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Around the world, jurisdictions that have built up a significant business as a domicile or administration centre for hedge funds and other alternative investments are bracing themselves for the impact of new regulations and legislation that are being hastily drafted in a bid to curb the perceived excesses of the past decade or so. Although there is scant evidence that alternatives played more than an incidental role in the dislocations to the global financial system of the past two years, they have found themselves in the firing line of politicians and regulators anxious to demonstrate that they are taking the problems in hand.

For a jurisdiction like Guernsey, which serves a predominantly European clientele, one of the biggest headaches for members of the island's substantial and well established alternative fund industry is the potential effect of a proposed European Union directive that appears likely to encourage EU-based managers to domicile their funds within the 27-member grouping and, at the least, to complicate the marketing efforts of managers or funds based outside.

However, with the Directive on Alternative Investment Fund Managers still in first draft form and with the proposals under fire both from the fund industry for being excessive, costly and constraining and from EU politicians who believe the legislation's provisions will be too easy to sidestep, it is not clear enough what kind of end-product is likely to emerge for professionals in Guernsey to plan ahead with confidence for the market conditions it will usher in.

On the other hand, they say, the island has the potential to be a winner in a new global environment where hedge funds are subject to much closer regulatory scrutiny and where high standards of corporate governance are viewed as a cornerstone of checks and balances designed to protect investors. In this regard, Guernsey can claim to be ahead of the global trend.

'As a result of the financial turmoil there has been increasing focus on the regulatory environment by world governments, as exemplified by the G20 meeting in April and moves to ensure that perceived tax havens are being properly regulated to common standards,' says Alan Brint, head of corporate and institutional business for the British Isles at RBC Wealth Management in the Channel Islands.

'For many years Jersey and Guernsey have positioned themselves as financial centres with significant expertise and infrastructure to support their products, which is obviously be an advantage. Both islands have approached the regulatory requirements head-on and in some respects have been leaders in the pack.'

Brint acknowledges that the draft EU directive seems designed to discourage alternative investment managers from using domiciles outside the union and to erode the advantages of traditional offshore centres, but adds: 'Having been in the fund industry since 1979, I've seen a lot of tax and regulatory changes in the UK and Europe that at the time threatened to be a death-blow to the offshore fund industry. However, there have always been new opportunities for the industry to work with, and hopefully there will be again this time. The offshore industry plays a vital role in financial services, and will survive.'

He is echoed by Stephen Cuddihee, a director of Praxis Fund Services, who says: 'People will look to jurisdictions with a strong regulatory environment, and Guernsey is very well positioned to take advantage of that. We continue to benefit from our strong, vastly experienced infrastructure of lawyers, accountants and fund administrators, and we're very well positioned to continue to pick up business as we come out of the economic crisis.'

It helps that when the G20 nations commissioned the Organisation for Economic Co-operation and Development to assess the willingness of international financial centres to adopt international standards of transparency and exchange of information on tax issues, Guernsey (along with fellow crown dependencies Jersey and the Isle of Man) was adjudged to have met and implemented them satisfactorily, says Andrew Walters, a partner with Guernsey law firm Ozannes. 'Being white-listed by the OECD has helped Guernsey's image and provided a defence against criticism from abroad,' he says.

'We were delighted we got through the barrier to be white-listed, but I didn't think we ever had a difficulty because we covered all the bases by having signed at least 12 bilateral tax information exchange agreements,' says Peter Niven, chief executive of Guernsey Finance, the island's promotional organisation for the industry.

He believes that this year's initiatives to persuade - or compel - jurisdictions such as Switzerland to ease their financial secrecy rules marks a major breakthrough because it brings significantly nearer the 'level playing field ' promised to offshore centres that began to co-operate with the OECD on tax issues around a decade ago.

'I don't think places like Switzerland ever thought it would be followed through in the way that it has,' Niven says. 'Switzerland has come under scrutiny from many different directions, including the UBS case in the US, and it is having to change their ways. From the point of view of Guernsey, which has never had nor seen the need for secrecy, it will hopefully create more of a level playing field in the future.'

He believes that a combination of pressure from the international community and the demands in particular of institutional investors are already changing global attitudes toward the way alternative investment vehicles are structured and managed. 'Investors are looking for strong corporate governance and directors that look after the interests of shareholders, rather than the fairly loose board structures found in places such as Cayman and the BVI,' he says.

'The issue of substance ties in with our corporate governance code and our day-to-day practices, which is why fund promoters are continuing to come here, and we will benefit further from any crackdown by the US on jurisdictions that are perceived to fall short of the required regulatory and transparency standards. People will have to change their mindsets. You can't go on with unregulated vehicles and peripatetic boards sitting on whichever beach they want to.'

However, Niven cautions that rival alternative fund jurisdictions in the Caribbean will make strenuous efforts to get onto the OECD's white list (Bermuda has already done so by concluding the required number of tax information exchange agreements), and that the barriers to doing international business will continue to rise in the future.

