A year after the introduction of the Qualifying Investor Fund regime opened new vistas for Guernsey's hedge fund business, administrators across the island are enjoying a broad-based boom that encompasses other types of alternative investment as well as hedge funds, and even includes its residual retail funds sector.
Fund assets grew at an unprecedented rate of more than 35 per cent in 2005 to pass the £100bn mark, partly down to the introduction of the QIF regime, but also to strong demand for two other Guernsey specialities, private equity and property funds. Peter Niven, chief executive of the industry promotional body GuernseyFinance, believes that business can only increase further as the regime is adjusted in response to feedback from the industry.
The QIF regime offers a fast-track procedure that enables funds to receive authorisation from the Guernsey Financial Services Commission within three working days of its application being received, an change that brings the island into line with leading hedge fund jurisdictions in the Caribbean such as the Cayman Islands and British Virgin Islands.
Just as importantly, the new regime has ushered in a new approach to authorisation and regulation that transfers the burden of due diligence and ongoing monitoring of funds onto their dministrator. Restricted currently to professional and experienced investors, this structure is set to be extended to other types of funds in the wake of the Harwood report, a root-and-branch review of Guernsey's fund regulation that is due to be published imminently (see separate article). Says Carl Rosumek, deputy director of investment business at the GFSC: 'The Guernsey Qualifying Investor Fund regime was introduced as a means of streamlining the approval process for both open and closed-ended investment funds aimed at professional, experienced and knowledgeable investors. The regime applies to funds of all types; it was not specifically designed for hedge funds.
'Under the regime the commission undertakes to grant the required fund approval within three working days, provided that an appropriately licensed Guernsey applicant has certified to the commission that the fund will be restricted to professional, experienced and knowledgeable investors, that the applicant has conducted due diligence on the promoter and associated parties and has found them to be fit and proper, and that the applicant is satisfied as to the fund's economic rationale and the disclosure of any risks associated with the investment vehicle.'
Says Niven: 'The QIF regime is just over a year old, and we recently tweaked it to include a provision that investors placing USD 100,000 into a fund will be treated as qualifying investors, which other jurisdictions already have done. We felt we wanted to see how the regime bedded down before we started to extend it, but we've now started doing that.'
Niven sees the changing regulatory structure and a planned reform of Guernsey's tax system as elements of a package that will not only boost the island's competitiveness as a centre for the domiciliation and servicing of alternative investment funds but could also lead to hedge fund managers choosing the island as a base for their operations.
He says: 'The past 12 months has been a good year for funds, and the number of funds that have gone through the QIF regimehas started to build up. But once we get these further building blocks in place, we will have a springboard from which to boost property, private equity and hedge funds. It's early days yet because people are still getting familiar with the concept, but once we start to implement the Harwood conclusions we'll see business really start to escalate.'
The changes include moves to ease the island's rules on the role of custodians, a bugbear for hedge funds in many jurisdictions. Says Benjamin Wrench, an associate lawyer with Ozannes Corporate: 'Guernsey has become much more attractive for hedge funds as a result of the GFSC relaxing its previous requirement for openended funds to appoint Guernsey regulated custodians, provided that a reputable prime broker has been appointed.
'The GFSC no longer requires those prime brokers to take on formal duties of oversight over the fund, and waives the obligation to have segregation requirements for the prime brokers holding the fund's assets and for subscription and redemption monies. A growing number of prime brokers have taken advantage of this, including Goldman Sachs and JP Morgan.'
Robin Fuller, managing director of HSBC Securities Services - which provides administration and custody services to more than USD 20 billion of assets in Guernsey - believes that the island's success is down to a combination of factors, including its acknowledged professionalism and expertise in providing services to fund promoters from around the world.
He says: 'Coupled with other enhancements to our legal and regulatory environment, QIFs have put Guernsey at the forefront of the international investment funds industry. Guernsey has always had a positive reputation, and such unprecedented growth is a tribute to the high standards of streamlined regulation and service provision throughout the island.'
According to Patrick Firth, managing director of Butterfield Fund Services (Guernsey), the strength of the QIF regime is that it is internationally competitive while maintaining the level of regulation Guernsey has always prided itself on. 'There are some places where it's quicker to get a fund authorised,' he says. 'What the QIF regime does is give certainty to authorisation by the regulator within three working days as long as the service provider has signed off on the due diligence. The industry is happy that it provides another weapon in the armoury, and the regulator's announcement that a minimum investment of USD 100,000 is an indication of a qualifying investor has also been well received.'
Says Fuller: 'Service providers can now offer an additional service to international fund managers who frequently operate to very challenging timetables. The new regime allows the licensing of funds within a three working day period, and Guernsey service providers are able to support the process of integrating what can be highly complex structures in a relatively short period of time.' He insists that the self-certification of funds by service providers does not actually involve a shift in responsibility.
