More than ever before, fund practitioners face changing regulatory and tax landscapes.
In many respects the question of “will I put my (next) fund platform offshore or onshore?” has never been harder to answer. This is often the downside of having too much information, some of which can be conflicting at times. It is worth clarifying the position as it stands regarding Channel Island platforms. The position for Channel Island (“CI”) funds has been and remains relatively straightforward, and straightforward should not be undervalued.
At the pre-launch stage, structuring is essential in order to identify a model that is fit for purpose yet streamlined such that there are no unnecessary costs and burdens on the fund that could potentially impact returns. The structure should envisage the intended investments and avoid being over-complicated by using too many SPVs, sometimes dotted in various locations. This can cause a host of issues, not least the running obligations and costs, but also in relation to substance. Too often service providers recommend setting up numerous SPVs without care to how “substance” will be achieved. At the minimum, the number of SPVs should be minimised where possible and concentrated in few jurisdictions.
The intended distribution model is key
There are interesting trends emerging with regard to the types of investments and where they are located. We have seen Middle-Eastern investment in US credit, Asian investment in African infrastructure and US investment in Scandinavian technology among many others. However, it is crucial that the fund structure should reflect the intended distribution channel(s), to ensure it is possible to distribute in the countries in which the manager is seeking to raise capital. The regulatory classification of a fund dictates who you can market to and who is eligible to invest. For example, will the fund be suitable for retail or institutional and professional investors? It is the regulatory classification that dictates where you can market your fund, i.e. outside Europe or within certain EU countries only.
The EU’s Alternative Investment Fund Manager’s Directive (“AIFMD”) is a specific piece of regulation concerning the management and distribution of alternative funds within the EU, and also includes specific measures that had to be adopted by third countries such as Guernsey and Jersey that wished to continue to be able to market in Europe. AIFMD offers European managers the opportunity to receive pan-European regulatory recognition and passporting of the funds they manage across Europe. Non-EU managers are currently not eligible to obtain similar recognition and must instead use National Private Placement Rules (“NPPR”) that have to meet minimum EU standards plus local specific requirements if applicable (e.g. Germany).
All CI regulated funds are eligible to be marketed into Europe (EU and EEA) in accordance with the AIFMD through NPPR. This is only relevant for EU-based managers. CI funds with non-EU managers that are not actively marketed into Europe fall outside the scope of the AIFMD altogether. This places the CI in the position whereby it is possible to operate in the European market, as well as service rest of world (“ROW”) models.
The geography of funds is changing, both in terms of changing investor bases and changing capital deployment. Data from organisations such as Preqin show that pan-European distribution is not prevalent in the alternatives sector and indeed that managers are increasingly looking outside the European market to raise funds, notably from the large international sovereign wealth and pension funds.
For ROW managers that are looking to raise some capital in Europe, feeder vehicles can provide substantial regulatory cost savings. Increasingly ROW investors are not willing to bear the regulatory costs imposed on funds distributing into Europe, which means regulatory solutions are required. Thus we are seeing an increasing use of CI feeder vehicles into European platforms, and the reverse of EU feeders into CI platforms works too. For example, in a 30:70 EU to ROW distribution model, a CI fund platform with an EU feeder could be an optimal solution. Alternatively it could be a CI platform that uses NPPR for the European distribution. Either way the overall platform will be regulated in the CI and in the case of the master-feeder structure, only the feeder vehicle will be subject to the heightened full AIFMD compliance costs and burden according to where it is located.
Regulation and tax rules coming together
The regulatory and tax status of investment funds has converged in recent times. With the continued emphasis on substance, sometimes for regulatory purposes and on other occasions for tax reasons, where a fund is actively managed and governed will continue to be looked at closely by authorities.
In relation to tax substance, Luxembourg has been suggesting that managers can achieve substance in Luxembourg in answer to the concerns raised by the BEPS project. It will remain to be seen whether this is accurate. Substance can only be achieved with…real substance. Unless and until fund managers put real management and governance into Luxembourg then it is unlikely that Luxembourg will be the answer to the problem and it will not stand up to scrutiny by regulatory and/or tax authorities.
Therefore Luxembourg offers no better a solution to the substance issue than Guernsey or Jersey does. At this point the experience that exists in the CI, notably in the alternatives sector, comes into play. CI directors have experience of sitting on funds right across the alternatives sector and the supporting services providers also have knowledge of operating these funds. Luxembourg is at the beginning of moving into the alternatives sector and it can be argued that it has a way to go before it has the experience and skills that currently exist in the CI.
In contrast, both Guernsey’s and Jersey’s fiscal models support fund executives to move and live in the CI. The financial services element of the fiscal policies are based on attracting highly skilled and experienced professionals to operate finance sector businesses in Guernsey and Jersey. Also relevant are changing UK tax rules notably in relation to disguised investment management fees, carried interest arrangements and how non-domiciled individuals are taxed, which can make the UK less attractive from a tax perspective for fund executives than it has been in the past. This among many other things mean some fund executives are willing to move and the CI has benefitted from senior fund executives moving to the islands.
Nowadays there is greater emphasis on regulatory and tax structuring of investment funds. The two should be considered together. When establishing a fund structure it is worthwhile to try to concentrate the active management and governance in one location if possible, and thus avoid diluting the management and governance so as to concern authorities as to where it is actually undertaken. CI funds can provide substance as well as opportunities to establish flexible platforms that suit the distribution models so as to reduce unnecessary regulatory compliance costs
The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.