Whilst Guernsey does not offer an ‘exempt’ investment fund in the traditional sense (i.e. one that is exempt from regulation/registration if the number of investors is less than a stated number) it does offer different types of regulated investment fund, a choice of application processes and a flexible regulatory approach that lends itself to the establishment of hedge funds in the jurisdiction.
In Guernsey an investment fund is either open-ended or closed-ended. There is a statutory definition for an open-ended fund. If an investment fund is not an open-ended fund then it is a closed-ended fund.
Open-ended funds
In an open-ended fund, investors are entitled either to have their units redeemed by the fund at its net asset value or to sell their units on an exchange at a price related to the value of the company’s assets to which the units relate. An open-ended fund may be established as Class A (equivalent to a UK authorised unit trust or OEIC), Class B or Class Q. Hedge funds which are open-ended tend to be established as either Class B or as Class Q.
Class B
Class B open-ended funds are not usually for sale to the general public but may be marketed to authorised persons and professional investors. Typically a Class B fund is established for marketing to institutions and high net worth individuals. The rules which apply to Class B fund’s documentation and scheme particulars are less comprehensive than those which apply to Class A funds. In particular, there are no prescribed investment restrictions other than that the fund’s property must be invested with the aim of spreading risk. Minimum disclosure requirements apply for scheme particulars but, again, these are less comprehensive than those which apply to Class A funds. No minimum subscription levels are prescribed and there is also a certain amount of flexibility in that the Guernsey Financial Services Commission (GFSC) may grant derogations from the Class B rules.
Class Q
Class Q funds are restricted to qualifying professional investors, namely, a government local authority, public authority, trustee of a trust with net assets exceeding £2 million, company or limited partnership if it, its parent or subsidiary have net assets exceeding £2 million or an individual who with his or her spouse has a minimum net worth of £500,000. There is no prescribed minimum individual subscription requirement.
The property of the fund must be subject to a spread of risk which will be at the discretion of the manager and, in the case of a company fund, the company. The criteria for the spread of risk must be specified in the fund’s scheme particulars.
The documentation requirements are simplified in relation to Class Q funds and considerable flexibility is permitted in respect of this type of fund.
Closed-ended funds
An investment fund will be closed-ended if it has shares which are only redeemable at the option of the directors of the fund. Consent is required under the provisions of the Control of Borrowing (Bailiwick of Guernsey) Ordinances, 1959 to 1989 (COBO) for a closed-ended fund to issue any securities, units or interests (as the case may be) where the amount raised would exceed £500,000 over a rolling period of 12 months.
Minimum disclosure requirements for a closed-ended fund’s scheme particulars apply. Ongoing regulation of closed-ended funds is achieved by means of conditions attaching to the COBO consent which require notification to the GFSC of any subsequent material changes, including to a fund’s parties, its constitutive documents and scheme particulars and the filing of annual accounts. A closed-ended fund requires a Guernsey administrator and, because a closed-ended fund is a category 2 controlled investment for the purposes of The Protection of Investors (Bailiwick of Guernsey) Law, 1989, as amended (the POI Law), regulation of the fund is also achieved, to a degree, via regulation of its administrator.
Closed-ended funds will become regulated under the POI Law in due course once amending legislation (still at the approval stage) is fully brought into force.
Principal players
Any person providing services (promotion, subscription, dealing, advising, management, administration, custody) to a fund, and doing so by way of business in or from within the Bailiwick of Guernsey, must be duly licensed under the POI Law. The Licensees (Financial Resources, Notification, Conduct of Business and Compliance) Rules, 1998 apply to those persons licensed under the POI Law and cover such matters as GFSC notification requirements and standards of conduct of business.
An administrator and custodian, both resident and licensed in Guernsey, are required for an open-ended fund. The promoter of an open-ended fund has traditionally established a special purpose company (SPC) in Guernsey to act as principal manager of the fund. The SPC will then delegate its administration functions to the local institution. There is no formal GFSC requirement, however, for there to be a principal manager SPC. In relation to a Class Q fund, subject to GFSC agreement, a SPC may be incorporated outside Guernsey.
A closed-ended fund is not required to have a Guernsey resident manager but it will be required to appoint a Guernsey resident company, licensed under the POI Law, to carry out its administration functions.
