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Loan vehicles could become integral part of burgeoning funds industry

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Malta's financial services industry has been continuously evolving since it joined the EU in 2004. The island has a buoyant banking and insurance sector, a trust and pensions sector, and along with its funds industry, has been growing in the region of 25 per cent per year, based on the MFSA's latest figures. 

With respect to setting up funds, the licensing process is very thorough. 

"We conduct extensive due diligence on everybody," comments Professor Joseph Bannister, Chairman of the MFSA. "In certain cases, we go a step further and involve security agencies. The first step is not the business plan and determining what a manager plans to do. The first step is always to pass our due diligence process. No due diligence, no licence."

Bannister says that the advice offered by the MFSA to prospective fund managers is "to come and talk to us, regardless of whether you are thinking of coming to Malta to establish a management company or a fund. We believe in always being open and transparent and knowing exactly what is going on. There's no such thing as simply filling in a form and sending it. We like to be proactive and meet with managers before they make a formal application." 

The MFSA's accessibility is one of Malta's many advantages. That it is an English-speaking island, with good availability of trained labour, is another. A third factor is cost. 

"We remain a cost-competitive jurisdiction. The average costs are about a half to a third lower than other European jurisdictions based on the managers we speak with," says Bannister.

Funnily enough, he notes that the manager dynamics have started to shift slightly since the introduction of the AIFMD two years ago. Prior to that, Malta was seen as just a funds domicile. Now, increasingly, managers are establishing an AIFM to take advantage of Malta's favourable tax regime, as well as launch funds. 

"Whereas previously we would be getting two or three new managers a year, since the AIFMD was introduced we've been getting on average 15 new managers a year," confirms Bannister. "Those moving here to operate the AIFM are typically risk management and research staff. The portfolio management tends to remain in London. It is a good development for Malta and its economy that such a trend is underway."

With respect to tax, Felicity Cole, Head of the Funds Department at Maltese law firm, Mamo TCV Advocates, explains: "If a private equity manager, for example, sets up a carry vehicle in Malta as a corporate it can be structured in such a way that it would be subject to an effective tax rate of 5 per cent. Malta also has what is known as the "Highly Qualified Expatriate" tax regime, which applies to senior management involved in Malta's financial services industry. This tax regime allows individuals to pay a tax rate of 15 per cent; an enticing proposition for senior management wishing to escape the big city lifestyle – and higher tax bracket – of the UK."

Private equity is one segment of Malta's funds market that has room for expansion, especially given the fact that the flexibility underpinning the Maltese PIF and AIF structures makes them suitable to accommodate private equity strategies. 

The MFSA is aware of this. On 19 November 2014, it introduced "Proposed Rules" that make it possible for PE funds to be structured either as PIFs or AIFs. 

Under the Proposed Rules, specific rules will apply to PE schemes that invest in non-listed companies or issuers. The Proposed Rules are truncated into seven sections and cover: (i) general requirements; (ii) service providers; (iii) investment objectives; (iv) policies and restrictions; (v) disclosure to investors; (vi) reporting requirements; and (vii) supplementary conditions for self-managed schemes.

Another development that could attract private equity managers is the introduction of Investment Services Rules for Loan Funds; the first of their kind to be issued by a European supervisory authority. 

"This has removed the danger that a loan fund would require a licence under the Financial Institutions Act (Cap. 376 of the Laws of Malta). 

"The introduction of the Rules places Malta in an almost unique position of having an ad hoc regulatory framework addressing the requirements of loan funds. We expect this to lead to a sharp increase in the number of funds establishing themselves in Malta," says Dr Louis de Gabriele of law firm Camilleri Preziosi. 

Bannister confirms that the first such loan fund has just been licensed. 

"In total we have four applications. We have licensed one, we're in the process of finalising the second one, and for the other two we have decided that they can operate outside of the new rules. We are certainly applying more stringent due diligence to these funds. We don't allow leverage, for example," says Bannister. 

Loan funds must also be closed-ended and have may only target specified professional investors. It may not invest more than 10 per cent of its capital in a single undertaking and the fund manager is also obliged to implement a number of policies, including a credit risk policy in order to establish the framework for lending.

Being able to structure loan funds could well help Malta attract private equity and real estate managers. The fact is, Europe's banking system is undergoing structural change. The capital requirements of Basel 3 means that banks are pulling back their financing activities in support of SMEs, requiring them to find alternative sources. Alternative fund managers and institutional investors are increasingly becoming that alternative source, just as is seen in the US. 

"Bank loans are reaching maturity and a lot of SMEs just can't get them renewed. This has played into the hands of alternative asset managers who are setting up direct lending vehicles in the "shadow banking" space," says Cole. "For Malta to have this loan fund regime where managers have certainty as to what these entities can and cannot do, is a positive development. The MFSA has also issued guidance on loan funds, in conjunction with the Investment Services Rules, which should prove helpful to fund managers." 

