Is redomiciliation the answer for alternative funds?
By Simon Gray – Never has there been so much discussion in the industry about the redomiciliation of funds from offshore to onshore financial centres, especially within the European Union, in order to meet the preferences of institutional investors cagy about jurisdictions and structures perceived to be scantily regulated, to widen their potential investor base, to position them for the impact of future regulation, or a combination of the three.
As with many aspects of the alternative investment industry, information on the subject is more anecdotal than rigorously statistical. However, a series of surveys seems to point to a broad shift toward a preference for onshore fund domiciles for the establishment of new funds and the moving of existing structures to new domiciles where this is legally possible (not all jurisdictions allow companies to move out to a new domicile with no interruption of their legal personality).
One of the biggest drivers of the redomiciliation process, it is reported, is the desire of alternative managers to take advantage of the marketing freedoms available within Europe to funds complying with the succession of directives on Undertakings for Collective Investment in Transferable Securities. Since the late 1980s the Ucits regime has grown into a regulatory standard for the cross-border distribution of retail funds accepted not only throughout the 27-member EU but increasingly worldwide.
However, there is also evidence of growing interest in transforming offshore funds into onshore structures subject to greater regulation, albeit proportionate to the investor protection needs of sophisticated clients such as institutions, corporations and high net worth individuals and families – in Europe usually Luxembourg-domiciled Specialised Investment Funds, Qualifying Investor Funds in Ireland or Professional Investor Funds in Malta.
Industry members nevertheless concede that, at least for now, redomiciliation is probably the exception rather than the rule. In many cases it is a cumbersome legal process that may well prove a distraction to all but the largest alternative investment managers from the more pressing tasks of managing their investments and attracting new capital.
It’s also sometimes insufficiently remembered that many funds draw capital from a variety of geographical sources. Investors from Asia, the Middle East or even North America may have little interest in seeing the funds in which they place their capital subject to what they might consider unnecessarily restrictive and costly regulation in Europe, even the light-touch approach available under the SIF, QIF or PIF regimes.
As a result, in many cases what industry members describe loosely as ‘redomiciliation’ in fact consists of establishing parallel structures, usually in a European jurisdiction alongside the Cayman Islands or another traditional hedge fund domicile, offering identical or similar strategies but serving different investor groups. This can give managers the best of both worlds, but it comes at a price, in terms of the cost of running and servicing two legal structures, the required governance and administrative obligations, and greater operational complexity.
A report last year from KPMG failed to detect a significant trend of alternative funds abandoning offshore centres, although it suggested that a dual strategy involving parallel structures could help managers maximise their appeal to different kinds of investor. The study found that domiciliation had little impact on allocation decisions for 81 per cent of institutional investors, especially those with the greatest experience with alternatives, but that new investors in alternatives were more concerned about liquidity and transparency and were more likely to allocate to funds domiciled onshore.
That’s not to say that redomiciliation in the literal sense is not happening. It does exist, especially the conversion of offshore hedge funds into Ucits-compliant structures, but just not necessarily on the scale suggested by the ambitious statements of marketing departments of law firms, consultants and business development agencies in onshore jurisdictions.
Authorities and industry members in Ireland have probably been as guilty as anyone of encouraging inflationary expectations about the amount of redomiciliation activity taking place. They loudly trumpeted the likely flow of funds crossing the Atlantic after the passage of the Companies (Miscellaneous Provisions) Act 2009 in December of that year made it possible for the first time to move companies to Ireland without winding them up and creating completely new structures. Ireland’s public relation blitz provoked a certain amount of mild irritation in Luxembourg, which had had similar provisions for years.
More vocal complaints were prompted in Cayman after the Irish Funds Industry Association was quoted as saying that the hedge fund industry was drifting away from the Caribbean island jurisdiction, which is still home to more that 9,500 registered funds. Tony Travers, then chairman of industry association Cayman Finance, tartly responded that at the end of 2010, a total of just four funds had been redomiciled to the EU, according to the Cayman Islands Monetary Authority – two to Luxembourg and two to Malta.
Today Cayman industry members say the volume of outward fund redomiciliation may have increased slightly in 2011 but remains insignificant by comparison with the total number of funds domiciled in the jurisdiction and the normal turnover of fund attrition (around 5 per cent a year) and creation.
