By Simon Gray – The Isle of Man has suffered its fair share of the alternative fund industry’s woes during the past three years of financial crisis and economic downturn, especially with the loss of one of its largest fund administrators, HSBC, and a decline in assets under administration from a peak of USD58bn to USD34bn at the end of 2009. However, members of the industry and government officials responsible for promoting the sector say the island is well positioned to recover ground in a business environment characterised by increased focus on transparency, regulation and governance – not to mention costs.
Like the Channel Islands, fellow dependencies of the British crown, the Isle of Man is seeking to capitalise on a reputation for high-quality services and good standing with international organisations such as the Organization for Economic Co-operation and Development and the Financial Action Task Force not only to win fund domicile and servicing business but to attract alternative fund managers looking for options outside the UK tax net and the European Union’s regulatory ambit.
Unlike Jersey and Guernsey, the island strategically positioned in the middle of the Irish Sea between Great Britain and Ireland does not suffer the space and housing constraints experienced by many offshore jurisdictions, making it easier to manage issues such as availability of skills. Arguably, it also benefits from a broader economic base, including a vigorous life assurance sector, that makes it less vulnerable to the fluctuations of the investment industry. In addition, the existence of value-added tax makes government revenues less dependent upon the economic activity generated by the financial sector.
Right now, in common with the other crown dependencies, the island’s position is complicated by a dispute with the EU over the ‘zero-10’ tax regimes adopted by the three territories over the past few years. The zero-10 approach, which exempts most companies from corporate income tax, was conceived in order to meet bring the islands into line with the EU Code of Conduct on Business Taxation, which frowned upon differences in the tax treatment of companies with local and international operations.
Recently, however, it has been suggested, somewhat indirectly, that while the zero-10 regimes may comply with the letter of the code of conduct, they breach its spirit. However, the specific complaint of the EU Code of Conduct Group is with attribution and deemed distribution provisions designed to prevent local taxpayers deferring income tax through companies retaining profits instead of distributing them. Because the measures did not apply to shareholders not resident in the respective jurisdiction, the provisions were deemed discriminatory.
Guernsey had signalled its willingness to respond to the apparent broader concerns about zero-10 by contemplating fundamental changes, perhaps involving a move to a standard 10 per cent corporate tax rate. But Jersey and the Isle of Man initially rejected the EU’s complaints on the grounds that the provisions in question involved personal rather than business taxation and therefore fell outside the remit of the code of conduct.
However, in February the two crown dependencies changed tack and effectively called the EU’s bluff by announcing the abolition of the attribution and deemed distribution rules, leaving zero-10 otherwise intact. The Isle of Man insists that the code of conduct group, as well as the union’s Economic and Financial Affairs Council (Ecofin), had determined as long ago as 2003 that zero-10 regimes as such did not constitute abusive and harmful tax practices.
Treasury Minister Anne Craine argues that the island has now met the objections raised to its tax system: “Indications from the UK Treasury [were] that, as expected, the code group considers the Attribution Regime for Individuals in combination with the island’s corporate tax system to be harmful. As we had been anticipating that the attribution regime would be found to be harmful, I moved to abolish it in [last month’s] Budget.
“We remain committed to our policy of being a good neighbour, which encompasses being responsive to the views of the European Union. At the same time, the Isle of Man is fiscally independent, and participates in the code of conduct process on a voluntary basis. It is not in the island’s interests to have aspects of our tax system which the EU sees as causing difficulty. Removing the attribution regime should end concerns over the zero-10 company tax system.”
The argument is set to rumble on for a few months yet, with the code of conduct group due to report to Ecofin, which in turn may not take a decision until May or June. But Brian Donegan, head of business development for investment capital markets in the financial services division of the Isle of Man’s Department of Economic Development, demurs at suggestions that the determination of Jersey and the Isle of Man to retain their zero-10 regimes risked bringing down the wrath of the EU on all three crown dependencies.
“We have been at great pains to be transparent and accountable with all European authorities, even though we don’t enjoy full membership of the EU nor full access to its markets for our financial products and services,” he says, noting that the Isle of Man decided many years ago that it would be fully accountable and compliant.
Indeed, Donegan points out that the island is using its growing list of tax information exchange agreements, with EU members among others, as a springboard to develop double taxation agreements that will be of particular benefit to the financial sector. “The expectation is that in time we will have a very acceptable network of double taxation agreements.”
Meanwhile, the island is preparing for the entry into force of the EU’s Alternative Investment Fund Managers Directive, for example through the creation of a dedicated working party within the fund development group comprising representatives of the regulator, the fund industry and the government. The group will examine the steps the jurisdiction needs to make over the coming months and years to ensure that funds domiciled in or managed from the Isle of Man are eligible for ‘passporting’ into EU markets once this is authorised by the directive, probably from around mid-2015.
