By Simon Gray – As though a mediocre investment climate and a difficult environment for fundraising weren’t enough to deal with, the alternative fund industry in Europe is now facing up to the home straight of implementation of the European Union’s Alternative Investment Fund Managers Directive, which is due to take effect as of July 22 next year. But while many professionals may see the legislation as a threat, or at best a distraction for urgent investment and operational issues, Malta and its fund service providers tend to see it more as an opportunity.
No-one can yet be absolutely sure how the directive is going to impact their business because it is still shrouded in uncertainty. The final wording of the directive itself may have been signed off by the EU institutions last year, but the so-called Level 2 measures – the directly applicable regulation from the European Commission setting out the detail of how the legislation is to be implemented in practice – are not only running later than expected but may differ in significant ways from the advice the Commission was given last year by the European Securities and Markets Authority.
Nowhere is the uncertainty more alarming than among investment managers or funds based outside the EU, who have in theory have been offered a route to obtain authorisation and the same cross-border marketing passport as their European-based counterparts, but not before July 2015, and only subject to subsequent decisions by the EU institutions that are by no means guaranteed.
It’s an ill wind that blows nobody any good, and industry professionals in Malta say the Mediterranean island could be a major beneficiary of the desire by managers abroad to ensure they retain access to the European market once the AIFM Directive is in force. The jurisdiction may have a valuable advantage over rival EU fund centres Luxembourg and Dublin in its significantly lower cost structure, a more important consideration when fundraising is slow and managers may be starting out with a relatively small pool of assets.
At first sight Malta’s fund industry does not seem to represent much of a threat to its bigger European rivals. At the end of June the Malta Financial Services Authority reported a total of 439 funds and sub-funds in locally-domiciled collective investment schemes with EUR10.33bn in assets under management, including 348 Professional Investor Funds (including sub-funds), the regulatory structure used by the alternative investment industry, with assets of EUR7.15bn. By contrast, at the same time Luxembourg was home to 3,867 funds (13,407 separate portfolios including sub-funds) with EUR2.22trn in assets, including 1,445 Specialised Investment Funds with assets of EUR259.17bn).
But these numbers do not necessarily tell the whole story. For one thing, the MFSA’s figures do not include funds and assets domiciled in the Cayman Islands or other traditional offshore fund domiciles but managed and/or administered by Maltese firms. For another, the island’s fund industry has grown extremely rapidly over the past few years despite a highly inhospitable global economic climate. At the end of 2006, just before the dawn of the financial crisis, Malta had just 153 funds with EUR2.09bn in assets, including 78 PIFs with EUR1.28bn.
The island has not been immune to the impact of the financial firestorms racing around the world in recent years, but by any standards it has performed impressively, capitalising on developments including the wave of spin-off fund management firms established in recent years under the impact of regulatory shifts such as the Volcker Rule, the increased preference of investors for fund vehicles established in regulated onshore European jurisdictions, and the growing appeal of once-exotic investment specialities such as Shariah funds.
By and large it has escaped blow-ups, bar the 2008 collapse of the La Valette Multi-Manager Property Fund, which resulted in a long-running row between disgruntled investors, the regulator and the fund’s manager, Bank of Valetta, which still continues. On September 5 the international accounting firm Mazars was appointed by the MFSA to examine investor files for evidence of mis-selling. However, the case has not affected international perceptions of Malta because the investors were overwhelmingly domestic.
So far the growth in domiciled funds has been driven mostly by smaller vehicles. “The typical size of fund launches we are seeing ranges from smaller launches with assets of between EUR10m and EUR20m, which constitute perhaps around 40 per cent of the Maltese fund market, to a handful of launches above the EUR500m mark, but these are only between 2 and 3 per cent of the total,” says Dr André Zerafa (pictured), a partner with law firm Ganado & Associates.
“So far Malta, with these few exceptions, has failed to attract big fund platforms. That is our next challenge now that Malta is on the map as a fund domicile of choice in the same way as Luxembourg or Ireland. The island does not does yet have their reputation, because they have been around for a lot longer, but we are fast catching up.”
Laragh Cassar, a partner with law firm Camilleri Preziosi, believes that a change in the jurisdiction’s stature and the background of its fund clientele is already underway. “Higher-profile clients are starting to come in,” she says. “Whereas previously business was largely dominated by middle-tier funds that needed a favourable environment, the bigger players are now considering Malta as it becomes better known and more popular.”
Cassar says some of the newcomers are funds groups that are establishing Maltese investment vehicles alongside existing offshore funds in order to ensure continued access to the European market under the AIFM Directive, or that have previously focused on markets such as North America or Asia but are now are seeking to attract European capital as well. “They know that they need an EU domicile to gain access to the market here, but with the passport mechanism, they see the directive not so much as a threat as an opportunity,” she says.