'We have been told this isn't the end of the story,' he says. 'For example, the old distinction between tax avoidance and tax evasion has now gone. It's now a question of where the marker will be set on what constitutes acceptable means of achieving tax efficiency. We've just had a shot across the bows, and it's an issue we need to watch very closely.'

Fund industry professionals in Guernsey believe the OECD designation finally nails the myth that the island is a tax haven. 'We're a low-tax, tax-neutral jurisdiction that allows people to do business without lots of bureaucracy or punitive tax rates,' says Joe Truelove, head of business development for corporate clients at Kleinwort Benson in Guernsey. 'Investors in Guernsey funds pay tax in their home jurisdiction. It's very transparent - we've got nothing to hide and nothing to fear.'

In the meantime, the authorities are continuing their efforts to respond to the financial industry's changing needs with new laws and rule-making where necessary. 'There's plenty of activity in the regulatory and legislative pipeline,' Walters says, 'but the authorities are waiting for the latest visit and report by the International Monetary Fund before pushing on with their legislative agenda.'

Niven says that amendments are already being drawn up to address 'things that slipped through the net' in Guernsey's companies legislation, which was enacted as recently as last year, but initiatives such as changes to the regulatory regime governing hedge funds will be left until after the IMF inspection. He adds: 'We have some things in the pipeline that we'd like to put in place to speed recovery from the downturn, but we're keeping quiet at the moment so that the competition doesn't hear about them.'

He acknowledges that the downturn is prompting a rethink of some of the details of the island's 0/10 tax strategy, which lowered the corporate income tax rate for all Guernsey companies to zero last year to resolve a dispute with the EU about tax rates that discriminated between local and offshore companies. The plan, drawn up at the height of the financial industry boom, envisaged using financial reserves to sustain the government temporarily in the hope that increased business activity would help to make up the shortfall in fiscal receipts.

However, the decline in other sources of revenue may well require efforts to raise taxes from new sources. Says Niven: The strategy was conceived at a time when business was booming, but now the so-called 'black hole' caused by the move to zero is bigger than originally forecast, and it will be more difficult to fill. We are unlikely to put up the basic tax rate for individuals, but there's n opportunity to raise more from indirect taxes, which have always been very low. Conceivably we may, like Jersey, bring in a low-rate value-added tax or goods and services tax to help balance the books.

'The policy was to watch the fiscal position for two or three years and meet the deficit from the 'rainy day' fund, but if the black hole is deeper than originally thought it will use up the fund more quickly, so we may have to react with increased taxes. If we had had a crystal ball and foreseen the downturn, we might not have done what we did, but now the authorities have to react to deal with the consequences.'

By Simon Gray

Around the world, jurisdictions that have built up a significant business as a domicile or administration centre for hedge funds and other alternative investments are bracing themselves for the impact of new regulations and legislation that are being hastily drafted in a bid to curb the perceived excesses of the past decade or so. Although there is scant evidence that alternatives played more than an incidental role in the dislocations to the global financial system of the past two years, they have found themselves in the firing line of politicians and regulators anxious to demonstrate that they are taking the problems in hand.

For a jurisdiction like Guernsey, which serves a predominantly European clientele, one of the biggest headaches for members of the island's substantial and well established alternative fund industry is the potential effect of a proposed European Union directive that appears likely to encourage EU-based managers to domicile their funds within the 27-member grouping and, at the least, to complicate the marketing efforts of managers or funds based outside.

However, with the Directive on Alternative Investment Fund Managers still in first draft form and with the proposals under fire both from the fund industry for being excessive, costly and constraining and from EU politicians who believe the legislation's provisions will be too easy to sidestep, it is not clear enough what kind of end-product is likely to emerge for professionals in Guernsey to plan ahead with confidence for the market conditions it will usher in.

On the other hand, they say, the island has the potential to be a winner in a new global environment where hedge funds are subject to much closer regulatory scrutiny and where high standards of corporate governance are viewed as a cornerstone of checks and balances designed to protect investors. In this regard, Guernsey can claim to be ahead of the global trend.

'As a result of the financial turmoil we're seeing a lot more focus on the regulatory environment, particularly the G20 meeting in April and moves to ensure that perceived tax havens are being properly regulated,' says Alan Brint, head of corporate and institutional business for the British Isles at Royal Bank of Canada in the Channel Islands.

'For many years Jersey and Guernsey have positioned themselves not as tax havens but financial centres with significant expertise and infrastructure to support their products, which is obviously be an advantage. Both islands have met the regulatory requirements head-on and in some respects have anticipated them.'

Brint acknowledges that the draft EU directive seems designed to discourage fund promoters from using domiciles outside the union and to erode the advantages of traditional offshore centres, but adds: 'Having been in the fund industry since 1979, I've seen a lot of tax and regulatory changes in the UK and Europe that at the time threatened to be a death-blow to the industry. However, there have always been new opportunities for the industry to take advantage of, and hopefully there will be again this time.'

