By Simon Gray - With a growing reputation as one of Europe’s key centres for the domicile and servicing of alternative investment vehicles, Jersey is starting to reap the benefits of its experience and expertise as the private equity industry at last shows some signs of recovery from the slump into which it was precipitated by the credit crunch, financial crisis and economic downturn, a series of setbacks that began more than four years ago and whose effects linger today.
The industry has been impacted in different ways. Shortages of credit cut off the leverage that drove outsized returns from buyout deals. Meanwhile the downturn depressed company values and severely disrupted the initial public offering market, shutting off another exit route for private equity deals as well as dampening the interest of investors in committing to new funds while capital was still locked up in existing ones.
To some extent it can also be argued that the past few years have made life more difficult for offshore fund jurisdictions, calling into question their commitment to international oversight standards and tax transparency – issues that have underpinned many of the regulatory changes that private equity and the alternative fund industry as a whole are now facing on both sides of the Atlantic.
Yet in many respects the G20-led move to bring offshore centres into line with onshore norms has benefited Jersey and other jurisdictions that have been able to demonstrate their readiness to comply with international standards, from the regulation of service providers to alternative funds to the island’s longstanding efforts to embrace the Organization for Economic Cooperation and Development’s campaign against harmful tax practices. And a reputation for compliance is also valuable to investors, especially institutions that have to answer to their own stakeholders.
“Investors want the reassurance of a robust regulatory framework, and Jersey remains a popular choice,” says Jane Pearce, head of the Ogier group’s fund administration business in the island. “The Channel Islands have done very well in making sure that they are managing the regulatory requirements sought by investors, for whom it is important to have confidence in the administration and management of assets within the jurisdiction.”
Her colleague Daniel Richards, a funds partner with the Ogier law firm, adds: “Jersey and Guernsey have always benefited from stability and certainty, which is why promoters follow a well-trodden path to the Channel Islands time and again. There’s also the advantage of a tax-neutral platform, vehicle flexibility and an experienced fund services industry, along with certainty over ongoing costs.”
Richards notes that the island’s endorsement by independent international standard-setters such as the International Monetary Fund and the International Organization Of Securities Commissions as well as the OECD has reinforced the impression worldwide that Jersey is a leader rather than a follower in the campaign to achieve appropriate and sufficient regulation across the global financial services industry.
The island’s common law tradition – particular important given the Anglo-Saxon predominance in the sector – and the respect enjoyed by its legal system are further arguments encouraging private equity houses to establish funds and in some cases management and administrative operations in the jurisdiction.
And while Jersey has regularly shown its willingness to respond to the concerns of its European neighbours, it has also stood up for itself under EU pressure, not least in defending its zero-10 tax regime – under which local companies are either exempt from corporate income tax or pay a 10 per cent rate – against charges that it created anomalies between the treatment of resident and non-resident shareholders.
All this is helpful at a time when the impending entry into force of the EU’s Alternative Investment Fund Managers Directive, scheduled for July 2013, is prompting private equity firms to ponder to what extent they should base operations within the union – and what kind of activities would be more effectively maintained outside. Many Jersey practitioners believe that the island is capable of meeting both needs.
Although broadly welcoming the consultation papers published over the past couple of months by the European Securities and Markets Authority, which is responsible for advising the European Commission on so-called Level 2 measures implementing the directive in detail, industry members mostly say they will remain cautious until they see the final outcome – understandably given some of the provisions found in early drafts of the legislation that threatened to exclude non-EU managers and funds from the European market altogether.
The final version is more accommodating, offering a ‘passport’ to the EU market from some time after July 2015 for foreign funds whose managers comply with the terms of the directive, subject to arrangements between supervisors and governments in areas such as regulatory co-operation and tax transparency. Although non-EU managers and funds will gain access to the passport at least two years later than vehicles domiciled and managed within the union, they should continue to be able to offer funds to sophisticated investors under national private placement regimes until at least 2018, and perhaps longer.
“As one of the principal fund domiciles within the European time zone, we’ve obviously paid close attention to the development of the directive and what that means for Jersey funds,” Richards says. “Between now and 2018, there will be complete stability for existing fund structures using private placement regimes to market to sophisticated investors within the EU, particularly for closed-ended alternative funds, which is our main market. There is also every likelihood that private placement regimes will continue after that date, with the possibility of the EU passport existing in parallel.”
Practitioners from jurisdictions that have signed the Iosco Multilateral Memorandum of Understanding to facilitate cross-border enforcement and exchange of information between securities regulators are encouraged that Esma seems willing to consider this agreement as a template for regulatory co-operation, which is stipulated for third-country market passporting access under the directive but not defined.
“Jersey was in fact a founding signatory of the Iosco memorandum, so we would be very comfortable using it as the way forward – that would definitely be our preferred template,” Richards says. “But if a bilateral approach with EU member states is the eventual outcome, Jersey has already shown that it can strike agreements – it already has regulatory co-operation in place with 11 EU member states including the UK and Spain.”
Andrew Weaver, head of the funds and investment services team in Jersey for law firm Appleby, says of the proposals: “It looks like a balanced approach. Esma appears to be suggesting a framework based largely on the Iosco MMoU, from which they will come up with an agreement that should then be agreed between the third-country and EU regulators. Jersey is already well established in the context of Iosco principles and methodologies and should be able to meet the obligations without any significant alteration to its regulation. Probably the biggest challenge will be the process of negotiating and collecting the signatures on the agreements.”
The directive’s provisions on fiscal co-operation cite tax information exchange agreements between third countries and EU member states in which funds are to be distributed. Jersey entered into its first Tiea (with the US) in 2002 and currently has nine agreements with EU countries as well as more with non-member countries. Anti-money laundering compliance is supposed to be measured against the Financial Action Task Force principles, on which the island has been certified by the IMF as having a better record than either the US or the UK.
