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Harwood and fund listings give Guernsey fresh momentum

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At international gatherings and seminars, representatives of Guernsey’s financial industry, not least its fund sector, continually reinforce the theme that the island is ‘open for business’.

At international gatherings and seminars, representatives of Guernsey’s financial industry, not least its fund sector, continually reinforce the theme that the island is ‘open for business’. It’s necessary, say practitioners, to counter suggestions from the jurisdiction’s rivals in the offshore world that the Guernsey industry somehow lacks the capacity and capability to accept a greater share of international financial services business.

Actions speak louder that words, however, and over the past year or so Guernsey has left potential clients in no doubt that it is both able and willing to compete strongly for business. First came the much-anticipated release of a report by a working party headed by leading advocate Peter Harwood, drawn up following extensive discussions with the Guernsey Financial Services Commission and industry members, that sets out a new blueprint for regulation of the island’s fund sector.

The Harwood Report, as it is universally known, builds on the commission’s established principles-based approach to financial supervision and extends the focus on regulation of service providers rather than products introduced with the Qualified Investor Fund regime in February 2005. The first fruit of the report, whose recommendations are expected to be fully implemented later this year or in the first quarter of 2008, is the regulatory framework for closed-ended Registered Funds, launched at the beginning of February.

The new regime, under which a fund’s administrator undertakes due diligence checks such as ascertaining the promoter’s integrity and competence on the commission’s behalf, in return for an accelerated approval process, dovetails neatly with the growing attractiveness of Guernsey closed-ended funds among managers of hedge funds and private equity seeking to establish ‘permanent capital’ vehicles, usually listed in London or Amsterdam.

The island is already well established as a domicile for funds of hedge funds that have been listed on the Main Market or Alternative Investment Market of the London Stock Exchange, but what seized the attention of alternative fund managers worldwide was the listing on the Euronext Amsterdam exchange of the EUR5bn KKR Private Equity Investors vehicle by Kohlberg Kravis Roberts, doyen of the US private equity industry.

Not all the high hopes engendered by the KKR float have been fulfilled, partly because the issue soaked up so much capital, but also on account of the price discount to net asset value that persisted in the fund’s first months of trading. However, as the appeal of permanent capital has grown over the past 12 months, along with increased investor appetite for the liquidity that comes with listing on a major exchange, Guernsey has stolen an important march on rival domiciles.

In the meantime, efforts over the coming months to implement the remaining Harwood Report recommendations are set to keep the island in the spotlight and, practitioners hope, further boost the perception abroad that the authorities are attentive to the needs of both fund sponsors and investors. However, opinions differ as to how far the changes usher in a genuinely new style and substance of regulation and how far they reshape existing practices in a unified and more coherent legal framework.

‘It will deliver a streamlined regulatory process,’ says Graham Hall, managing partner of the corporate group at law firm Carey Olsen. ‘Some of our legislation, although very good, is in need of updating, such as the Protection of Investors legislation. It has been changed to adapt to new circumstances, but it’s now time for a thorough review and to have some uniformity between our various structures.

‘For instance, closed-ended structures in Guernsey are regulated principally under the Control of Borrowing legislation, which dates back to the days of exchange controls. These were abolished many years ago but we’ve kept the controlling ordinance as a means of regulating the raising of capital through equity or loans. It’s primarily used for regulating the closed-ended fund sector, and it’s time for that to be brought into line with the Protection of Investors legislation.’

The author of the report says it serves an additional purpose. Harwood, a partner with Ozannes, says the importance of the fund industry will grow following the implementation of tax reforms that will reduce the rate of corporate taxation for most Guernsey companies to zero, while certain financial institutions such as banks will pay a rate of just 10 per cent on their profits. This will swing a greater proportion of the tax burden onto individuals, he says.

Creating a standard corporate tax rate of zero has become the standard response of the UK’s crown dependencies and other offshore jurisdictions to a demand by the European Union that they harmonise the tax treatment of domestic and offshore companies. However, it will leave a gap in tax revenues that must be filled. Says Harwood: ‘With the 0/10 tax regime, the focus of tax gathering will clearly be on individuals rather than corporate vehicles.

‘We therefore need to create more highly-paid jobs, and the [fund] industry will probably be predominant in that process. The States of Guernsey have been asked to loosen up their policy on the availability of housing licences and the ability to bring in people from outside the island, because we need to attract high value-added business. While it is possible to outsource a lot of the more mundane back office work, Guernsey needs an environment that will attract front-office people, who are actually taking investment decisions or are key to marketing, who are paid reasonable salaries and therefore will increase the tax take.’

Harwood believes that the new approach will banish any lingering perception of an onerous regulatory environment that might have deterred business in the past. ‘Guernsey has always been regarded as well regulated, but there was frustration at what was perceived to be a slightly laborious regulatory process, which was in fact perhaps more perception than reality,’ he says.

‘But when you explain to people about the three-stage [fund authorisation] process and you can never offer guarantees, there is always some uncertainty about timetables. The registered fund regime removes that uncertainty. It means we can compete more easily with jurisdictions like Cayman where the regulatory process has never been a stumbling block, or Jersey, which has already benefited from the introduction of Expert Funds.’

Peter Moffatt, director of investment business at the Guernsey Financial Services Commission, says the new regulatory philosophy reflects the maturing of the island’s funds industry. ‘Traditionally our approach has been that for anyone wanting to domicile a fund in Guernsey, the fund itself and the offering documents have to be vetted by the commission, to ensure the sponsors are fit and proper, and have the experience to know what they are doing,’ he says.

