By James Williams – Malta remains a relatively small European domicile. Combined net assets of Maltese funds at the end of June 2012 totalled EUR10.3billion; up from EUR8.3billion in 2011 but still way off more established jurisdictions like Luxembourg, whose wholesale funds market has ballooned to EUR2.523trillion according to its national regulator, the CSSF.
Malta, however, knows what its strengths are and continues to focus on presenting itself as a viable option for hedge fund and private equity managers. The number of Maltese funds is now up to 578 according to the island’s promoter, FinanceMalta, of which 460 are Professional Investor Funds (PIFs). Only 64 registered funds are UCITS; becoming a wholesale market is not a realistic aim.
Maintaining a niche is critical to Malta’s success. Indeed, one of the net results of Europe’s recent implement of the AIFM Directive is to level the playing field as far as funds are concerned, as all regulated funds, whatever the domicile, will now fall under the AIFMD model.
James Farrugia, Senior Associate at law firm Ganado Advocates thinks that under the Directive, Malta will be well placed to grow its fund manager numbers going forward: “On the fund side, domiciles are becoming similar. Competitive differences are diminishing. Under the AIFMD US managers have two options: to either set up a new AIFM in an EU member state or else seek authorisation for the US manager with a member state of reference, which might be the UK, Germany etc depending on the domicile of the fund, where the investors are located and so on.
“Of the two choices I believe a lot of US managers will choose to establish a new AIFM. And in that context, I think Malta has a lot of attractive qualities. On the fund side Malta will continue getting its fair share of new registrations but I’m much more bullish on the asset managers. I think we’ll see more AIFMs being established.”
Kenneth Farrugia is the Chairman of FinanceMalta. He is confident that in the long-run the Directive will be beneficial to the European Fund Industry but has some concerns: “There is a risk that the Directive will shut out offshore funds run by non-EU managers who don’t wish to become compliant because of timeline issues, logistical issues etc. This could result in these managers using an investment universe exclusive of Europe. On balance, I think it will be beneficial (to become AIFMD-compliant) because the more transparent the hedge fund industry becomes the more attractive it will be to investors as has been the case with the development concerning the UCITS Directive.
“It should hopefully attract more business to Europe’s fund industry and I think Malta is well placed to attract a fair share of that business, as we have seen in recent times. I’m convinced the growth trend that Malta has experienced so far will be sustained going forward because of the positive experience that people have experienced since choosing Malta as a domicile and its service providers,” opines Farrugia.
Joseph Saliba, partner at MamoTCV Advocates, thinks it’s too early to talk about what impact the Directive will have on Malta’s funds industry. He does, however, concede that for non-EU managers who want to maintain “a strong foothold in Europe and for whom European distribution is an important part of their business model, the Directive will be necessary for them to comply with.”
He agrees with Farrugia that a good number of managers will likely choose a European domicile to set up their AIFM and that Malta could be viewed as a favourable candidate because of two main advantages:
“Firstly, the cost advantages that Malta offers when you compare it to other European domiciles. They are approximately 50 to 60% of the overall costs compared to Ireland and Luxembourg.
“Secondly, as admitted by fund promoters from various jurisdictions, we have a reputation for having a regulator that is approachable and offers the fastest speed to market for funds here in Europe. You can get a fund licensed in six to eight weeks from the time of submission of the application,” says Saliba.
One negative that must be addressed by 2017 is the lack of custodians operating on the island. Without a wide range of custodians, managers will be reluctant to launch AIFs in Malta. Equally, without a sizeable funds market, custodians will be reluctant to set up operations if they don’t feel the margins on offer are worthwhile.
“It’s a bit of a chicken and egg situation; who comes first, the funds or the custodians? You need fund volumes to grow to attract the custodians, but you also need the custodians to encourage greater fund formation,” adds Saliba.
Kenneth Farrugia admits that a lack of custodians is the island’s Achilles heel but he posits that just as service providers are able to provide cross-border services under UCITS IV, the same could happen for custodians.
“Custody passporting is currently being discussed as a further development to the UCITS Directive. Ultimately, if you have a fund based in Malta and the manager appoints a London-based custodian regulated by the FCA that should not be an issue. The custody passport in my view should follow the management passport brought to fruition in UCITS IV. As things stand the depositary requirement under AIFMD is discriminatory against countries like Malta whose depository industry is in its infancy.
“I think within the next four years there will be a strong drive within the European Commission to enable custodians to provide their services on a cross-border basis. At this juncture, the limited number of Malta-based custodians is not a weakness because managers have the flexibility to appoint their own international custodian. Nonetheless this will be an issue in 2017 once the requirement to appoint a domestic depositary will come into force,” says Farrugia.
Ganado’s James Farrugia concurs with this point on custody passporting: “By 2017 I think having a depositary passport will become inevitable because not having one will constitute a barrier to the movement of services across the EU.”
One of the positive knock-on effects of having more custodians on the island is that the number of UCITS funds would likely grow. Kenneth Farrugia says that while UCITS represents an important growth dynamic it is nevertheless on a menu of offerings so far as the funds sector is concerned.