He is echoed by Stephen Cuddihee, a director of Praxis Fund Services, who says: 'People will look to jurisdictions with a strong regulatory environment, and Guernsey is very well positioned to take advantage of that. We continue to benefit from our strong, vastly experienced infrastructure of lawyers, accountants and fund administrators, and we're very well positioned to continue to pick up business as we come out of the economic crisis.'

It helps that when the G20 nations commissioned the Organisation for Economic Co-operation and Development to assess the willingness of international financial centres to adopt international standards of transparency and exchange of information on tax issues, Guernsey (along with fellow crown dependencies Jersey and the Isle of Man) was adjudged to have met and implemented them satisfactorily, says Andrew Walters, a partner with Guernsey law firm Ozannes. 'Being white-listed by the OECD has helped Guernsey's image and provided a defence against criticism from abroad,' he says.

'We were delighted we got through the barrier to be white-listed, but I didn't think we ever had a difficulty because we covered all the bases by having signed at least 12 bilateral tax information exchange agreements,' says Peter Niven, chief executive of Guernsey Finance, the island's promotional organisation for the industry.

He believes that this year's initiatives to persuade - or compel - jurisdictions such as Switzerland to ease their financial secrecy rules marks a major breakthrough because it brings significantly nearer the 'level playing field ' promised to offshore centres that began to co-operate with the OECD on tax issues around a decade ago.

'I don't think places like Switzerland ever thought it would be followed through in the way that it has,' Niven says. 'Switzerland has come under scrutiny from many different directions, including the UBS case in the US, and it is having to change their ways. From the point of view of Guernsey, which has never had nor seen the need for secrecy, it will hopefully create more of a level playing field in the future.'

He believes that a combination of pressure from the international community and the demands in particular of institutional investors are already changing global attitudes toward the way alternative investment vehicles are structured and managed. 'Investors are looking for strong corporate governance and directors that look after the interests of shareholders, rather than the fairly loose board structures found in places such as Cayman and the BVI,' he says.

'The issue of substance ties in with our corporate governance code and our day-to-day practices, which is why fund promoters are continuing to come here, and we will benefit further from any crackdown by the US on jurisdictions that are perceived to fall short of the required regulatory and transparency standards. People will have to change their mindsets. You can't go on with unregulated vehicles and peripatetic boards sitting on whichever beach they want to.'

However, Niven cautions that rival alternative fund jurisdictions in the Caribbean will make strenuous efforts to get onto the OECD's white list (Bermuda has already done so by concluding the required number of tax information exchange agreements), and that the barriers to doing international business will continue to rise in the future.

'We have been told this isn't the end of the story,' he says. 'For example, the old distinction between tax avoidance and tax evasion has now gone. It's now a question of where the marker will be set on what constitutes acceptable means of achieving tax efficiency. We've just had a shot across the bows, and it's an issue we need to watch very closely.'

Fund industry professionals in Guernsey believe the OECD designation finally nails the myth that the island is a tax haven. 'We're a low-tax, tax-neutral jurisdiction that allows people to do business without lots of bureaucracy or punitive tax rates,' says Joe Truelove, head of business development for corporate clients at Kleinwort Benson in Guernsey. 'Investors in Guernsey funds pay tax in their home jurisdiction. It's very transparent - we've got nothing to hide and nothing to fear.'

In the meantime, the authorities are continuing their efforts to respond to the financial industry's changing needs with new laws and rule-making where necessary. 'There's plenty of activity in the regulatory and legislative pipeline,' Walters says, 'but the authorities are waiting for the latest visit and report by the International Monetary Fund before pushing on with their legislative agenda.'

Niven says that amendments are already being drawn up to address 'things that slipped through the net' in Guernsey's companies legislation, which was enacted as recently as last year, but initiatives such as changes to the regulatory regime governing hedge funds will be left until after the IMF inspection. He adds: 'We have some things in the pipeline that we'd like to put in place to speed recovery from the downturn, but we're keeping quiet at the moment so that the competition doesn't hear about them.'

He acknowledges that the downturn is prompting a rethink of some of the details of the island's 0/10 tax strategy, which lowered the corporate income tax rate for all Guernsey companies to zero last year to resolve a dispute with the EU about tax rates that discriminated between local and offshore companies. The plan, drawn up at the height of the financial industry boom, envisaged using financial reserves to sustain the government temporarily in the hope that increased business activity would help to make up the shortfall in fiscal receipts.

However, the decline in other sources of revenue may well require efforts to raise taxes from new sources. Says Niven: The strategy was conceived at a time when business was booming, but now the so-called 'black hole' caused by the move to zero is bigger than originally forecast, and it will be more difficult to fill. We are unlikely to put up the basic tax rate for individuals, but there's n opportunity to raise more from indirect taxes, which have always been very low. Conceivably we may, like Jersey, bring in a low-rate value-added tax or goods and services tax to help balance the books.

'The policy was to watch the fiscal position for two or three years and meet the deficit from the 'rainy day' fund, but if the black hole is deeper than originally thought it will use up the fund more quickly, so we may have to react with increased taxes. If we had had a crystal ball and foreseen the downturn, we might not have done what we did, but now the authorities have to react to deal with the consequences.'


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