'Administrators have always worked in partnership with the GFSC in ensuring high standards of regulation and corporate governance are met. The new regime only highlights the work licensed service providers are doing on behalf of the fund as part of normal compliance procedures.' Adds Firth: 'To the extent that administrators already discharge their duties in terms of the due diligence, there should be no impact on them. It falls into the broad spectrum of work we were doing already. It formalises it and brings it into a slightly different format, but the actual work required is pretty similar to what we were doing before.' Industry observers note that Guernsey's fund administration industry, like that elsewhere, has seen consolidation in recent years, most notably with the acquisition last year of Baring Financial Services Group, which includes Guernsey International Fund Managers, by Northern Trust. But the sector is also seeing new start-ups.
Says Fuller: 'The growth rate of the fund industry as a whole will continue to drive corporate activity, including consolidations and start-ups. As the levels of fund administration continue to increase, we would expect to see further global players enter the market as threshold levels become more appealing, and more specialist funds look to Guernsey as their chosen domicile.' KPMG partner Neale Jehan notes that Guernsey's broad mix of administrators, ranging from big international service providers that are part of global banking groups to niche providers specialising in different areas of the alternative investment market, vary in their ability to outsource work to other jurisdictions.
He says: 'The international service providers clearly have capacity in other jurisdictions and may choose to outsource retail-type administration to a centre of excellence elsewhere, but if you move down the scale there are mid-tier administrators that tend to be locally-owned businesses, and may not have the ability to outsource within their own group. These firms might want the flexibility to outsource to specialist providers elsewhere.
'Right at the bottom there are a large number of new entrants. The growth in the industry has brought many new start-up administration entities that are offshoots of existing financial services businesses that previously did not specialise in administration, and that are generating a lot more capacity, at the smaller, more niche level. Whatever regime comes into place needs to cater to all the businesses, whether they're international or very local.'
Jehan notes that since many companies in the market are part of international groups, there is no guarantee that consolidation will follow the logic of administration business. 'Consolidation is likely to be driven at a higher level than fund administration,' he says. 'There may be consolidation among some of the local businesses, but I don't think that will happen for a few years yet.' Says Franks: 'The global players are becoming a lot more international in the way they run their businesses. We'll find there's more pressure on groups to do the vanilla stuff in lower-cost jurisdictions, while the value added business in which a Guernsey administrator can add value will continue to be performed here.
But this is obviously subject to the regulatory framework in place and to how much you can do in less costly locations.' Conversely, Guernsey administrators are continuing to win business from funds domiciled in other jurisdictions. Says Fuller: 'This helps Guernsey service international investment managers, who by the nature of their client base have to offer products domiciled in a number of jurisdictions.' Butterfield Fund Services is probably the largest provider of administration services to non-Guernsey schemes as measured by assets. Says Firth: 'We can provide additional benefits for managers based in the UK or Europe, not only from the time zone point of view, but also increasingly as regards corporate governance. It's increasingly beneficial to be able get over to Guernsey quickly and to hold board meetings here.
Says Niven: 'Cayman does extremely well in terms of funds, a lot of which come out of the US, and I'm not sure we're trying to compete with that kind of volume. You can set up a fund in Cayman and not a great deal happens there, but investors more and more are looking at corporate governance, at how these funds are run.
'They want some solidity, they want the ability to identify who's running what and where they're doing it. In Guernsey we've built up a lot of expertise and have put together all the various component parts of the funds industry, including a very good cadre of nonexecutive directors. We've established an excellent track record over many years.'
That track record includes the establishment of the Channel Islands Stock Exchange, which opened in Guernsey in 1998 and whose first listings, out of a total that recently passed 1,000, were hedge funds launched by Man Group. Today the exchange, which enjoys official recognition from the UK and other jurisdictions, is used by many managers to list their funds. It also includes protected cell companies, a Guernsey innovation more than a decade ago. Says Wrench: 'Illustrative of Guernsey's leading edge as a funds domicile, the protected cell company was pioneered on the island and subsequently has been adopted by most offshore financial centres. It is particularly suited to funds of hedge funds because it provides a statutory basis for ringfencing assets and liabilities within each cell.'
Last year Guernsey's protected cell company ordinance was amended to extend its application, previously limited to insurance companies and investment funds, to any company that is administered by a firm regulated by the GFSC. Says Franks: 'The PCC legislation has been used by funds here for a long time, because it works quite nicely with umbrella funds.
'Over the years the PCC has proved an effective model. A legal case that was coming up was going to test whether that cellular structure worked in a court of law, but because there was an out-of court settlement, we never got to see that proof. The challenge for PCCs has always been whether the ring-fencing provisions would stand up in a court of law, but since every country has one now, it's more accepted than it might have been 20 years ago.
'We've had PCCs so long now that when people think of protected cell companies, they think of Guernsey. Jersey is currently playing catch-up by introducing PCC legislation, so it will be interesting to see the dynamics of that on the Guernsey marketplace. It has been one of the drivers of competition between Guernsey and Jersey in the past.' In general, though, Guernsey administrators are sanguine about their competitive prospects. Says Fuller: 'Guernsey is an established fund domicile with an internationally recognised but pragmatic regulatory environment.
"We would like to build on a vision of Guernsey as a domicile of choice rather than simply somewhere to establish a funds administration. Its geopolitical position, standards of corporate governance and skills-based economy should make it a jurisdiction of choice for European fund managers and managers of funds with a European investor base.'