“Considering the various compromises drafts that were put forward, what’s emerged is workable for the Isle of Man,” says PwC partner Peter Craig. “The retention of the private placement regimes is crucial, because it would have been very hard for the island if they had been abruptly abolished and access to the UK market had disappeared overnight. The phased approach means Isle of Man funds are not instantly excluded, and it gives a reasonable timescale to meet the required criteria.”
Donegan agrees, saying: “The final form of the AIFM Directive is less onerous than the first draft that appeared in 2009, when it looked as though there would be a Fortress Europe-type approach to the alternative fund industry. We believe that when the time comes, our products and services will be capable of being considered equivalent for the purposes of passporting within the EU. We also believe we will benefit from the strength of our reputation. Institutions and managers are very keen to ensure that their own good name is not at risk in any way as a result of the jurisdictions in which they hold investments or run operations.”
Mike Kelly, managing director of ABN Amro Fund Services (IOM), the former Fortis Prime Fund Solutions business that is in the process of being acquired by Credit Suisse, agrees that being recognised as a well-regulated jurisdiction will help the Isle of Man to gain any necessary approvals for its fund business under the future EU passporting regime.
“We are very fortunate in having a very close working relationship with our regulator,” he says. “The Isle of Man Financial Supervision Commission can hear directly from the industry what it feels it needs in order to obtain regulatory equivalence. The regulator is ready to work with its counterparts in EU jurisdictions and get the agreements in place to enable us to market our products within Europe.”
Gill Crennell (pictured), a senior associate with law firm Appleby, says the relationship has also proved its value when the need for internal regulatory change has become evident. “The Isle of Man has a really good track record in moving quickly on regulation,” she says. “If something is identified as being needed, the Fund Management Association can draw on its good working relationship with the regulator.
“For example, treasury shares for traditional Isle of Man companies whose shares are admitted to trading on an established market were introduced in May last year in direct response to a request from local fund administrators. This may give us an edge over regulatory relationships in other jurisdictions.”
For now, the government’s strategy is to rebuild the momentum the Isle of Man enjoyed before the financial crisis as the global industry resumes its upward path. “The hedge fund industry seems to be back to its pre-Lehman asset levels and we’re starting to see signs of a pick-up in the Isle of Man as well,” Donegan says. “When the crisis peaked in 2008 we had just under USD58bn in assets under administration.”
The Isle of Man Funds Review Group, which comprises representatives from the sector, regulator and government, recently completed the latest in a series of regular reviews of the island’s fund industry. Says Donegan: “The chief recommendation was that we needed to do more to keep our profile up, especially among the lawyers in the City of London who decide where funds should be incorporated and domiciled. We have a strong offering in terms of our licensing regime for fund management as well as our regulatory, legal and fiscal infrastructure. But we need to focus our attention on ensuring that people are aware of the benefits we offer.”
The jurisdiction’s outreach strategy includes the sponsorship of major hedge fund conferences, regular panel-based debates on topical issues in London for audiences drawn from the industry, and presentations to key City law firms. Donegan also invites managers to visit the Isle of Man to inspect it for themselves: “Visitors really appreciate the substance and benefits of our funds offering.”
Susan Macgregor, assistant vice-president in the Isle of Man intermediary and institutional wealth solutions team at Barclays Wealth, agrees that the island needs to maintain its focus on targeting key markets, with close co-operation between the government and the Fund Managers Association. “We have a very co-ordinated approach and our marketing efforts are quite significant, but we don’t want to take our foot off the pedal when competition with other jurisdictions is so intense,” she says.
Donegan notes that the fund industry remains a vital part of the island’s financial services sector. “In line with many other countries and territories around the world, the Isle of Man is facing a period of financial readjustment, but it is starting this process from a position of relative strength, with low unemployment, no external borrowing, sound reserves and a reputation for political stability,” he says.
“Our economy is holding up well, which is a tribute to the diversity and resilience of the island as a leading centre for international business. Its pragmatic and careful budgeting in recent years has allowed us to make significant investment in the island’s infrastructure, including a new hospital, schools, an energy-from-waste facility and world-class telecoms services.”
Angus Gilmore, director of operations and risk at Ernst & Young and chairman of the Isle of Man Fund Managers Association, adds: “We are not by any means sitting still, but looking to develop new products that the markets want and persuading people to use the Isle of Man rather than our competitor jurisdictions. Institutional investors seem to be having more of a say in domicile decisions. They want to see funds domiciled in a jurisdiction where there is legal recourse, where the law is similar to what they are used to, and preferably in a time zone not too far away. The Isle of Man can offer all of these things.”