw on the services provided by its banking, wealth management and risk management sectors. In addition, it is supported by a comprehensive network of investment, legal, tax, audit, accounting and actuarial advisers, including multi-jurisdictional law firms and the 'big four' accountancy firms where there is specialist expertise in alternatives.
The GFSC has grown a reputation for its robust yet pragmatic approach to regulation – for example, all Guernsey schemes remain regulated but 'fast track' routes have been introduced which allow for the speedy launch of funds where appropriate. In addition, Guernsey's skilled workforce not only has access to in-house training but also the GTA University Centre, which works with the Institute of Directors (IoD) to ensure that the Island has a pool of experienced and well qualified non-executive directors maintaining high standards of corporate governance.
One of the Island's great strengths is the ability for Guernsey vehicles to list on the local CISX (which now has more than 4,000 securities listed), Euronext Amsterdam or the LSE. Data direct from the LSE to the end of December 2010, shows that there are more Guernsey-incorporated companies and securities listed on its markets than there are entities from any other competitor jurisdiction. In addition, the Hong Kong Stock Exchange (HKEx) has formally approved Guernsey as an acceptable overseas jurisdiction for the purpose of companies incorporated in the Island seeking to list on the exchange.
The international stage
Receiving approval for Guernsey companies to list on HKEx is a very positive development for our finance industry in terms of doing business in Asia, which is a key part of our efforts to diversify our business flows from traditional centres such as the City of London to the 'emerging' markets that also include Russia.
However, Europe remains an important source of new business and that is why it was so important that we engaged early on in the discussions regarding the Alternative Investment Fund Managers (AIFM) Directive. Our government, industry and regulator worked extremely hard to inform and educate the community in Brussels about our finance industry and in particular the funds sector.
The resulting agreement for the framework of the Directive not only provides some certainty but also places Guernsey in a good position going forward in terms of having access to the EU markets. There is still much work to do and government, industry and the regulator are continuing to ensure that Guernsey is represented in the most appropriate ways during the next stages of the process. We are confident that the outcome will be positive for the future of our funds industry.
Our position certainly will not have been harmed by the publication of two reports at the start of this year. In January, the IMF commended Guernsey's high standards of financial regulation, supervision and stability along with our robust criminal justice framework to the extent that the Island was judged to have a high level of compliance with all the criteria against which it is assessed and scoring the highest of any jurisdiction so far assessed.
Later that same month, the OECD built on its white listing of Guernsey at the earliest opportunity by endorsing the Island's ongoing commitment to tax transparency and exchange of information. Guernsey has now signed Tax Information Exchange Agreements (TIEAs) with 29 jurisdictions and we are in advanced discussions with a number of other jurisdictions, as well as pursuing the Island's removal from (mainly outdated but still operational) 'blacklists' and the potential for Double Taxation Agreements (DTAs).
We are not blind to the fact that there are many challenges ahead. For example, the 'Zero-10' corporate tax systems of the Crown Dependencies have come under European scrutiny. We are undertaking a review but our politicians have been clear from the outset that any future regime must be both compliant and also competitive, i.e. there will be continued tax neutrality for financial services products. As such, the fund industry's exempt status is not under threat and may even be extended.
The right conclusion
Guernsey is committed to providing an environment that is attractive to domiciling (private equity) fund structures which are investing into Russia. There are already numerous successful examples but we are looking to attract much more of this business in the coming years as the Russian economy continues to develop. We are now preparing to speak to more managers and advisers both in Moscow and other centres such as London to see how we might grow this meeting of minds in the future.
Fiona Le Poidevin is Deputy Chief Executive of Guernsey Finance.
For more information about Guernsey's finance industry please visit www.guernseyfinance.com.
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