The cost of doing business in Malta is a significant benefit for smaller and start-up managers; some industry members put total set-up costs, including regulatory fees, at between one-third and half the level in Luxembourg. Fears that costs might rise as the industry grows, a problem for Dublin in the early 2000s, have so far proved needless. However, Zerafa argues that in any case this is no longer as substantial a driver for the choice of a Maltese domicile as it may have been in the past.
“Costs are still important, but they have gone down the list of priorities for the typical fund promoter,” he says. “Today they are looking at the capability of service providers in Malta, the capacity of the industry here, and an approachable regulator. Time to market may not be as fast as in the Cayman Islands, where funds are not regulated in the same way that they are in EU member states, but it is still reasonable at around 10 weeks to launch. All these factors have militated in favour of Malta.”
At this point, most industry members are reluctant to hazard a guess about the extent to which these advantages may be compromised by the AIFM Directive. However, the authorities are determined that the island will be ready for the July 2013 implementation deadline – even if, as is increasingly conjectured, a significant proportion of the EU membership will not.
At the beginning of September the MFSA published a consultation paper outlining its plans for transposing the directive into national law. Says Zerafa: “There will be a revamp of Malta’s main funds law, the Investment Services Act, but the bulk of the obligations stemming from the directive will be implemented through rules and regulations. This would give the MFSA the flexibility to adapt the rules according to what comes out of the Level II measures, rather than having to go back each time to change the main law through an act of parliament.”
Says Cassar: “We currently have a very concise rulebook regarding non-retail funds, which will have to be substantially changed in the light of the directive. For example, right now there is no differentiation between a passportable non-retail fund that would fall within the scope of the directive and one that would not. They will need to distinguish between the two cases. And the rights and obligations conferred by the directive will need to be incorporated into the local rules.”
The deadline for responses to the MFSA’s consultation paper falls at the end of September, and Cassar says that if Malta’s MiFID implementation is anything to go by, adoption of the directive and its associated rules should take place rapidly. According to Zerafa, the plan is to have all the legislation, rules and regulations adopted by the first quarter of 2013, comfortably ahead of the transposition deadline. Already the regulator is preparing more or less formal education and training sessions both for licence-holders and members of the local support services sector on the way in which the directive will affect Maltese firms and their clients.
Joseph Ghio, a partner with Fenech & Fenech Advocates, says some potential clients are “sitting on the fence” about whether to domicile funds, or indeed their investment management company, within the EU or outside until it becomes clear exactly how implementation of the directive will work out in practice.
“This is particularly affecting business from the other side of the Atlantic,” Ghio says. “American managers are watching developments very closely, but they feel they still don’t have all the information they need about the AIFM directive to take decisions. Until the Level 2 measures are published, the AIFMD remains a moving target.”
However, he believes the uncertainty also has positive aspects in that market players are taking the opportunity to re-examine their existing, often long-standing business models. The focus on how the international regulated fund space will change is creating new opportunities for Malta to become more visible,” Ghio says. “The directive is prompting people to look for alternatives and options for how to remodel their business, and Malta can offer a very acceptable alternative.”
One AIFM Directive issue that is set to affect Malta in the medium term is the directive’s requirement that assets be deposited with a custodian in the jurisdiction in which the fund is domiciled. For now Malta has just a handful of licensed custodians, and only two international names, HSBC and Deutsche Bank. Local industry professionals acknowledge that some fund managers are uneasy at having a relatively limited choice, and that this issue is one factor in Malta’s more sedate growth in the UCITS market.
The authorities have made attracting more custodians a priority; two well-known – but still anonymous – industry names are reported to be in the pipeline. In the meantime, Malta plans to use its option to exercise a derogation to the local custody requirement until 2017, by which time it is possible that progress on the vexed issue of an EU passport for depositaries could render the question moot.
“I’m not aware of new players coming into the market as yet, but Malta is certainly actively trying to attract larger custodians,” says Paul Mifsud, managing director of Sparkasse Bank Malta, the subsidiary of an Austrian savings bank that has carved out a significant custody market share.
However, he believes it may be difficult to attract global players while new business in Malta remains dominated by small and start-up fund businesses. “Larger custodians normally require larger business, and they normally charge fairly elevated minimum fees,” Mifsud says. “I don’t see the market being ready for that, because some of managers coming here are relatively small. A big custodian would start off by asking for EUR25,000 or EUR30,000 as a minimum annual fee.”
His view is shared by Ximo Vicent, head of credit and investments at another niche custody provider, Mediterranean Bank (not to be confused with Mid-Med Bank, forerunner of HSBC Bank Malta), which was established in 2005 and is now owned by UK private equity firm Anacap Financial Partners. “Many players here in Malta are focused on bigger funds, but we offer a cost-efficient custody solution designed for small funds,” he says.