Over the past 10 to 15 years Dublin and Luxembourg have secured position as the locations of choice for sophisticated European investment funds, leaving the UK in their wake. However, the current political and regulatory focus on the asset management industry could actually present the UK, should it grasp the opportunity, with a premier chance to redraw the European asset management landscape.
A vast range of political agendas has created an increased focus on low, or no, tax jurisdictions, and as a consequence there has been a call for full tax information exchange. Certain territories have agreed to information exchange in a bid to maintain their status as offshore fund domiciles of choice. However, a shift in market mindset has already occurred and hedge fund strategies are being adapted into regulated frameworks, such as the flowering of Ucits offerings we have seen over the past 12 months.
At a time when global competition to attract asset managers away from the UK is on the rise, providing asset managers with a suitable onshore product could help to keep this fundamental industry in the country. Should the asset management industry respond to this prospect, the UK stands to harvest significant economic benefit including the creation of much-needed jobs for the asset management industry in the areas of fund administration, accounting, advisory and legal.
The recent changes to the taxation of UK-resident collective investment schemes do indeed create an opportunity for London to become the European centre of choice for fund location. These changes will allow hedge fund managers to consider domiciling their hedge fund products onshore, using a UK-regulated vehicle. However, the delay in reaching this point means that the authorities must now go a step further to ensure that the asset management industry can really move ahead of the competition and attract funds to Britain.
Increasing awareness of the risk of fraud and heightened concerns about due diligence and governance are likely to drive some investors to prefer an onshore regulated fund product. However, the opportunity to make London the centre of choice for the alternatives sector already exists in the form of the possibly little-appreciated UK regulatory framework for onshore funds.
The Qualified Investor Scheme (QIS) has existed in the UK since 2004, offering the comfort of an authorised scheme yet permitting managers – and therefore institutional and sophisticated investors – some of the flexibility associated with an unregulated vehicle in terms of permitted investment strategies and gearing. However, a major impediment has been tax uncertainty at both fund and investor level, which has led to barely a dozen such funds having come in existence.
Tax changes introduced this year should remove a large proportion of the barrier that has until now prevented alternative asset managers from choosing the UK as a fund domicile. These include the introduction of measures such as the genuine diversity of ownership condition, replacing the 10 per cent ownership limit for QISs.
In addition, the introduction of an effective tax exemption for UK Authorised Investment Funds, in the form of the Tax Elected Fund regime, should facilitate the development of a UK flexible fund product with tax certainty at both investor and product level. The Tax Elected Funds regime means that a fund can make an election now to pass the tax liability through to its investors themselves, avoiding the taxation impact falling at the vehicle level.
HM Treasury, HM Revenue & Customs and the Financial Services Authority have taken significant steps toward aligning the tax regime applicable in the UK with that of offshore tax territories through their recent changes, and they continue to engage in dialogue about this topic. Further advancements in the space have focused on the prevailing assumption that a hedge fund is ‘trading’ in nature from a UK tax perspective due to the high frequency of trades and the systematic portfolio churn.
This has come in the form of a ‘white list’ of allowable investment transactions, resulting in a clear line as to which activities are trading in the eyes of HMRC and which are not trading, and thus whether or not the sale of an asset will be treated as an income or a capital item. Unfortunately, the white list applies only to certain vehicles designated by HMRC, and therefore for some entities we are still left with a degree of uncertainty and complexity in this area.
Perhaps however, we need to consider whether either investors or managers are actually looking to utilise such an onshore product when the current offshore model is cost-effective, flexible and well established. The current model also makes it possible to accommodate the requirements of many different investors, which again is something that any new UK model would need to emulate – otherwise the market would simply ignore the product and fail to consider the UK as a centre of choice.
When discussing such an issue with clients, there is concern about the lack of certainty in the UK tax regime, and clients feel that offshore territories have a simpler path to achieving a tax-efficient model. The sensitivity is that competitor tax regimes are less prone to major change, which is crucially important for both managers and investors.
The question which therefore remains is whether the UK government is willing to tweak or even rebuild the current market offerings, from a regulatory and tax perspective, in order to have a chance of winning the battle to be considered the centre of choice for European hedge funds. The potential reward is to sweep up the substantial economic rewards that come with such a position in areas including fund administration, accounting, advisory and legal work, which are already big business in Luxembourg and Dublin and create a great deal of employment and wealth there.
•The issue is arising at a time when the latest version of the European Union’s Ucits cross-border fund legislation is being implemented in member states. The Ucits IV Directive enables management companies to be based in a single location as well as bringing master-feeder structures under the aegis of the Ucits regime. This will also require the UK Treasury, HMRC and FSA to consider what needs to be done to adjust the UK regime to facilitate the creation of master-feeder structures as part of their efforts to keep the country competitive for managers.
The government has demonstrated its willingness by commissioning a working group to come up with recommendations to maintain the UK’s competitiveness as a location for asset managers and to identify development opportunities for the sector. The report notably proposed creating an attractive onshore fund regime for alternative vehicles such as hedge funds. However, the challenge will remain as to whether any new UK onshore hedge fund regime would be enticing enough to displace a long established offshore market and mindset that for now appears to have become the preferred choice.
There is certainly reason to believe that in the future, following the experience of the credit crunch and of the Madoff scandal, institutional investors may want more access to onshore regulated products. At the same time the industry is facing up to the EU’s proposed Directive on Alternative Investment Fund Managers, which will place more focus on the marketing of onshore versus offshore products. This parallels the way last year’s G20 meeting in London has put pressure on offshore financial centres to ensure that they offer an equivalent standard of regulation to onshore jurisdictions and clamp down on their use by individuals for tax evasion.
For all these reasons, it’s exactly the right time for the UK to respond, lest the opportunity to capture a significant share of the domicile market for both retail and alternative funds passes the country by. This is the message from members of the asset management industry. Last November the Asset Managers Working Group reported to the Chancellor of the Exchequer that the UK would benefit from a well-designed onshore hedge fund regime, and the Alternative Investment Managers Association has been lobbying the Treasury and HMRC on the same issue. The moment has come for action.
Lachlan Roos is the UK tax hedge fund leader and Robert Mellor is the UK tax financial services markets leader with PricewaterhouseCoopers LLP, both specialising in the provision of tax advice to clients in the alternative asset management space