When the new legislation governing alternative investment funds came into force in Germany more than two years ago, HSBC's Alternative Fund Services (AFS) took a two-fold approach to capitalise on the development of the market. On one hand, in partnership with its software provider, Advent Geneva, and with advice from PricewaterhouseCoopers, AFS launched a project to deliver tax transparency to their clients to enable them to distribute their funds in Germany.
At the same time, AFS set up a structure that will enable it to service German domestic hedge funds using INKA, the KAG of HSBC Group, which is already one of the largest administrators of traditional long-only funds, and HSBC Trinkaus & Burkhardt as custodian bank and prime broker, both located in Düsseldorf. This dual approach to the German market is starting to pay off as interest starts to grow among international investment houses, and as German institutional investors start to exploit their new-found freedom to invest more widely in alternatives.
The German market has been slower to develop following the introduction of the new investment legislation than was expected by many of those involved, including legislators and regulators. To a certain degree, the expectations about the speed at which the hedge fund sector would grow were unrealistic because although the law itself was very liberal, the tax transparency issue was a huge one for the market.
In fact, it turned out to be a long process to get the tax transparency service in place and work was only finished on it in November 2005. Initially, that stopped a number of potential entrants coming into the market, temporarily at least. However, tax transparency has been resolved as an issue now that AFS and a couple of other providers can deliver it, and soon others will be in the same position. The tax transparency project is run out of AFS's New York office, in part because their software provider is US-based, and the US office was working together with Advent Geneva to set up this functionality. In addition, most of the funds that are seeking tax transparency need it in order to be eligible for investment by funds of hedge funds, and many of the managers are based in or around New York.
The business is centralised in New York, but there has also been strong demand from funds administered in Dublin as well as from Luxembourg, Singapore and Hong Kong. For the moment, some 25 funds have been made tax transparent for the German market; they are mostly Cayman-domiciled funds but under the German rules they can be from anywhere as long as they are tax-transparent. Putting in place and gaining approval for AFS's structure to service domestic German hedge funds has also been a lengthy process, since there are numerous regulatory conditions to fulfil, but INKA received approval also in mid-December last year. When offering hedge fund services INKA can use certain administrative tasks for which specialist expertise is available in Luxembourg, Dublin or any other Alternative Fund Services business within the HSBC Group.
So far demand has been slow from German-domiciled hedge funds, but this is likely to change if some of the large traditional investment houses - with whom INKA is currently enjoying considerable success on the long-only side - start to add alternatives to their offering, following an example already set by leading international asset managers such as Gartmore, New Star and Jupiter. In the meantime HSBC Trinkaus & Burkhardt has launched its own long/short product, although it may look to Luxembourg for expertise with more complex strategies in the future.
By Claude Noesen - senior client relationship manager with responsibility for business development with HSBC's Alternative Fund Services in Luxembourg.