By Simon Gray - With a growing reputation for expert capability within a broad-based financial services framework, Jersey seems poised to sustain a growth trend in the private equity sector that has continued even through the more difficult environment of the past three years. That period has seen consolidation among alternative fund administrators, notably the acquisition two years ago of local market leader Mourant International Finance Administration by State Street, but also the establishment of niche firms specialising in private equity and property funds.
Industry members agree that the arrival of State Street has been an extremely positive sign for Jersey. “It was a great show of confidence in the island,” says Ashley Le Feuvre, a senior manager in the funds and SPV group at Volaw Trust & Corporate Services. “What it means is that there is a broad range of service providers from fairly small firms up to global players. In addition, high-quality non-executive directors are available, and with all the good audit and accountancy firms here, a private equity promoter coming to Jersey should be able to find everything they need in the island.”
His colleague Kate Anderson, head of the funds legal team at Voisin, adds: “Those service providers who’ve survived the past couple of years have come out of it fairly strong. It’s weeded out the few that didn’t really have the resources to be in fund administration and helped to consolidate a service provider industry with the capability to handle the work here. Knowledge and experience is very high on the island – it’s not a brass nameplate fund domicile where nothing actually happens.”
Jersey has attempted to chart a course commensurate with the size and calibre of its workforce, balancing the determination of the political authorities to keep the island “open for business” by enabling companies to bring in skills scarce or unavailable on the island with an outsourcing regime designed to promote a focus on performing higher added value work locally while less valuable or more labour-intensive functions are carried out in more appropriate jurisdictions.
The downturn of the past few years has arguably offered Jersey a breathing space from the overheated market of the mid-2000s, allowing service providers to concentrate on the quality of their services and infrastructure under less pressure from inflows of new business. It has also reinforced the island’s reputation for service expertise and sound regulation at a time when these attributes have become more prized, not least by investors.
That’s not to say that private equity work now is flowing back to Jersey in the volumes experienced before the crisis, and life remains particularly difficult for newcomers to the market trying to raise capital for the first time. However, providers say that private equity houses with established track records and institutional investor rosters are starting to get new funds off the starting blocks in appreciably greater numbers, while – not necessarily coincidentally – transactional business is also picking up.
“Throughout this year we have seen a stronger flow of both UK and European private equity and real estate funds work,” says James Mulholland, a partner with Carey Olsen in Jersey. “Since 2008 there has been a logjam of managers looking to start raising their next fund, but slowed down because they haven’t been able to crystallise their track record with exit transactions. Now that this is happening at last, they can think about going to the market.”
Mulholland says the current inflow of business is characterised by opportunistic investments stories such as special situations and distressed real estate. He adds, “We are comforted by the uptick in acquisition work undertaken by private equity firms, with Jersey and Guernsey featuring structuring activity ranging from bid vehicles to the issue of listed debt securities. There has been quite a significant bounce-back of M&A activity in the third quarter, although the European sovereign debt crisis will inevitably dampen activity for the rest of the year.”
According to Le Feuvre, Volaw has seen more fundraising for private equity real estate funds than classic buyout vehicles. He adds: “On the private equity side we are working on a new fund following a buy and build strategy for an existing client, but while there are definitely signs that people want to invest, in our recent experience there is more interest in property.”
Le Feuvre argues that the period between the announcement of a fund and its closing has grown significantly over the past few years. “Lead times are definitely much longer, in part because clients are going through expanded due diligence before investment decisions are taken. Promoters may be talking about a structure for quite a long time before it actually moves toward establishment. Even if investors really like a promoter’s idea, the time horizon to getting a capital commitment and going ahead with establishment of the fund can still be quite lengthy.”
Andrew Weaver, head of the funds and investment services team at Appleby, says: “There’s a lot of activity on the fund formation side but fewer funds are actually achieving closing, apart from those from some of the big private equity houses with a long track record. There are also spin-outs taking place from major financial services firms and banks as private equity teams become independent. This is positive for the industry because it adds to its diversity.”
“It’s business as normal in Jersey, with the caveat that there is a lower volume of activity in the market, and that will continue until the ‘dry powder’ that was not used over the past two or three years is spent. That element is holding back the formation of the next generation of funds, together with the turbulence in the capital markets, the denominator effect on investors and their ability to make money available for commitments.”
The denominator effect – the artificial growth of private equity holdings as a proportion of an institution’s overall portfolio as a result of a slump in the value of other types of investment, resulting in the institution exceeding its agreed allocation to the asset class – is weighing on the ability of private equity firms to raise new funds, Weaver says, even assuming that investors are still maintaining their existing levels of private equity investment, which is not always a given.
“Two years ago the denominator effect wasn’t so much of an issue because people weren’t trying to raise new funds, but it did have an effect on meeting drawdowns,” he says. “That has resolved itself, but new funds continue to find it hard to raise capital from institutional investors because the scale of their allocation to private equity has been reduced by the decline in value of their other investments. It has to have an impact.”
Ogier funds partner Daniel Richards says the firm has seen an appreciable uptick in interest in launching new structures after a period of relative dearth, including both listed investment structures and non-listed private equity funds. He says: “We seem to be moving from a period of restructuring and consolidation, including negotiation with existing stakeholders, into one characterised by new launches and new money becoming available.”
