By Simon Gray - Malta's efforts to put itself on the map as a fund domicile and servicing centre within the European Union have been an undoubted success. Although fund numbers and aggregate assets are still low by comparison with its main competitors within the EU, Luxembourg and Ireland, over the past three years the Mediterranean island nation has forced itself to the attention of managers and promoters examining whether investor attitudes and the new global regulatory environment make it advisable to base at least part of their fund range onshore in Europe.
Over the next few years, the authorities and industry practitioners hope, a sustained recovery in the global investment environment and increased awareness among investors of the benefits of alternative strategies will boost the size of the industry while Malta’s resources and skill base, coupled with significantly lower costs than its rivals, win a bigger slice of the growing pie.
An important factor will be the introduction in July 2013 of the EU’s Alternative Investment Fund Managers Directive, which will eventually oblige all managers seeking to market funds to sophisticated investors in Europe to comply with the continent’s regulatory system. This will include prescriptions regarding the responsibilities of depositories and fund manager remuneration that industry members continue to regard as problematic, even though detailed implementation rules have not yet been finalised.
On one hand, the AIFM Directive could provide a significant boost to Malta, since EU-based managers and funds will gain earlier access to ‘passporting’ arrangements that will enable funds to be marketed (relatively) freely throughout the 27-nation union, and the island’s reputation for cost-competitiveness and flexibility should appeal to managers looking for a European base. But there are also fears that the directive’s uniform rules may iron out at least some of Malta’s current advantages.
The directive’s requirement on alternative funds to appoint a depositary responsible to a large degree for the safekeeping of assets also poses questions about Malta’s range of custodians, which remains limited enough to raise concern about the jurisdiction’s ability to deliver a full array of services in the AIFM Directive era – although the recent addition of Deutsche Bank as a depositary is a promising sign.
The relative shortage of custodians does not currently affect alternative funds set up under Malta’s Professional Investor Fund regime, but it is seen as a major reason why the island has not become more popular as a domicile for Ucits funds. This has probably cost it at least some business at a time when managers are rushing to target European investors by taking advantage of the more elastic rules on use of derivatives and leverage provided by the Ucits III Directive in 2002 to package alternative strategies within the Ucits framework.
In addition, some members of the industry worry that Malta’s cost advantage over its competitors could diminish. They point out that salaries and other expenses in the island’s fund sector are creeping upward, noting that Dublin went in a decade from a low-cost alternative to Luxembourg to an appreciably more expensive centre, although it’s hard to argue that rising costs braked Ireland’s growth to any significant degree.
A key priority for Malta is ensuring that the sector’s workforce remains capable of accommodating the growth expected in the coming years – itself an important factor in keeping costs under control – and the industry has undertaken various initiatives to strengthen links with the Maltese education system to help provide the skills firms will need in the future.
“Together with [promotional body] FinanceMalta, the Institute of Financial Service Practitioners has been in dialogue with the University of Malta for some time to remodel certain aspects of its courses, making them more practically oriented toward what the market needs,” says Dr Joseph Ghio, a partner with law firm Fenech & Fenech Advocates.
“Fund accounting was put on the university syllabus a few years ago, and now specialist elements are being introduced to that course. We have had a master’s degree in financial services for some 15 years, and it is now held by many of the professionals working in the industry. We are not only producing executives but also lower-level employees to complete the human resources package we need to do business.”
Malta may not be a very large country but its population of some 400,000 is not far off Luxembourg’s 500,000, notes Dermot Butler (pictured), chairman of Custom House Global Fund Services, although for obvious reasons it lacks the extensive pool of cross-border commuters available to the grand duchy in neighbouring areas of Belgium, France and Germany. “Still, the workforce is large compared with fund jurisdictions such as Cayman and Bermuda,” he says.
Butler is confident that the island’s labour pool is capable of sustaining significant expansion in fund services. “There may be a learning curve, and to begin with the legal profession may find itself under pressure, but it doesn’t take long for firms to gear up,” he says. “And since Malta is a member of the EU, there are no legal obstacles to importing trained people from other member states.”
Paul Mifsud, managing director of Sparkasse Bank Malta, says that in general the core skills required by fund administrators, custodians, accountancy firms and law practices are readily available, although specialists in areas such as asset management, which the authorities have targeted for future growth, are thinner on the ground. “We suffer in terms of the most specialised function, for example experienced traders and risk analysts, but we are well provided for entry-level positions,” he says.