Ashley Le Feuvre, a senior manager in the funds and SPV group at Volaw Trust & Corporate Services, believes that being close to the EU but outside it, Jersey could find itself to some extent in the best of both worlds as a third-country jurisdiction whose robust regulatory regime is acceptable to European and non-EU based counterparts alike. There are even suggestions that non-member jurisdictions could benefit by learning from the early teething problems of the AIFM Directive regime, although he cautions that there is still behind-the-scenes mistrust of the offshore financial sector.
“We were cautiously optimistic after seeing the first draft of the detailed measures,” Le Feuvre says. “However, in the end we will have to drill down into individual nations’ implementing legislation, and there are still certain countries within Europe that see Jersey and other offshore territories negatively.
“Wilfully or not, they don’t seem to grasp how we are positioned in terms of tax neutrality. Jersey’s general philosophy is that that while everything needs to be taxed somewhere, it doesn’t need to be taxed twice. We wish to be a conduit and an aid to international business, not a means of assisting people to avoid tax. But certain countries within Europe continue to take a dim view of the offshore industry, so it remains to be seen to what extent we will benefit from a true European passport.”
Le Feuvre argues that as long as the ongoing Level 2 implementation process continues, a degree of uncertainty will remain. “This was highlighted by the European Securities and Markets Authority’s recent consultation on third country issues, which has raised fresh concerns over how the directive will be applied to non-EU managers and funds,” he says.
“In particular, as Aima has pointed out, the consultation paper reintroduced the concept of ‘equivalence’, which was dismissed during last year’s negotiations on the framework directive. In some parts of the proposal it is unclear who would be responsible for assessing equivalence, and in addition, the completion of a large number of third country assessments ahead of the implementation deadline seems unlikely.”
Nigel Strachan, chairman of the Jersey Funds Association, is more sanguine about how Jersey will fare under the directive. He says: “If you had to draw a line in the sand today, we are probably as well-placed as any other jurisdiction (if not better) because of our excellent regulatory environment, depth of experience, range of service providers, political and fiscal stability and very favourable IMF rankings. We will do whatever is needed to make sure we have a fully compliant AIFMD product as necessary.
“That said, if managers can continue to use the private placement route for fundraising beyond 2018, they will, and while we already have an excellent range of fund products, we may adapt as the regulatory environment evolves. The Jersey Funds Association is working closely with government and the Jersey Financial Services Commission to make sure we know what the directive requires and that we are doing whatever is needed.”
James Mulholland, a partner with law firm Carey Olsen, is upbeat about the outcome. “As an industry, we’re certainly not afraid of the directive,” he says. “There has been some scaremongering in the past and some rather vocal viewpoints pro and against, but we view it as an opportunity for the Channel Islands given our well-regulated fund regimes. If we have a good AIFM Directive-compliant product, we can offer not only the benefits of an offshore platform but the ability to market within Europe.”
Mulholland notes wryly that he has effectively bet his career on Jersey’s prospects in the AIFM Directive era. “This time last year I was in London when I got a telephone call from Carey Olsen, who were looking for a private equity funds lawyer for their Jersey team,” he says. “It was a wonderful opportunity, but the directive and its impact on the offshore world loomed large in my consideration. To some extent I’ve staked my career on a positive view of the directive.”
Now that the shape of the legislation is becoming clear, the industry is ready to move proactively to ensure it can match the offerings of onshore jurisdictions such as Luxembourg. “Lawyers on both islands and other key stakeholders are working hard behind-the-scenes on proposals to develop the fund regimes and tailor them to the requirements of the directive,” Mulholland says. “That would enable funds and managers to go offshore but still enjoy the benefits of the passporting route through a directive-compliant fund regime.”
While the Expert Funds regime appears well suited to meet the eventual AIFM Directive rules, with a few tweaks in areas such as capital requirements, Jersey has already moved to increase the attractiveness of its private equity offering with changes earlier this year to its partnership legislation the introduce for the first time separate limited partnerships and incorporated limited partnerships.
“Up to now, limited partnerships established in Jersey have not had their own distinct legal personality in the way that a company does,” says Ben Robins, a partner and head of the global funds practice at law firm Mourant Ozannes. “The incorporated limited partnership is a body corporate with some of the features of a limited partnership but also some of the characteristics of companies. Aside from funds, it may be of particular interest in using local partnerships for management or carried interest vehicles. But what it does do is add to the range of options available in the island.”
There is also ongoing talk about changes to the rules governing funds set up under the Control of Borrowing Ordinance, a regime for funds with 50 or fewer investors and that offers a lighter touch for general partners – potentially offering lower running costs for smaller and mid-sized managers at a time when margins are notably tighter than they were a few years ago.
Currently the review of the COBO regime appears to be on the back burner, in part because it makes sense to delay further changes to domestic legislation until it is clear what the EU directive entails. “We were looking at a full-scale review of the COBO law a couple of years ago, but it has been put on hold,” says Kate Anderson, head of the funds legal team at law firm Voisin. “Reform will hopefully have a positive if not necessarily radical impact on the fund industry, but the authorities are currently dealing with the directive. I am sure that they will take up the review again when appropriate.”
There are also efforts to improve the competitiveness of Jersey vehicles from a tax point of view by building on its efforts to conclude tax information exchange agreements. “There is a growing desire within the island to build its double tax treaty network,” Weaver says. “This is important because Luxembourg, for example, has a very strong business on the private equity transaction vehicle rather than fund formation side, driven by its extensive tax treaty network. Jersey would like to enhance its position by developing the relationships it has built through Tieas to create full double tax treaties, and it already has a full treaty with Malta.”
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