By Simon Gray - In a global environment where managers of classic alternative investment strategies are having to work harder than ever to attract capital from wary investors, members of the industry in the Channel Islands say the jurisdictions are benefiting from a burgeoning international reputation for broad-ranging expertise that is particularly attractive to promoters of innovative strategies and exotic asset classes.
Alongside the islands’ established range of specialist fund experience, covering funds of hedge funds and hedge fund managed account platforms, private equity vehicles, property funds and certain types of retail product including exchange-traded funds, Jersey and Guernsey are also increasingly being chosen as the domicile and/or servicing centre for less traditional alternative investments ranging from forestry
The Channel Islands Stock Exchange, established in 1998 to serve the financial industry across both islands, has proved central to the development of new investment products in Jersey and Guernsey thanks to the growing importance of stock market listings for funds, particularly among institutional investors, and the CISX’s designation as a recognised exchange by various international authorities (unlike, for example, the London Stock Exchange’s Alternative Investment Market and Specialised Fund Market), which is important to investors for tax purposes.
“We play an important role in the process of capital-raising both initially and post-listing, as well as making securities eligible for investment through our recognised status,” says CISX chief executive Tamara Menteshvili. “For example, many institutions are restricted in their ability to invest in securities that are not listed on a recognised exchange.”
Gavin Farrell, a partner in Guernsey with law firm Mourant Ozannes, says the CISX has benefited from a rethink among promoters in the light of the mixed success enjoyed by Channel Islands-based permanent capital-type vehicles in recent years, such as KKR Private Equity Investors. Around the middle of the past decade there was a flurry of such deals, several of them involving listings on the Euronext Amsterdam exchange, but the promised liquidity largely failed to materialise and in a number of cases shares traded at a significant discount to NAV.
“Although there is still a high proportion of listed products among our instructions, we don’t see as many AIM-admitted or SFM listings as in the past,” Farrell says. “However, the number of CISX listings that we’re doing is still very buoyant. The use of the AIM trading platform or SFM listing and a CISX listing is a popular route, because neither AIM nor SFM is a recognised exchange for HM Revenue & Customs. The original Euronext-listed permanent capital vehicles like KKR were a product of their time, but now they are very few and far between.”
Speaking at the recent CISX International Business Summit conference in Jersey, Menteshvili noted that the Channel Islands market, whose total number of listings is again approaching 4,000, is much more geared to international as opposed to domestic business than most other exchanges. This could increase in the future as the CISX seeks further international recognition, for instance from South Africa.
“We are continuing to build niche markets in the listing area, including structured funds and property funds,” she told delegates, “but there has been growing interest in the specialised alternative investment sector, including soft commodities, gold and biofuels. We are also seeing growth in our existing range of specialist debt products, especially acquisition vehicles for private equity firms.”
Mike Bane, a partner with Ernst & Young in Guernsey, also sees signs of new confidence in the closed-ended fund sector. “We’ve started to see quite a significant ratcheting up of new transactions,” he says. “Some of this involves feeder funds channelling capital into hedge fund strategies, like the successful new money-raising for BlueCrest earlier this year, and other managers seem to be following that trend. This isn’t just raising money within established listed structures but the creation of closed-ended feeders into existing open-ended structures.
“This is an interesting reflection on current sentiment. Recently we’ve seen a trend for discounts to NAV narrowing. These moves suggest there is an expectation in the market that discounts will narrow further, and it’s a good time to be raising money for closed-ended structures. We have already seen more activity in the rest of the closed-ended sector. Some emerging market equity funds have been launched recently, and we are seeing exotic products using complex underlying derivatives or in unusual sectors such as insuranceand litigation claims.”
According to Menteshvili, the exchange is continuing to build upon its long history of innovation in the fund sector, which has included being first to the market with the listing of protected and incorporated cell companies and of partnership interests. In addition to the recent surge of interest in structured funds, with three new issuers coming to the market this year, the CISX – which pioneered the trading of open-ended funds in 2005 – is now working on central settlement of such transactions in the same way as electronic trades involving closed-ended fund shares or equities. “I believe this will revolutionise the way open-ended funds are traded, and potentially their whole back-office operations,” she told conference delegates.
