By Simon Dinning - The past year, like the two or three before it, has been a difficult one for the hedge fund industry in London, but there are signs of positive activity as the number of new fund launches continues to increase. A significant forward stride has brought some resolution on one of the industry’s biggest headaches over the past two years, the European Union’s Directive on Alternative Investment Fund Managers. While not perfect, it is in much better shape than many dared hope.
Last year started slowly in terms of new fund creation, but picked up significantly in the third and fourth quarters, with many managers looking to launch funds in the first months of 2011. Established managers are benefiting more than start-ups as institutional investors, still wary after the downturn of 2008, look for a well-established track record of performance and stability. Average fund size appears to be down, but one must take the positives in an industry that has seen turbulent times.
Things have undoubtedly changed since the halcyon days of the mid-2000s. The financial crisis gave investors a much stronger voice, and they became much more aware of the role of boards in fund governance. Greater focus on the independence of directors is a good thing for the industry, as it indicates that managers are paying more attention to the needs of investors. Similarly, investors are conducting much more extensive due diligence on managers and prospects before they’re willing to part with their money.
Another sign of investors’ new-found strength in their relationship with managers is resistance to gating provisions in fund documentation. As the crisis unfolded, managers saw the importance of being able to prevent a run on their funds, but now we appear to have gone full circle and, understandably, investors are much more reluctant to countenance the imposition of gates.
Still, some things have not changed in the industry. There was considerable speculation that managers would have to move away from the 2-and-20 fee model to attract investors, but our experience is that it has survived the turbulence relatively intact. Also, despite all the rhetoric surrounding a clampdown on offshore centres and their role in the financial crisis, it is clear that London-based managers continue to find hedge funds domiciled in the Cayman Islands and British Virgin Islands best suited to their needs and those of their investors.
Following a lengthy period of uncertainty, the final form of the AIFM Directive is positive news for the offshore fund industry, especially established jurisdictions like Cayman and the BVI. Private placement has been the standard distribution model for the marketing of alternative investment funds both within and outside the EU for a number of years.
Cayman and BVI general partners of limited partnerships and locally-incorporated managers of corporate funds set up in the jurisdictions can continue to market alternative investment funds in the EU through private placements, until at least 2018, when the directive will be subject to review.
However, once the directive comes into effect, EU managers will no longer be permitted to use the private placement rules to market alternative investment funds, even for domestic distribution, but will have to comply with the more onerous requirements of the proposed passporting regime. This may lead arrangers to prefer to use a third-country manager and alternative investment fund formed in Cayman or the BVI.
Simon Dinning is the managing partner of Ogier’s London office
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