On 19th July 2016, the European Securities and Markets Authority ('ESMA') once again recommended Guernsey for a third country passport under the Alternative Investment Fund Managers Directive (AIFMD). This followed ESMA's announcement last summer that Guernsey had demonstrated the ability to satisfy the criteria required under AIFMD.
The independent EU regulatory authority assessed Guernsey, alongside 11 other non-EU jurisdictions, as part of its non-EU AIFMD passport reviews. In its final assessment, ESMA has concluded that 'there are no significant obstacles regarding investor protection, competition, market disruption and the monitoring of systemic risk impeding the application of the AIFMD passport to Guernsey'.
For Guernsey, being in the first wave is important for two reasons. Firstly, because it demonstrates that it has a strong regulatory framework in place and meets the OECD's tax transparency guidelines – both of which are significant if you are an investment manager looking to set-up a fund under AIFMD. And secondly, because some jurisdictions will likely turn off their national private placement regimes once the third country passport is formally introduced.
"At the moment, managers of Guernsey funds need to privately place into Europe and that works well. If Guernsey were not in the first wave, there would be a danger of there being an unknown period of time, during which managers would not be able to market into certain jurisdictions. Luckily, that won't be the case," explains Andrew Whittaker, Chairman of the Guernsey Investment Fund Association.
Certain countries, such as the UK, have left their national private placement regimes intact such that it remains 'business as usual' for managers looking to market a Guernsey fund. And whilst there will likely remain a core number of EU and non-EU managers who use Guernsey specifically to remain out of full scope of AIFMD and continue down the NPPR route, there are plenty of managers who will look to take full advantage of the third country passport and opt in to the AIFMD regime on an equivalent basis.
AIFMD opt-in regime
"We have a full set of AIFMD opt-in rules which mirror the requirements of a full scope EU AIFM," confirms Paul Wilkes, Group Partner, Collas Crill, a prominent Channel Islands law firm. "I was part of the drafting committee and the view we took was that by getting the rules in place early, it would give the Guernsey Financial Services Commission ('GFSC') sufficient time to look at the rules and carefully consider them. We wanted our clients to have the opportunity to opt-in as early as possible, even though it doesn't yet give them the right to passport their funds into Europe.
"However, what it does do is allow managers to tell investors, 'Yes, we're not in Europe but we are subject to the same rules as we have opted in to the Guernsey AIFMD regime, which is equivalent'.
Manager led product
Both Luxembourg and Malta have recently unveiled new unregulated funds in a clear sign that Europe is evolving under AIFMD. Known as the Reserved AIF and the Notified AIF respectively, the regulatory oversight of the AIF lies squarely with the AIFM, thereby avoiding a dual layer of regulation at both the manager and the fund level.
In anticipation of receiving the third country passport, Guernsey has looked at these recent developments and moved quickly to introduce an AIFMD friendly product of its own. Known as the Manager Led Product ('MLP'), "it allows fund promoters to have an AIFM and fund(s) underneath, for example, a Guernsey GP/LP structure, thereby making it more efficient for the AIFM to manage funds from Guernsey," says Whittaker.
The MLP was unveiled by the GFSC on 11th May 2016. It aims to ensure a proportionate risk-based level of product regulation for any AIFM that establishes itself in Guernsey and seeks to market an AIF into Europe under the National Private Placement Regime arrangements. Once an AIFM has been licensed by the GFSC, they will be able to freely launch new partnership structures and corporate funds by simple notification, reducing the amount of red tape. For new managers wishing to operate under AIFMD via a hosted solution (using a 3rd party AIFM), the introduction of the MLP could be a game changer for Guernsey.
"Since the Directive was introduced I've always regarded it as a big opportunity for Guernsey," says Wilkes. "Once we have the third country passport it will give better access to European capital than Guernsey has ever had. It's a significant opportunity for Guernsey funds over the long term," adding that Guernsey's USP, compared to EU onshore jurisdictions, is the Island's expertise in asset classes such as private equity, real estate, alternative hedge fund strategies; service levels for sophisticated private funds; quick turnaround times by the GFSC, and most importantly, cost. "There are real cost benefits to setting up a Guernsey fund. Once the third country passport is available, it's up to us to become as competitive as possible."
Fund structuring options
Investment managers may make application for authorisation or consent under one of three routes:
- Authorised Fund by standard application;
- Authorised Fund by Qualifying Investor ("QIF") application;
- Registered Fund application.
The QIF process
Promoters of authorised funds, which are typically offered to professional or experienced investors willing to invest a minimum of USD100,000, are able to take advantage of the qualifying investor fund or "QIF" fast-track application process. Under such a scenario, an appropriately licensed Guernsey administrator must certify to the Guernsey Financial Services Commission ('GFSC') that it has performed sufficient due diligence on the promoter and that the requisite disclosures are made in the offering document of the scheme.
The benefit to managers under this arrangement (and the registered fund option) is speed to market. The administrator does all the heavy lifting, so that by the time a fund application reaches the Commission, it typically provides a guaranteed response time of three business days; a significant benefit to managers who need to get their fund to market to avoid losing investor capital commitments.
Class B Authorised Fund
For an Authorised Fund there are four choices: an authorised closed ended fund or a Class A, Class B or Class Q open-ended fund. "Class A is the Guernsey equivalent of UCITS. Class B is by far the most common open-ended vehicle for hedge funds. The basic tenet is that you have to disclose in the fund documents what the investment strategy is, what the restrictions are, etc. Traditionally HNW investors and institutional investors are the main investors in Class B funds.
"Class Q is the most flexible of the three classes of Authorised Fund in respect to how much the manager needs to involve investors should they wish to change the fund's investment objectives. Because of that flexibility it is limited to a definition of 'Qualifying Investor' – namely HNW individuals, professional investors," says Wilkes. He says that the 'QIF' process can be applied to any Guernsey authorised fund: Managers can fast track a Class B Authorised Fund using the QIF process giving them the flexibility of a Class B fund and the recognition of a Class B fund in the market."
As a general rule of thumb, all Guernsey-domiciled funds are required to appoint a locally licensed administrator, which is referred to as a "designated manager". If a fund promoter chooses an open-ended fund structure, the fund must generally appoint a Guernsey licensed custodian to hold and safeguard its assets.
By contrast, a Guernsey closed-ended fund is not required to appoint a local custodian. It is not mandatory for either an authorised or registered fund to have a locally regulated or a local manager/adviser. All three classes of Authorised Fund, and the Guernsey Registered Fund, will be eligible for the third country passport, going forward.
An original version of this article was published in Hedgeweek's guide to setting up an AIF in Europe, July 2016. It has been updated to reflect ESMA's announcement of 19 July 2016.
For more information about Guernsey's finance industry please visit www.guernseyfinance.com.
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