The islands’ service providers have already demonstrated their ability to adapt to legislative changes that require new structuring and planning solutions, according to Andrew Isham, a director with Deloitte & Touche in Jersey. “For example, in recent times we have seen the emergence of foundations alongside our well-established trust business, new type of partnership and corporate entity, as well as the flexibility offered by incorporated or protected cell companies,” he told the conference.
Ross Youngs, head of sales for the Channel Islands and Isle of Man for BNP Paribas Securities Services, explains the jurisdictions’ innovative edge in terms of speed of thought and movement. “The Channel Islands have an advantage in their entrepreneurial spirit,” he says. “We tend to move into new markets faster than many competing jurisdictions. For example, there’s a lot of private equity-style investment going into the areas of energy and infrastructure. Since we’re very strong at administering private equity structures, it’s logical for us to get more involved with infrastructure and energy, which are a booming asset class.
“We also have first-moved advantage in areas such as green and Shariah-compliant funds, and we’ve also handled business like US life settlement funds as well as innovative debt products. In the process, for instance, we have learned the principles of what is involved in the administration of Shariah-compliant funds. What clients find attractive about us is that we listen and we strive to evolve.”
In addition, Youngs argues that Jersey and Guernsey offer fund promoters a combination of high-quality service provider names and substance on the ground. “If you look at where the Channel Islands fit in as a domicile jurisdiction, we have some unique advantages,” he says. “They win hands down in terms of substance and the number of staff dedicated to financial services.”
Noting that both islands have a policy of only granting licences to top global banks, ensuring a high standard of counterparty for incoming business, Youngs adds: “We have enough staff to support funds within the domicile rather than outsourcing it to centres like Dublin or Luxembourg. Investors in a fund domiciled here can be confident it is actually administered in the Channel Islands, that it has real substance, and it has effective independent directors that are resident in the islands and provide robust corporate governance.”
The European Union’s newly-agreed Directive on Alternative Investment Fund Managers and other changes in the global regulatory environment prompted by the experience of the financial crisis, but also the Madoff fraud and other scandals, will impact custodians in particular in the years to come, Youngs cautions.
“It means we need to understand what responsibility is entailed by the custody function and what responsibility we take for our sub-custodian network, which could potentially increase both our risks and the cost of doing business,” he says. “We need to think about the different alternative asset classes. How do we provide custody to private equity funds that fall within the scope of the directive? What risk does that present to us as a business?
“Global custody is a very commoditised product, and larger institutions have invested a lot in building straight-through processing models to make their operations as slick as possible. What the AIFM Directive will do is slow some of that down by increasing the amount of oversight and compliance a custodian must do to discharge its responsibilities.
“In addition to traditional safekeeping of assets, it will impose on the custodian the fiduciary duty to ensure that the assets are managed properly, for instance ensuring that NAVs are calculated correctly, that the fees and expenses are in line with what the prospectus says, and that the investment manager is doing what he’s promised. There’s a level of responsibility on custodians of closed-ended funds that wasn’t there before.”
Meanwhile, the increased importance of substantial activities and presence in fund domiciles, for both regulatory and tax purposes, is helping to beef up the private equity and hedge fund sectors in both Channel Islands. Says Farrell: “One of the growth areas over the past few years is among private equity managers, not just individuals like Guy Hands or Jon Moulton coming over for personal reasons, but firms such as Apax and Permira setting up back-office or front-desk operations in Guernsey.”
According to Farrell and his Jersey-based colleague Ed Devenport, the trend is partly driven by tax considerations and partly because firms see an opportunity to carry out back-office work more cost-effectively in-house rather than outsourcing it to third-party service providers. “It’s not just about the expense of administration, but also wanting to have a real physical presence,” Devenport says.
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