“People have set up UCITS funds in Malta but clearly the growth so far has been primarily driven by the setting up of hedge funds. Malta has an attractive hedge fund framework consisting of the PIF regime which offers three different fund typologies as well as an AIF regime allowing Managers to launch AIFs under the AIFMD.
“Going forward, I believe we will continue to see growth in the UCITS space but hedge funds will remain the primary growth driver.”
Choosing between a PIF and an AIF
If that is the case, managers need to understand the options available to them. Given that the MFSA has decided to retain its PIF regime, alongside the AIFMD, managers have two fund structures available to them: the PIF, or the AIF.
New licences for PIFs will continue to be issued under the updated Investment Services Rules for Professional Investor Funds in the following cases:
i) Applicants who opt to apply to be licensed as a ‘de minimis’ self-managed AIF;
ii) Applicants who opt to apply for a PIF licence provided the PIF is managed by a de minimis AIFM;
iii) Applicants who opt to apply for a PIF licence provided the PIF is managed by a AIFM in full compliance with the AIFMD;
iv) Applicants who opt to apply for a PIF licence provided the PIF is managed by a non-EU AIFM in terms of the relevant conditions of the AIFMD under which other EU-Member States may allow them to market to professional investors in their territory.
The potential problem with category (iii) is that hedge fund managers who choose the PIF and who exceed the ‘de minimis’ threshold (EUR100million in AuM) will expose the fund to two regimes and layers of regulation.
“This would also be the situation when a self-managed PIF exceeds the de minimis threshold or opts in to the AIFMD. In light of this, we would recommend that the PIF regime is chosen by those promoters/managers which prefer to remain de minimis and not opt-in,” explains Kurt Hyzler of CSB Group.
So the PIF regime is more suited to smaller managers with less than EUR100million. Were they to launch a Qualifying Investor PIF, they would not be allowed to passport it across Europe because the manager would not fall within the scope of the Directive. It would only be available to investors through national private placement regimes of EU member states, or reverse solicitation.
If, however, the manager is running hundreds of millions in AuM and wants to take advantage of the passporting opportunity, they can choose to launch either an AIF, or a PIF.
But as Hyzler comments: “The MFSA, although it makes the PIF available to AIFMs, has acknowledged that fund promoters/AIFMs may be dissuaded from launching PIFs because it would end up exposing the fund to two sets of regulations.
“In this case, I would recommend the AIFM to launch an AIF rather than a PIF. However, if the manager is a de minimis manager with AuM below EUR100million and doesn’t foresee this changing, nor does he need to avail of the fund passport, then the PIF regime would be the license of choice for the fund.
“It is only when the PIF is self-managed that the AIFMD impacts directly on the fund. If the fund is de minimis, the reporting requirements to the said fund are much lighter than an AIFMD-compliant PIF.”
As James Farrugia of Ganado Advocates points out, it ultimately boils down to the manager, how large they are, and what their long-term objectives are. Even if they qualify as ‘de minimis’, some managers might still choose to have an AIF – or a PIF – and comply with the Directive because it might help them attract potential investors.
And on this point – the nature of the investor – rests a crucial difference between a PIF and AIF, which could further influence a manager’s decision.
“If a manager sets up an AIF under the AIFMD in Malta he can only sell it to professional clients as defined under Mifid I, which mainly covers institutions and other eligible professional clients. This is a much narrower definition than ‘qualifying investors’.
“If the intention is to sell the Malta fund beyond the EU to places like Switzerland, where the manager doesn’t need to worry about only targeting professional clients, then they should choose the PIF. This is another advantage that Malta possibly has over Ireland and Luxembourg,” explains Farrugia.
Indeed, both of these jurisdictions offer funds that only fall under the professional client definition.
In effect, the AIF is more of an institutional-focused product. The PIF, by contrast, gives the manager more flexibility as to the type of investors he can market the fund to.
“The difference with the AIF is that the AIFM can only speak to professional clients and when it comes to reverse solicitation it can still only accept professional clients because of eligibility requirements applicable to Maltese AIFs. If the manager wants an AIF-branded product to sell across Europe then the AIF regime is fine. If they want more flexibility for their product they can still choose a PIF, yet at the same time attract a wider range of potential investors,” adds Farrugia.
When asked what a de minimis manager with a PIF should do when the EUR100million AuM threshold is about to be crossed, Hyzler says that the manager should restructure the fund as an AIF and change its license accordingly.
While the MFSA should be commended for keeping the PIF regime, it is, understandably, creating a bit of confusion.
“The fact that Malta has retained the PIF regime effectively means that fund managers are being afforded more flexibility when deciding on how to tailor and structure their business and operations. When it comes to the marketing of PIFs on a European Union level, whilst these do not enjoy the EU passporting entitlements granted by the AIFMD, fund managers may still avail themselves of existing EU Member States’ national private placement regimes in order to market their PIFs,” says Bradley Gatt of DF Advocates.
“However, we understand that private placement regimes currently available in a number of EU Member States may eventually be shelved. The more this happens, the less attractive the PIF regime may become for those managers interested in setting up their funds and marketing them in the European Union.”
The extent to which managers choose Malta to set up PIFs or AIFs remains to be seen. As Hyzler concludes: “We’re still in limbo in terms of how things will pan out. We’re still waiting for the dust to settle.”
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