By Simon Gray - After a year in which some reports suggested that London’s hedge fund industry was about to up sticks and move en masse to Switzerland, there are still few signs that the city’s dominance within Europe is coming to an end. The number of actual departures so far is small even if some of the names involved have been high-profile; meanwhile the ranks of the industry are being swelled by a surge of start-up operations launched by individuals exiting existing asset managers or the proprietary trading desks of investment banks.
But professionals caution that while London’s continuing appeal as an alternative asset management hub is evident, it is still too early to assess the long-term impact of a series of developments pressing on hedge fund managers: regulatory changes agreed by the European Union in November affecting alternative fund managers; new rules, both European and domestic, governing financial sector remuneration; a significant increase in the tax burden on high-earning individuals; and tighter restrictions on the scope of non-domiciled status for UK residents that can allow qualifying individuals to escape taxation on their worldwide income.
At least part of the furore over the prospect of a mass exodus stemmed from a survey by consultants Kinetic Partners that suggested that hedge fund managers representing as much as 25 per cent of employment in the sector were in the process of moving or planning to leave for Switzerland, although the firm now plays down the issue, noting that London’s appeal remains powerful from both a professional and a lifestyle perspective.
“London has always been the primary location for hedge fund [managers], and this is not going to change any time soon,” says Kinetic founder member David Butler (pictured). “It still offers an ideal location for fund managers in terms of the financial services offering, transport connections to global cities, networking opportunities and access to resources, and most importantly, it is still a fantastic, vibrant and ambitious city in which to live and do business. What is true is that London will have to raise its game to compete with emerging jurisdictions that offer lower taxes and lighter regulation.”
Other members of the industry concur that while many hedge fund managers have probably at least considered the idea of relocating to another jurisdiction, the number that have actually decided to take the plunge remains small. “Nothing has really changed,” says Chris Cattermole, sales manager for Advent Software’s Geneva system for Europe, the Middle East and Africa. “A handful of fund managers have moved some operations out to Switzerland, but in most cases it’s only certain parts of their business, and they still have a footprint in the UK.”
Much of the media furore has been sparked by the establishment of offices in Switzerland by firms including Brevan Howard (Geneva), BlueCrest Capital and Moore Capital (both Zurich), coupled with the departures of key individual such as Brevan Howard founder Alan Howard and BlueCrest’s Michael Platt.
“Many managers now, particularly if they’re not UK-domiciled, are much more willing to countenance conducting some of their activities offshore,” says Mark Stapleton, a partner in the international tax group of law firm Dechert. “That said, the people who have announced they are moving to Switzerland, I suspect, tend to be those who have made their money and are quite keen to live offshore anyway. But there’s no doubt that the increase in the top rate of income tax from 40 to 50 per cent has led to a lot more people doing tax planning.”
A more bullish view comes from Andrew Rubio, chief executive of financial outsourcing and consultancy firm Throgmorton, who says: “London is still the leader of the pack, the best place in Europe. Moving to Switzerland only works if you’re big enough to have an infrastructure there but still have the main part of your business in London, because it’s the centre of the capital-raising universe in Europe.”
Rubio notes that Frederic Denjoy, one of the Brevan Howard partners who moved to Switzerland, has now returned to London to start up his own business, and says that the needs and interest of family and children are another factor that make most industry professionals reluctant to move. “There’s a huge amount of inertia keeping people in London,” he says. “Unless you’re all ultra-rich, it’s difficult to persuade your people to leave. It’s true that it has come close to a tipping point, but ultimately
London has been reaffirmed.”
One of the key issues on the agenda of hedge fund managers over the next couple of years will be the implementation of the impending EU Directive on Alternative Investment Fund Managers. The directive, which will come into force early in 2013 and govern many aspects of how alternative managers do business, is regarded by most London-based professionals as a vast improvement on the first draft published in April 2009, but it remains far from popular across the industry.
While the directive will create a single European market for funds aimed at sophisticated investors and allow managers to market their products across EU borders with minimal formalities, some of the provisions still cause dismay. Overall the legislation is viewed as adding a significantly increased regulatory burden out of proportion with any benefits it may bring in terms of investor protection or identification of potential systemic risk.
In addition, there are a couple of complications. First, although the directive sets out the regulatory framework within which funds marketed in Europe and their managers will operate, much of the detail must be filled out by secondary legislation or implementing regulations drawn up by the European Commission on the advice of the new European Securities and Markets Authority, a much more institutional body than the Committee of European Securities Regulators which it replaced.
Secondly, funds not domiciled within the EU – a large proportion of the products run by London-based managers – will not be able to qualify for an EU marketing ‘passport’ until 2015, two years after EU-domiciled funds of EU managers. Even then this will be subject to rules that have not yet been drawn up in areas such as regulatory co-operation between the fund domicile jurisdiction and any target market within the EU. Extending the passport system will itself require additional legislation and many industry members say they will believe it when they see it.
“Level one of the directive has been agreed, which means that the structure is there, and a phase of more detailed rulemaking has begun ahead of full implementation by 2013,” Butler says. “And so begins a fairly protracted implementation procedure and, to some extent, a ‘wait and see’ game leading toward full implementation by member states by 2013, which step by step will shed light on the final shape the directive will take and what this will mean for managers.
“Fears have been expressed that the directive will go too far in limiting the activities of investors and managers globally and will have a stifling effect on the industry. This will particularly affect London as many managers who up to now have had relative freedom in their activities will be under pressure to move to a regulated fund structure. Of itself, the directive is unlikely to have a material effect on London’s position in the hedge fund world, but negative factors such as tax, infrastructure and the attractions of other locations will have an impact.”
Overall, however, London has escaped “relatively unscathed’ under the final form of the EU legislation, according to Martin Cornish, who has just joined law firm K&L Gates as an investment management partner. He says: “Some of the more draconian aspects of the rules have been postponed for between three and five years, in terms of the marketing of Cayman and other funds into Europe. Those rules won’t rear their ugly head until between 2015 and 2018, which is a long time in any world.
“The new rules will increase compliance costs for sure. A lot more reporting to regulators and investors is required, so managers will find that being based here is more onerous than in the past, and more onerous than it might be in some non-EU jurisdiction. The decision for everyone will be whether they need to be here. However, I don’t expect that the rules will lead anyone to conclude that they cannot possibly conduct business here any more. It will be a bit more painful, and a bit more restrictive, and managers will have slightly higher running costs, but nothing in those rules will make it impossible for them to compete with rivals in other centres.”
Nevertheless, some industry members believe the various issues hanging over the alternative investment industry in London make it imperative to focus on marketing it effectively – at least as well as rival financial centres do. “A lot of what the UK could do to consolidate its existing fund industry base is around its branding and people’s perceptions,” says Eversheds partner Michaela Walker. “We need to do a better spin job, like Luxembourg does.”
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