However, Ireland has scored some successes. Earlier this month the migration was announced of the BlueAlpha Global Equity Fund from Jersey to Ireland as a Ucits fund. According to law firm Walkers, which managed the redomiciliation for South African-based investment manager BlueAlpha, the key factors behind the decision included investor appetite for Ireland’s regulatory environment, the global branding of Ucits that makes it easier to register the fund for sale in South Africa as well as in Europe, and Ireland’s favourable tax regime and lower withholding tax rates.
The Irish legislation allows a fund to re-register in Ireland by way of continuation, which allows it to retain its existing corporate identity, track record and performance data. Migrating funds may be structured as Ucits (in order to benefit from the pan-European marketing passport) or as QIFs, which offer greater flexibility in terms of investment strategy. Walkers says the redomiciliation is only the second to Ireland involving conversion of an offshore fund into a Ucits; the majority are redomiciled as QIFs.
It has been possible to redomicile funds to Malta since 2002 under the Continuation of Companies Regulations, which allow companies to retain the same legal personality. At the beginning of last year the Malta Financial Services Authority published guidelines regarding the redomiciliation of offshore funds due to an increase in the number of managers enquiring about the redomiciliation procedures. The MFSA notes that the Maltese regime allows funds to have external administrators and custodians, unlike Ireland and Luxembourg, which require service providers to have a presence in the fund’s domicile.
According to Olivier Sciales (pictured), a partner with Luxembourg law firm Chevalier & Sciales, the grand duchy offers a choice of vehicles into which an incoming fund can be redomiciled between a Ucits, a SIF and a fund established under Part II (non-Ucits funds) of the country’s investment fund legislation. The redomiciled fund can be an open-ended or closed-ended company (Sicav or Sicaf) and in some cases a contractual fund (FCP), depending on the procedure employed.
The three methods of relocating a fund to Luxembourg consist of contribution in kind of all the assets and, if applicable, liabilities of the offshore fund to a Luxembourg Ucits, Part II or SIF fund in the form of a Sicav, Sicaf or FCP; redomiciliation of the offshore fund as a Ucits, Part II or SIF fund, in the form of a Sicav or Sicaf only; and merger of the offshore fund into a Ucits, Part II or SIF fund as a Sicav, Sicaf or FCP. “The choice of relocation method will depend mainly on the preferred legal structure rather than the investment strategy or assets,” Sciales says. “The length of the process may vary according to the nature of the Luxembourg vehicle and the relocation method.”
However, the Luxembourg fund industry has generally remained measured about the outlook for redomiciliation, and its caution is supported by a study commissioned by the Association of the Luxembourg Fund Industry from Oliver Wyman and published last month. The report predicts that the EU’s Alternative Investment Fund Managers Directive will lead to some redomiciliation of alternative funds to onshore locations in Europe, mainly by European-based managers, but that offshore centres such as Cayman and the main US fund jurisdiction, Delaware, will remain major domiciles for such funds.
The study concludes that some alternative fund managers that otherwise would have domiciled funds offshore will instead go onshore due to regulatory reasons and/or investor demand, with European onshore funds likely to be domiciled in Luxembourg or Ireland. It forecasts increasing co-domiciliation and use of clone fund structures between offshore and onshore jurisdictions, the possible emergence of one or more new offshore fund centres in Asia and/or the Middle East, and efforts by existing domiciles to improve infrastructure and reduce bureaucracy as they compete more vigorously for business.
“While it was widely believed within Europe that a consequence of the AIFM Directive and the related regulatory pressure exercised by the G20 countries would be widespread redomiciliation of funds into EU domiciles and a fall in the number of offshore funds, this report demonstrates that the offshore landscape in the last two years has remained stable,” says Alfi chairman Marc Saluzzi.
“While Europe has established Ucits as a global fund brand, we have a long way to go if we are to achieve the same in the alternative fund industry. We need to work hard to ensure that we have the right regulation and infrastructure to attract funds here. In Luxembourg we are also committed to helping fund managers and institutional investors leverage the development of regulated European alternative funds.”
Please click here to download a copy of the Global Fund Media Special Report: Guide to Relocation 2011
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