Originally published in the HFM Week, Guernsey Report, June 2008
Gavin Farrell of Ozannes shares a refreshing perspective on the hedge fund industry and gives his view on how the island is withstanding the credit crisis.
As assessments of the world's current economic state go, you are unlikely to find anything more frank than the following, provided by Gavin Farrell, corporate partner with Guernsey-based law firm Ozannes: "If there's one lesson to be learnt, then it's that easy money can only last so long."
In an industry primed for damage limitation, it is a somewhat refreshing perspective. But then, by virtue of his position as an offshore lawyer, Farrell is afforded a more objective view than most. And while he freely admits to possessing neither the solution to the global crisis nor the type of knowledge to address it, he is more than qualified to present a matter-of-fact evaluation of its impact on the offshore fund structures he deals in.
Before Farrell assesses the impact, however, he establishes the fund environment in which both he and Ozannes operate. What is it about the nature of Guernsey's fund structure that attracts clients over other offshore jurisdictions?
He highlights three types of offshore competitors. There is the polarised competition; European offshore centres such as the Channel Islands and the Isle of Man, then the EU offshore centres such as Dublin, Luxembourg and, increasingly, Malta, and thirdly, the Caribbean. Farrell has found that clients choose the first type, Guernsey in particular, to capitalise on the facilities including those measures that relate to corporate governance and which support the offshore tax neutrality of the funds, a benefit that certain jurisdictions, in the Caribbean for example, may lack. "Some potential end fund users, especially in the UK with HMRC's central management and control rules, have concerns with the Caribbean, as a fund industry," he says. "They believe its offshore tax structure may be too precarious to sustain the offshore nature of the product."
He continues: "Our business is not only to offer a structure and flexibility similar to that of other offshore jurisdictions, but to place great importance on the administration as well as the corporate governance aspect of an offshore structure. This, in turn, supports the offshore tax neutrality treatment of a fund. Indeed, clients come to us because we strive to have a structure which would withstand any attack by an onshore tax authority claiming we are smoke and mirrors and nothing else. We take great mileage from cases such as Wood vs Halden."
A robust, yet flexible, regulatory framework
Potential clients may have a greater level of comfort when choosing a jurisdiction like Guernsey. While it is not over-regulated, it is sufficiently so to offer comfort to institutional investors, promoters, sponsors or managers looking to set up new structures. This robust, yet flexible, regulatory framework has been an important factor in Guernsey's stability in the face of the volatile global market and is increasingly centred on the Guernsey service providers and not the products.
In terms of the credit crunch impacting Guernsey and similar offshore jurisdictions, Farrell mentions two main effects.
The first is that, unsurprisingly, certain launches have been either delayed or aborted. Ozannes' lawyers get their instructions from the major law firms which are there for structuring deals, and the effect the crunch has had on a number of launch programmes has been dramatic. Simply put, some sponsors have either not wanted to proceed in the current climate or wished to delay, at times indefinitely, or have not been able to raise enough capital to justify a launch.
The second main effect is more positive. Guernsey's business diversity means it is not centred on one type, or one small group of funds. To that effect, while Guernsey has had its casualties, business has continued to flow. For this, Farrell pays tribute to the island's regulator. "We don't put all our eggs into one basket," he says. "Our flexible regulatory regime has always seen us attract a great diversity of fund types and now some new lines of business have been set up in light of the credit crunch. We've been able to capitalise on opportunistic structures; including private equity structures or opportunistic funds in terms of distressed debt."
Farrell indicates that Guernsey is at the forefront in terms of industry efficiency. "All offshore jurisdictions are trying to lessen the regulators approval system for alternative funds. However, we were at the forefront of the self-certified certificated regime for offshore funds a number of years ago; including the original open ended Class Q Schemes in the 90s. We have mileage on regulatory flexibility because we were among the trailblazers in implementing a self-certified regime for products."
Guernsey's fund business legacy
Farrell is under no illusion and accepts that all offshore jurisdictions will lay claim to similarly impressive flexibility. The reason he gives for it being particularly apparent in Guernsey relates to, what could be called, its fund business legacy. "In many ways, the island has been successful by default," he says, candidly.
This assessment derives from Guernsey's traditional industry position. Fifteen to 20 years ago, Jersey's fund industry's primary interest was in retail, blue-chip types of business, and there was even a message that it was closed to new business of non-retail type. As a result, Guernsey, not being as well known at this point, had to find another source and started capitalising on the alternative types that Jersey did not want. The alternative classes, not being as popular, took advantage of Guernsey's willingness to develop that line of business, and made the island the centre for variation.
When, a few years later, there was a reversal of the business flow into the Channel Islands, whereby the blue-chip end of the market waned in favour of alternative types, Guernsey had a head start.Because alternative types covered the close-ended sector of the market, including fund of hedge funds and private equity, Guernsey now has a large diversity; grown from the concept of alternative or nonmainstream retail products. This legacy means that the island is, currently, far better equipped to hedge its bets and deal with multiple structures.
"It's difficult, however, to say whether we've withstood the credit crisis more because of a framework," Farrell concedes. "But the fact that we've got a great deal of flexibility borne from our ability to diversify the type of business lines coming into Guernsey means we were more attuned to scoop up any alternative types of fund coming in, and not necessarily just those that were affected by the credit crunch."
Because, like all financial centres, Guernsey has suffered in recent months, Farrell is keen to avoid using the credit crunch as a means of validating the island's framework. He uses it, instead, to highlight its welcoming approach to business. "What the crisis has demonstrated is that Guernsey is not just in a one horse race. That's been very apparent, not only through the regulatory regime but through the experience of our back-office service providers, primarily the administrators. They have been able to deal with anything that comes through the door because they have been doing so for the last two decades and have built a book of experience and expertise."
The biggest challenge for Guernsey is to maintain investor confidence. It has a stable economy, that hasn't been effected by the credit crunch to the same extent that the UK and US have. "It hasn't had a major impact on our general economy," says Farrell. "There is safety for end users of Guernsey products – it's not going to go belly up tomorrow. Relaying this to potential clients is integral."
Guernsey's business hasn't slowed in the way it was expected. The main difference is that there isn't the same number of large transactions; raising US$200m-US$500m for new funds in the current climate is a considerable challenge. "We are definitely doing more small transactions and less of the larger ones." Farrell says. "But that's to be expected. It's merely reflecting the current state of the market in light of the capital raising, investor confidence and comfort in investing."
Farrell maintains his realistic perspective in conclusion. "My understanding is that there still is a lot of liquidity in the market but people are going to think twice before ploughing into particular products. After all, we must not be complacent." However, he finishes on a positive note. "While we were slightly less busy in Q1 of this year than at the same period last year, we are flat out at the moment. And I'm sure it's the same for other law firms. Business continues to flow and that's always encouraging."
For more information about Guernsey's finance industry please visit www.guernseyfinance.com.
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