Mon, 23/06/2014 - 11:49
On 2 June 2014 the IRS published its first list of FATCA-compliant institutions in what represents the first significant sign of FATCA regulation gathering pace.
The cut-off date for hedge fund managers to get on this list was 5 May 2014. Hedge fund managers can still register and they will get on the next published list available by the IRS who stated they will published that list periodicaly most likely monthly. According to Michael Megaw (pictured), Managing Director at SS&C GlobeOp, one of the industry’s leading hedge fund administrators, a good number of managers have opted to move quickly and gone through the registration process.
“They’ve figured out which entities have to register with the IRS and by doing so they are agreeing to implement policies and procedures to make them FATCA-compliant. As part of that they receive their GIIN number, which the manager will use to communicate their FATCA compliance with their counterparties. Now that that first registration date has passed, the due diligence process on new “individual” investors into a fund will need to begin after July 1, 2014,” says Megaw. The due diligence for new “entity” investors was pushed out until June 30, 2015.
Many managers today are suffering from regulatory fatigue. It is proving to be both a huge operational compliance burden and an unwelcome cost. Nevertheless, resigned to the situation that FACTA is going nowhere, hedge fund managers have rolled up their sleeves and gotten on with it. Far easier to register early because as Megaw says, each counterparty that a fund deals with will be checking to make sure the manager has the required GIIN number and is FATCA-compliant; as indeed will investors.
Impact on managers
FATCA makes no distinction between managers. Whether they are a USD50mn start-up or a USD5bn veteran, everybody falls under its gaze. That, of course, is the whole point: to stop investors getting away without paying their taxes.
“It was generally targeted at banks but then got widened out to include the entire alternative investment community. By doing that it has put a pretty significant operational burden on managers. I think the impact of FATCA is going to force managers to put more controls and processes in place with regards to investing onboarding and knowing who their investors are,” says Megaw, adding:
“It’s also going to force them to have some mechanism whereby if they do find something erroneous with their investors that they have a way to mitigate that discrepancy or report it to the relevant tax authorities.”
One of the reasons why FATCA is morphing into global legislation – this in no way applies just to the US market – is to help managers running funds in different domiciles to deal with the reporting requirements. Both the UK and, significantly, the Cayman Islands, have signed Model 1 inter-governmental agreements (IGAs) with the IRS.
In Cayman, for example, this means that FFIs will be able to report directly to the Tax Information Reporting Authority (‘TIA’) to streamline the process. The Caymans also signed an IGA type agreement directly with the UK (which also entered into similar agreements with its other overseas territories and Crown dependencies); this is completely outside the scope of the US. A hedge fund does not have the expertise or system to manage this, but your administrator with the right tools can.
Investor transparency lies at the heart of FATCA and there are a couple of terms that managers need to be aware of.
“The first is ‘US Indicia’. This means you find something that doesn’t tally up e.g. an investor has a US address and they are but are claiming tax-exempt status. This doesn’t necessarily mean there’s anything wrong but it requires the manager collecting additional documentation.
“The second is the ‘recalcitrant’ investor. This is where the manager is trying to get documentation on an investor to prove who they are but the investor is not providing that documentation. They aren’t responding to the manager’s requests,” comments Megaw.
This is just part of how FATCA could significantly impact managers going forward. Achieving the required level of investor transparency is far from easy and the risk is that managers will start to lose focus on what they are meant to do: attract capital and deliver alpha to investors. They aren’t tax experts.
“This is a struggle that a lot of managers face today. It’s an unfortunate (yet unavoidable) cost of doing business. How do they manage FATCA? Who do they partner with? Do they hire an internal team, do they outsource?
We have signed a large number of clients who are using our FATCA solution to manage this challenge,” confirms Megaw.
Moreover, given that FATCA is only ever going to extend its tentacles, getting one’s policies and procedures in place to become compliant is just the start of it. FATCA is set to become an ongoing, constantly evolving, compliance exercise; something that tends to get lost in the debate according to Megaw.
“Depending upon the fund domicile, the investor base, there are other FATCA-type initiatives out there that are going to put even more burden on the manager.