The GFSC has adopted (and issued), as regards hedge funds, a flexible approach to authorisation policy, with particular reference to prime brokers and custody arrangements, which provides that:
For institutional and expert investor hedge funds, a locally licensed custodian is not required. Instead, a prime broker, regulated in an acceptable jurisdiction and having substantial net worth, may be appointed to the fund and the GFSC will not require the prime broker to take on the formal duties of oversight over the fund’s manager (which would otherwise be exercisable by a custodian). The segregation of a fund’s assets from those of the prime broker will not be required even if the fund’s assets exceed the level of credit extended by the prime broker. As a consequence of the fact that a locally licensed custodian is not appointed, certain rules relating to the contents of the principal documents or scheme particulars (which are designed to provide checks and balances on the manager) are not applicable and need not be complied with.
Hedge funds targeted at retail and less sophisticated investors do require a custodian (usually a Guernsey licensed institution, unless the GFSC agrees to waive this requirement on grounds that the regulator of the custodian in its home jurisdiction will monitor the custodian’s role of oversight of the fund’s manager). The GFSC may waive the requirement for the custodian to take control of the fund’s property if a prime broker, who is regulated in an acceptable jurisdiction and has substantial net worth, holds that property. For this type of hedge fund the prime broker will be expected to segregate its assets from all fund assets exceeding those required for collateral against credit extended via the prime broker and surplus fund assets must be fully protected against the failure of the prime broker.
In each case above, full disclosure of the arrangements and risks arising out of the appointment of the prime broker and, if that is the case, lack of a custodian, must be set out in the fund’s scheme particulars.
It is usual for a closed-ended fund to have a custodian but there is no formal requirement for it to do so. Again, any Guernsey resident entity acting as custodian must be duly licensed under the POI Law.
Taxation
With effect from January 2008 the States of Guernsey has introduced a zero rate of tax for companies carrying on all but a few specified types of regulated banking or utilities business.
A company licensed under the POI Law to undertake the controlled investment business of management will therefore be subject to income tax at 0%.
Investment funds (both open-ended and closed-ended) continue to be able to apply to the Administrator of Income Tax in Guernsey for exempt status for Guernsey tax under the Income Tax (Exempt Bodies) (Guernsey) Ordinance, 1989 provided there are no Guernsey resident beneficial owners (although an open-ended fund may permit some Guernsey resident beneficial owners without jeopardising its exempt status). An application for exempt status must be made each year to the Income Tax Authority for which the current annual fee is £600.
The benefit of having exempt tax status is that the fund will not be considered resident in Guernsey for Guernsey income tax purposes. A company that has exempt status for Guernsey tax purposes is exempt from tax in Guernsey on both bank deposit interest and any income that does not have its source in Guernsey. Payments of dividends and interest by a company that has exempt status for Guernsey tax purposes are regarded as having their source outside Guernsey and hence are payable without deduction of tax in Guernsey.
In the absence of an exemption, an investment fund would be treated as resident in Guernsey for Guernsey income tax purposes and subject to income tax at 0%. A fund taxed at the zero rate would not be required to withhold Guernsey income tax from interest or dividends paid by it other than in respect of distributions (including deemed distributions) paid to Guernsey resident individuals.
Guernsey currently does not levy taxes upon capital inheritances, capital gains (with the exception of a dwellings profit tax), gifts, sales or turnover, nor are there any estate duties, save for an ad valorem fee for the grant of probate or letters of administration. No stamp duty is chargeable in Guernsey on the issue, transfer, switching or redemption of shares in a Guernsey company. However, document duty is payable on the creation or increase of authorised share capital at the rate of one half of one per cent. of the authorised share capital of a company incorporated in Guernsey up to a maximum of £5,000 in the lifetime of a company.
Pre-marketing
There is no restriction on pre-marketing of closed-ended fund and red herring documents may be issued provided that appropriate wording has been included. No monies may be raised, however, until consent has been given by the GFSC. For open-ended funds, technically the issue of draft scheme particulars is not permitted. However, the GFSC will not object to the issue of draft scheme particulars provided that such documents make clear that authorisation has not been received at the time the draft is issued. Again, no monies may be raised until authorisation has been given by the GFSC to the fund.
Application process – traditional
The traditional procedure for establishing a fund in Guernsey is a three stage process (outline, interim and final) which is essentially the same for all types of fund, whether open-ended or closed-ended.
Application is initially made to the GFSC seeking outline consent (for a closed-ended fund) or outline authorisation (for an open-ended fund). An outline must be given of the type of fund proposed, the principal players, the investment policy and the proposed charges to investors.
In the case of a fund promoter who is new to the Island, the GFSC will also require details of the promoter, to include matters such as its operating history, ultimate beneficial ownership (individuals holding more than 15% in particular), group structure and evidence of a favourable track record and latest audited accounts.