‘As the industry has matured, we felt our vetting of the offering documents in particular didn’t necessarily add as much value as it did at the outset. Investors in institutional vehicles such as insurers and pension funds have access to all the expertise and skills to work out whether the fund is suitable for their needs and has the right risk profile. We shouldn’t really be trying to second-guess that.

‘This is even more true where the fund will to be listed, because the prospectus will also go through the listing process, which is designed to ensure the right disclosures are made, and it didn’t seem obvious that the commission was adding much value. On the other hand, institutional investors expect the same rigorous standards of administration as retail investors once the fund is up and running. The whole idea of registered funds is that not really vetting the prospectus allows us to shift our monitoring effort onto the ongoing administration and custody of the vehicle.’

According to Peter Franks, a partner with Ernst & Young, the regulatory changes in Guernsey over the past two years have already broadened considerably the range of business the island is attracting. He says: ‘We’ve seen a wider range of alternative funds set up in Guernsey, such as renewable energy funds buying wind farms throughout the world, or timber funds buying tracts of timber across the globe – structures that are probably more commonplace in the US environment but not so much in Europe. We used to be reliant on business from the UK, but we now have German, US and Asian managers. We are becoming a more global player.’

Hall says the streamlining of the approval process and the shifting of responsibility for due diligence onto the administrator is already proving popular with clients. ‘Demand increased significantly in the first weeks and months after the introduction of the regime,’ he says. ‘That surprised me because a lot of thought goes into the creation of an investment fund – it isn’t something you do in three days, and if you have a listing with Euronext or in the UK you’d have a review anyway from the respective listing authorities. But what is helpful to the client above all is certainty.’

According to Ozannes partner Gavin Farrell, the detail of Guernsey’s regulatory regime is less important than the spirit of co-operation between the commission and the industry that underpins it. ‘People come to Guernsey because they want a certain level of regulatory protection but they don’t want it to be over-burdensome,’ he says ‘There’s a great deal of flexibility and commercial acumen at the commission.

‘There’s a dialogue between us that means that on a case by case basis we can discuss how to move forward with a particular transaction or product. For managers, it’s another stamp of approval for something that’s always been established in practice. The registered closed-ended fund regime offers a mixture of the Guernsey, UK and Cayman regimes, because you still have the Guernsey regulatory consent, the Cayman system of registration, and the UK emphasis on the service provider rather than the product itself. The next step will be to amend the law to extend the registered fund process to open-ended schemes.’

Harwood notes that all Guernsey funds come under some sort of regulatory scrutiny, something that does not apply to a number of other jurisdictions. ‘There’s a lot of fund work in Jersey that never comes on the regulatory radar screen,’ he says. ‘All Guernsey investment funds get caught, whereas other jurisdictions have certain carve-outs that help different sectors, notably private equity.’

However, Guernsey has no ambition to emulate the Cayman Islands, the predominant domicile for the global hedge fund industry with more than 8,000 active funds as well as an unknown number of additional alternative investment vehicles such as private equity partnerships. Harwood says there is no interest in recreating a model that relies on a combination of market forces and regulatory oversight in other jurisdictions where funds are administered, listed or managed.

‘A number of people made representations to the working party that we should follow the Cayman model,’ he says. ‘Very few Cayman funds are administered there – at least 90 per cent are administered in other centres, primarily Dublin. There are a lot of hedge funds floating around without really having a regulatory base, just the Cayman audit sign-off. But we insisted we had to have a clearly identified regulatory base in Guernsey, with administration carried out by a licensed entity that is answerable to and responsible to the commission.’

A significant area of growth for Guernsey administrators consists of servicing of funds domiciled in other jurisdictions, including Cayman, particularly following the removal of a requirement that subjected such funds to a second level of regulation by the island’s regulator. Does domicile matter? ‘It’s really a commodity,’ says Richard Boléat, a director of Capita Fiduciary Group who is based in Jersey. ‘It’s very rare in my experience for investors to draw conclusions about a fund from whether it is domiciled in Jersey or Guernsey, and why would you?’

However, it may be important particularly for London-based investment managers seeking to ensure that their offshore funds do not fall into the UK tax net. ‘Guernsey domicile has some value in demonstrating tax nexus,’ he says. ‘If a fund is domiciled in one jurisdiction and the board of directors sits in another, there are technical arguments about where that fund is truly tax-resident.’

Adds Peter Niven, chief executive of GuernseyFinance, the island’s promotional agency for the industry: ‘Increasingly people are finding that HM Revenue & Customs are being very much more robust in looking at offshore structures, and in some cases are not looking any further than the London manager. If the fund is registered in Cayman, the administration is done in Dublin and the board sits anywhere, they may decide it’s all effectively run out of the UK. But with a Guernsey structure, you look straight through the manager into Guernsey – that’s where the hearts and minds are, where the decisions are made.’

GuernseyFinance is spearheading a long-term campaign to attract investment managers to move all or part of their operations to the island, not only to improve the tax position of the firm or its principals – although the switch to the 0/10 corporate tax structure clearly helps – but to take advantage of the quality of life on an island that is barely an hour’s flight from London. ‘We’re working hand in hand with our colleagues in Commerce & Employment to attract high net worth individuals to the island, including hedge fund managers,’ Niven says. Echoing Harwood, he adds: ‘With the shift from corporate toward individual taxation, the more high earners we can attract to the island, the better for us.’

Guernsey already has a small but significant fund management industry, including managers of both alternative funds and traditional assets as well as some, like Collins Stewart, that straddle the two categories. Says chief investment officer Kevin Boscher: ‘There are a few more boutique-type managers like ourselves, and some more hedge funds that have established on the island. But there aren’t many that are now as big as Collins Stewart, drawing on resources in Jersey, the Isle of Man and London as well as Guernsey and managing a total of GBP2.7bn.’

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