“With the explicit support of the US both the OECD and the EU are rolling out new information exchange initiatives centred on a FATCA IGA style agreement. It has cross sharing of information in place with various tax authorities, all of which continues to magnify the complexity of FATCA. My point here is that this is not just about having expertise in the US. That’s what makes it so challenging for managers. It’s not like they can hire one expert to do this. They need multiple experts if they do this internally because there are so many nuances across the globe to deal with,” comments Megaw.
One of the other reasons to explain why there was a rush to register early and get on the first IRS list could be that it helps managers demonstrate best practices in the eyes of existing and prospective investors.
“It’s not because managers want to be FATCA-compliant early; it’s because the industry at large is dictating compliance and views it as favorable on their part by doing so” says Megaw. “If a manager is able to answer investor questions right away on FATCA it indicates that they are running a hedge fund that understands the complexity of the landscape, which sends out a positive message.”
There really is no benefit to procrastination when it comes to this legislation. What managers are increasingly finding is that their counterparties and investors want to know that they are FATCA-compliant, or at the very least in the process of becoming so. It will not hurt you to wait to become registered and on the road to compliance but it will certainly not help you.
Indeed, the consequences for not complying with FATCA are pernicious. The penalty facing FFIs is a 30 per cent withholding tax on gross proceeds, either on the investor or the fund as a whole in year 3 if the first 2 years prove FATCA non-compliance. As Megaw rightly states: “That could potentially shut down a manager’s business overnight.”
The stakes are high and managers can’t run the risk of having recalcitrant investors. The last thing they want is for all other investors to be hit with withholding tax because they didn’t have the right operational set-up in place to remedy the situation.
When asked how managers should deal with the ever-changing dynamics of FATCA, Megaw says:
“They need to ask themselves whether they have the policies in place so that, in a scalable way, they are able to keep on top of every piece of compliance going forward, which could in itself require a significant internal team of people.
“How do managers deal with FATCA and strike the right balance such that their business is not affected? That’s a fundamental question and one that managers really are struggling with.”
SS&C GlobeOp’s FATCA solution
All of which explains why SS&C GlobeOp built out it’s a holistic FATCA solution last year. As a firm there are numerous reasons why it is well placed to take on this onerous exercise on behalf of its clients. Firstly, the firm’s tax and investor relations’ expertise (AML, KYC etc) has long been a key part of the business.
“Where we differ a little, from other administrators, is that we are also a technology firm that can deploy applications and services quickly. It’s embedded in the company’s DNA.
That’s really what FATCA requires. Having a scalable solution in place is important, transparency into the procedures that a manager is performing on investors is important, as well as the ability to have things in place ahead of changes in regulation; in essence, having a solution that is flexible enough to adjust to FATCA or any future regulatory change or new requirement,” says Megaw.
For managers, a big part of FATCA will be having the ability to track the due diligence on investors. The IRS as well as all the global tax jurisdictions will demand it.
Given the way SS&C GlobeOp has structured its technology, it can track exactly what the manager did on investors – which documents were checked, what searches were made.
“As our solution keeps track of everything, the manager doesn’t have to worry about transparency on whether a task was completed or not. It gives the manager comfort and meets the regulations head on; we can meet all of the demands required of managers under FATCA and as new procedures come in we can adjust quickly and implement them for our clients.”
The adoption of SS&C GlobeOp’s FATCA solution is now pretty wide as firms begin to absorb the enormity of the challenge that confronts them.
As for advice to non-US managers who have US investors and/or deal with US counterparties, Megaw comments:
“My advice is do your research on FATCA. Talking to a service provider like SS&C GlobeOp is a good place to start because we have a solid understanding of the legislation and can break it down into pieces that make sense.
“Then I think it comes down to doing a cost benefit analysis; is this something the manager wants to take on in-house or outsource externally? Managers need to know that FATCA - or its clones - are not going away. It’s probably the most important piece of legislation to hit the industry in recent memory.
Scalability, staying on top of developments, knowing what needs to be done and having a defined process in place: these are all benefits that our solution provides.”
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