Following outline consent, and in order to fill in the detail, the investment fund’s scheme particulars or equivalent document and constitutive document (the trust deed, limited partnership agreement or memorandum and articles of association) must be filed, together with the relevant application fee for closed-ended or open-ended funds (currently £2,400 and £2,800 respectively). The GFSC will endeavour to respond within 10 working days but does not guarantee to do so.
It is likely that at this stage the GFSC will raise a list of points to be addressed by the applicants. Once the points raised by the GFSC have been agreed, certified true and final copies of the scheme particulars and all other documentation constituting or relating to the fund are submitted. The response time for receipt of final consent or authorisation following this final application is usually 48 hours.
Application process – fast track
There are two separate fast track regimes (each allowing approval approximately 3 days after submission of a satisfactorily completed application) which operate along the same lines, such that the GFSC relies upon a Guernsey administrator to the fund to undertake the due diligence and other checks that otherwise the GFSC would itself undertake and to confirm to the GFSC certain matters regarding the fund and give certain undertakings and warranties.
By far the most popular of these has proved to be the registered (REG) closed-ended fund process, which was introduced in 2007.
Registered funds are not restricted to certain types of investors, although such funds may not be promoted directly to members of the public in Guernsey. Providing the relevant documents and warranties are delivered to its satisfaction, the GFSC will issue COBO consent within three working days of receipt of an application.
The fund administrator must warrant to the GFSC that:
– It has performed sufficient due diligence to be satisfied that the promoter and associated parties are fit and proper;
– Effective procedures are in place to ensure that the fund is not offered directly to the public within Guernsey (for which purpose ‘public’ means any person not regulated under Guernsey’s financial services regulatory laws); and
– The fund’s status as a registered fund is specifically referred to in the scheme particulars and such document makes clear that neither the GFSC nor the States of Guernsey Policy Council have reviewed the documentation nor take any responsibility for the fund or the documentation.
All warranties made by the administrator must be based upon documentary evidence which can be produced immediately should the GFSC so request.
The qualifying investor funds (QIF) regime, introduced in 2005 to complement the traditional approval procedure, applies to both open-ended and closed-ended funds. However, in practice, this is now used only for open-ended funds following the introduction of the registered closed-ended fund regime.
Under the QIF regime, the GFSC will grant fund approval within three working days (subject to receipt of various documentation, including the scheme particulars, to its satisfaction) provided that an appropriately licensed Guernsey applicant (usually the administrator) has certified to the GFSC that:
The fund will be restricted to professional, experienced and knowledgeable investors (i.e. qualified investors as defined) including an individual investor who makes an individual investment of not less than US$100,000;
– The applicant has conducted due diligence on the promoter and associated parties and understands them to be fit and proper; and
– The applicant is satisfied as to the fund’s economic rationale and the disclosure of any risks associated with the investment vehicle.
In order to ensure that such certification can be made it is necessary that:
– Funds which are approved under the QIF regime have in place measures to ensure that they are only available to investors who fall within the qualifying investor definitions. The GFSC will assess licensees’ systems and controls in place to ensure that that is the case as part of their monitoring of licensees; and
– The applicant will need to conduct due diligence on the promoter and/or investment manager in order to ensure that it is in good standing and will need to consider the track record and experience of the directors, controllers and management of the promoter and/or investment manager to ensure that such persons are fit and proper.
– The GFSC has issued suggested minimum wording in relation to the warranties to be obtained from potential investors regarding their qualified status and the disclosure to be made in the scheme particulars in respect of the regime.
Conclusion
The GFSC has a practical approach to investment fund regulation, understanding that institutional and expert investors require fewer regulatory protections than retail investors.
It has always been, and remains, the case that the Class B framework can accommodate a wide spectrum of investor markets, from purely retail to exclusively institutional and the rules themselves give the GFSC the right to grant waivers to individual funds or to a group of funds, providing the granting of such waivers would not increase regulatory risk.
Guernsey is well positioned within the global offshore market to provide a competitive alternative to the Cayman Island’s hedge fund structures. The geographical position of Guernsey, only 35 minutes flight from London, means that it is easier for directors actually to attend board meetings in person and therefore for the fund to demonstrate that its mind, management and control is exercised in or from Guernsey rather than the investment manager’s home jurisdiction.
By Peter Harwood, Partner, Gavin Farrell, Partner, Paul Christopher, Partner, and Val Rouse, Associate, Ozannes, Guernsey