His colleague Jane Pearce, head of Ogier’s fund administration business in Jersey, argues that the fundraising process is not necessarily shorter but that promoters have revised their capital commitment targets downward. “The length of the fundraising period is a function of the size of fund they are trying to raise,” she says.
“Back in 2007 and 2008 the typical size of a mid-market fund had crept up from about USD350m to USD500m or even USD1bn. Fund sizes have now returned to their previous level, but the length of time for fundraising remains similar to that in the past. It’s promoters who are still trying to raise larger amounts that are facing delays.”
A revival in business, however incremental, is good news for Jersey’s service provider industry, which has gone through a shake-up of its own over the past few years. Fears that onshore fund administration centres, especially Luxembourg, might seize a significant chunk of the market for fund establishment and servicing appear to have been largely unfounded.
Instead private equity firms targeting investment particularly in Europe have developed structures that often incorporate Channel Islands-domiciled fund vehicles and Luxembourg acquisition and holding vehicles – hence a trend on the part of specialist fund administrators in Jersey and Guernsey to set up offices in the grand duchy.
“Luxembourg, the only European jurisdiction that we see trying to make headway in the private equity space, is still primarily seen as a jurisdiction for the provision of holding companies rather than funds,” says Ben Robins, head of the global funds practice at Mourant Ozannes. “While there are some private equity funds there, firms are having to acquaint themselves with an unfamiliar model because they don’t have the same Anglo-Saxon legal forms such as partnerships.”
Hence the proliferation of private equity structures embracing vehicles in more than one jurisdiction: “We’ve seen many private equity administrators in Jersey opening a Luxembourg office, because they were not only administering funds but having to organise Luxembourg companies for the investments, serviced by local administrators. Most of the large players in Jersey and Guernsey now have a Luxembourg presence or capability.”
Most members of the industry expect to see continuing consolidation in the alternative fund administration sector, but note that private equity is less susceptible to the streamlined processes and economies of scale that can be achieved with long-only mutual funds and many hedge fund strategies. And, they point out, other changes across the global financial industry, such as moves to curtail proprietary trading by investment banks, might benefit niche providers rather than global conglomerates.
“We live in a world of increasing consolidation,” says Jersey Funds Association chairman Nigel Strachan. “Over the past two years we have seen the acquisition of MIFA by State Street. There are not as many independent fund administration service providers left.
“Some of the smaller trust companies have moved into fund administration, but it’s a mature and competitive market with high barriers to entry. In some cases they can continue because they have a niche markets in which to operate, but otherwise I would not be surprised to see many of them acquired in the coming years. However, remaining independent has distinct advantages, including autonomy, speedier decision-making, and a focused approach.”
Weaver says: “While consolidation is continuing in the service provider sector, there is diversification going on in terms of demand for services, especially because of the US requiring banks to divest themselves of their proprietary trading businesses. In some ways, that plays to the strength of the independents.
“Whereas Goldman Sachs Private Equity might have used State Street as a fund administrator, a mid-market private equity team that has spun off from Goldman might prefer a smaller, more boutique service provider. There are pressures pulling in all different directions. We are hearing from fund managers who feel that as a consequence of consolidation in the industry, they are no longer getting the same personalised service they did before.”
While private equity has traditionally favoured a more bespoke approach to administration than the conveyor belt approach available for more orthodox asset classes, Weaver argues the appeal of a more artisanal model should not be exaggerated. “Service providers of all kinds are focusing more on efficiencies, economies of scale and specialisation of staff. That is part of the normal evolutionary development of business.”
Still, the current period of change and uncertainty throughout the private equity value chain is resulting in a state of flux. “At this stage there is a lot of movement in the market as established managers, funds and teams change their service providers, which to some extent reflects the consolidation going on” he says. “Either these firms are not happy with the resulting change, or they are not sure where it will take them, and it’s a trigger for them to investigate other options. And with new fund formation down from previous levels, there’s even more competition for existing business.”
Once, Robins acknowledges, Jersey might have lagged Guernsey as a centre for private equity business, but it has largely caught up in recent years, certainly in terms of the range of service providers. “There is a very good range of administrators in Jersey, from the very large institutional businesses such as State Street and JP Morgan via mid-size firms to very small niche players who do nothing but private equity,” he says. “They don’t want to dabble in other asset classes but seek a reputation for being very specialised, and my experience of working with those firms has been that they tend to do a pretty good job.”
But smaller firms face particular challenges in a market environment characterised not only by economic uncertainty but growing regulatory pressure. “One of the key challenges over the next three to five years will be how they can cope with the new regulations,” Robins says. “Legislation such as Fatca in particular will have a huge impact on administrators. Offering Fatca-compliant products that help you deal with that will put you at a significant advantage.
“Will it make life more tricky for small to medium sized firms than the big players? Possibly, because the latter may be able to create global platforms to roll out across their worldwide offices. Yes, there is scope for further industry consolidation, but a lot of small to mid-sized players do a fantastic job, and we need to keep that range, because different clients want different things. Some want an administrator with a large balance sheet, while others place a higher priority on really personal service from a small team.”
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