Encouraging highly-skilled expatriates to bring their talents to the country is crucial if it is to expand the share of higher added value services within its financial industry, according to George Gregory, a partner and head of tax and corporate services at professional services firm RSM Malta, which has carved out a substantial area of expertise among fund management companies domiciled in the island. “The fund managers established here face a major issue in finding resources,” he says.
However, Gregory believes that the government’s scheme to offer a special tax regime for expatriates in the financial industry, first announced in November 2009 and implemented earlier this year, will help to remedy this deficiency. “For up to five years, expatriates in certain positions at the top end of the industry will be charged a flat 15 per cent tax rate starting from salaries of EUR75,000, and anything above EUR5m will be tax-free. This should help to expand the industry and transfer expertise to local people.”
The potential appeal of Malta to fund management companies has already increased following the implementation in July of the Ucits IV Directive, which provides a legal framework allowing fund firms established in one EU country to provide management services to funds domiciled in another member state. It should grow further once the AIFM Directive extends this management passport to alternative funds.
Ghio believes the much-debated directive could create a gateway to Europe for alternative funds comparable with what the Ucits regime has done for the cross-border marketing of retail investment vehicles, and that Malta is well positioned to benefit – subject to the eventual shape of the so-called Level 2 detailed implementation measures from the European Securities and Markets Authority (Esma), currently under consultation.
“We are seeing an increase in people looking at Malta as a way into Europe, not necessarily instead of an offshore jurisdiction but in parallel, and perhaps as a member state of reference [where managers will be regulated] under the AIFM Directive,” he says. “We are still waiting to see how passporting will work, what the fine detail of the third-country provisions will look like, and how different countries will implement rules in areas such as private placement and depositary liability. All this remains very much a moving target for now, but the industry is watching the space very closely.”
Last November’s compromise agreement between the European Parliament and EU member states, which had drawn up competing and contradictory drafts of the directive, has relieved some of the uncertainty. Says Ghio: “Since the directive was first proposed, firms that were considering setting up funds within the EU or redomiciling existing ones there have been sitting on the fence because of uncertainty about the treatment of non-EU jurisdictions. They adopted a wait-and-see approach: will it be approved, will it be shelved?
“To some extent that caused a lull in activity, although in fact last year was one of the most active yet in terms of the licensing of new hedge funds here. But the delay in approving the directive [it formally became law on July 21] has given time for Malta to get more firmly on the map as an alternative to existing jurisdictions.”
Ghio argues that the benefits of Malta’s decade of experience will not be lost under the AIFM Directive. “All member states will be on the same starting line, but we have the advantage of having been in the hedge fund business since the late 1990s, when the first legislation was introduced in Malta regulating collective investment schemes for professional investors, and we have generated the critical mass to be credible as a jurisdiction,” he says.
But some industry members are less certain about how much Malta will benefit from the creation of a level playing field across Europe, arguing that the advantages the island has derived from its regulatory regime may no longer apply – although its cost structure and English-speaking workforce will still help it to compete.
Smaller countries have long exploited their small size and fast decision-making processes to create a favourable tax environment for the fund industry, which explains why Ireland, Luxembourg and Malta have benefited most, while other would-be domiciles such as the UK have struggled to get their regulatory and tax regimes pulling in the same direction. But the flexibility of Malta’s regime for non-retail funds may not stand out so far from other jurisdictions once the directive comes into force.
The other concern is that with so much responsibility and potential liability being shifted to the fund’s depositary under the directive, fewer institutions may wish to participate in the market. This could complicate Malta’s efforts to attract more custodians.
At Sparkasse Bank, one of the established custodians, Mifsud is less alarmist about the implications of the directive (and of Ucits V, the mooted next iteration of the retail fund regime, which is likely to set similar levels of responsibility for depositaries), but he acknowledges that greater vigilance will be required. “There are many grey areas with the depositary function,” he says. “In some areas the directive is fairly vague.
“We understand that the legislator is trying to protect investors, but it is naïve simply to throw all the liability onto depositaries without recognising that they have to work with a range of other service providers including global custodians, sub-custodians and prime brokers.
“We will probably have to increase fees, because the monitoring role of the custodian will in the future have to cover the sub-custodian as well as the asset manager. But the legislators and regulators responsible for finalising the legislation in detail should drill down into what safekeeping really means and what a custodian is and is not allowed to do. Some of the matters are being addressed in Esma’s consultation papers, but I believe there are still some grey areas.”
Greater clarity will probably be required if Malta is to attract more institutions, especially big global names, to its custody sector, yet industry professionals say that without a bigger choice of depositaries, the island’s ability to compete effectively for Ucits business will remain hobbled and its appeal to international fund managers once the AIFM Directive regime takes effect will be compromised.
“Custodians have been trickling in, but there is room for plenty more,” says Katya Tua, head of investment services at Simon Tortell & Associates. “That is something we have been pushing for especially because of the need for Ucits to have a local custodian. It would increase the competitiveness of the jurisdiction to have more service providers, especially custodians that are well-recognised global names.”
The line-up currently includes HSBC, local institution Bank of Valetta and Sparkasse Bank, part of the Austrian savings bank group. Anthony O'Driscoll, managing director of Apex Fund Services Malta, adds: “Not having the custodian infrastructure limits the growth of the Ucits market. The arrival of Deutsche has added to Malta’s competitiveness, but we need a few more players to increase the options available to investment managers.
“The island is less appealing for Ucits funds if managers’ choice is limited to a couple of custodians. They want to know that if the relationship with a one custodian doesn’t work, there are other possibilities in the marketplace. That’s not the case in Malta at present, which is why the sector isn’t growing as fast it could be. Given the current popularity of Ucits, they should be growing much quicker in Malta.”
However, Mifsud is not convinced that lack of choice is solely responsible for the slow growth of the Ucits sector. “We will see whether that is true or false once the Ucits IV Directive has been in place for a while,” he says. “It’s very easy to say that the dearth of Ucits business is due to the lack of custodians, but I believe there is a shortage of investment managers willing to take on the challenge of managing a Ucits fund.
“A lot of managers and promoters wish to run Ucits schemes but don’t have systems robust enough to manage the exposures, limits and all the various controls to run the portfolios. It’s an issue of investment management maturity. Under the Ucits IV management company passport, a Ucits can be domiciled in Malta with a Maltese custodian, but run by a non-domiciled, non-resident investment manager. We hope this will increase activity in the island.”
According to Mifsud, Sparkasse Bank is already seeing stepped-up interest from promoters in offering absolute return strategies through Ucits structures. “Many strategies can be run just as efficiently under the Ucits regime,” he says. “Sparkasse is seeing more and more requests of this type rather than for true hedge funds, with managers using a Ucits rather than a Professional Investment Fund structure.”
Andrew Frankish, a director of IDS Fund Services Malta, also reports that interest in Malta-domiciled Ucits is growing, but he does not expect them to exceed PIFs in popularity any time soon. “Only a handful of the funds registered last year were Ucits,” he says. “This year we will probably see more, but it’s won’t be anywhere near the PIF regime. The latter is where Malta is really competitive, even with Ucits IV provisions such as management passporting and mergers.”
The other big area of concern for industry members is cost – right now a big plus for the jurisdiction, but one that it would hurt to lose. According to Ghio, some erosion of Malta’s advantage is inevitable. “The more successful we are in attracting fund business, the more likely it is that costs will rise as people move around and are poached by other firms,” he says. “That would simply reflect our success, as it does with Luxembourg and Dublin today.
“However, we have to be careful not to increase our cost base too quickly. Some things we can’t control, but others we can. I would be very concerned if legal and other advisory costs continue to rise and we end up with a cost structure comparable with Luxembourg’s. That could be very dangerous because if managers find they are paying the same amount, they may be more inclined to stick to Luxembourg as a longer-established jurisdiction they are used to doing business with. To maintain our growth and guarantee our longevity, we must be careful not to lose this cost advantage.”
Gregory also sees costs rising, albeit slowly, and he also believes that Malta may find greater competition from centres such as Dublin, where a seemingly inexorable cost spiral has been abruptly halted by the financial crisis. “We should be careful about how we advertise ourselves as a low-cost jurisdiction because salaries and other costs are increasing, and you have to throw in the extra cost of travel,” he says.
“In the past service providers in Ireland were probably more reluctant to take on smaller funds, and countries like Malta benefited from that. But now Ireland will take whatever it can, and it is a bigger threat.”
Frankish estimates that the cost of running a fund or a management operation in Malta is currently barely half of that in Luxembourg or Dublin, but he cautions: “The cost of fund accounting in particular is increasing. In Dublin a few years ago, after bonus time people were moving around from company to company and costs climbed rapidly. It’s very easy for things to get away from you and for your advantage to disappear.”