This reflects the evolution of Malta's funds industry. "The introduction of the new loan fund rules in May 2014 has brought about marked interest in setting up loan funds in Malta. This development will further complement the existing range of fund strategies in the industry going forward," comments Kenneth Farrugia, Chairman of FinanceMalta. 

Aside from loan funds, another aspect of Malta's funds industry that could attract PERE managers over the next few years is the introduction of the Securitisation Cell Companies Regulations, enacted on 28th November 2014. There are some that think Malta could become Europe's leading securitisation centre. 

"The SCC offers interesting structuring possibilities for securitisation transactions, and can be used to create securitisation platforms," explains Paul Mifsud, Managing Director, Sparkasse Bank Malta, plc. "The SCC may enter into one or more securitisation transactions in respect of a cell, but the securitisation assets allocated to such a cell must originate from the same originator. The originator for a particular cell could be a special purpose vehicle holding the underlying assets or even a securitisation vehicle in its own right. The Maltese Securitisation Act actually recognises the use of two-tier structures whereby an issuing vehicle and acquisition vehicle are created."

Securitisation vehicles, whether in the form of an SCC or a simple company, are not subject to particular conduct of business rules or risk management requirements at present. Nevertheless, a securitisation vehicle that does not offer securities to the public is required to notify the MFSA that it intends to enter into one or more securitisation transactions. 

Public securitisation vehicles, namely securitisation vehicles which issue financial instruments to the public on a continuous basis, are required to obtain a license from the MFSA "but to our knowledge, there are no licensed public securitisation vehicles in Malta yet," states Mifsud. He adds:

"One of the reasons why managers are increasingly interested in securitisation is that, in essence, it allows asset managers to turn real estate and other alternative investments into book-entry securities that can be held in an investor's or fund's portfolio with a custodian or directly with a central securities depositary." 

It is still early days. For some, securitisation remains a dirty word following the 2008 financial debacle. The more important point to make here is that Malta continues to look ahead and make adjustments to its legal and regulatory framework to support as wide a range of fund structuring possibilities as possible. 

From a fund structuring perspective, the rather unique self-managed PIF (or AIF for those wishing to freely market it across Europe) is one that continues to attract certain promoters to the island. 

These structures are ideal for those wishing to avoid setting up as their own AIFM. Rather than then establish a standalone fund structure, appoint a board of directors to the manager, and take full discretionary control of the fund strategy, a self-managed PIF is more of a collaborative affair whereby the fund strategy is controlled by an investment committee; typically this will be a small number of select investors including the promoter, to whom the portfolio management could be delegated. In all instances, there is no management company involvement. 

As such, a self-managed PIF cannot appoint an existing third party manager to provide the portfolio management in a sort of quasi sub-advisory arrangement. The most it could do would be to second certain people to the investment committee to provide, for example, research and advisory services. 

"The self-managed PIF license would authorise the investment committee members to manage the fund or funds set up under the scheme. Whilst the investment management function may not be totally outsourced to a third party manager, they may be delegated specific portfolio management or be appointed to act as investment advisers to the fund," comments Dr Jean Farrugia, senior partner with DF Advocates, who goes on to say:  

"Although the self-managed PIF regime allows the scheme to internally manage the investment operations of the funds set up under the scheme via the investment committee, a self-managed PIF license is of course not equivalent to and should not be confused with a fund management license. Nonetheless it is quite popular and works for certain promoters who are solely interested in launching and managing their own funds."

If, a year or two into running the self-managed PIF, the decision is made to restructure it as a third-party managed PIF, a separate fund licence would need to be acquired. One cannot just switch the SICAV – the most common legal structure for self-managed PIFs – to sit underneath the fund management company. 

First, one would need to apply for a fund manager license. Then, they would switch the scheme from a self-managed PIF to a third-party managed PIF, do away with the investment committee at the fund level and put it in place at the fund manager level. At that point, one would be appointed as the investment manager to the fund and could transfer the track record of the self-managed PIF to the new fund structure.

"It must be said however that such conversion is not so common," says Farrugia. "The reason being, that in the event that the fund promoters wish to attract different type of investors to their fund with a different investment profile, they would generally set up the scheme as a multi-fund/umbrella scheme and therefore set up different sub-funds under the same scheme catering for different type of investment strategies and different categories of investors without having to become a licensed fund manager. The assets and liabilities of each sub-fund would be considered as legally segregated from the assets in the other sub-funds." 

The SICAV legal structure has long been used for platform umbrella structures and Incorporated Cell Company structures. But as a concluding observation it is worth noting that Recognised Incorporated Cell Company (`RICC') structures are becoming a viable alternative. A RICC can be operated in a purely administrative way, against a platform fee, to support each incorporated cell, each of which enjoys its own separate legal personality. 

"The RICC works in a more advantageous way to a SICAV in that different SICAVs – not just sub-funds – can be plugged in to the RICC as incorporated cells," comments Dr Stefania Grech of Chetcuti Cauchi Advocates. "The RICC will have legal agreements in place with each underlying incorporated cell, which will be fund structures in and of themselves; multi-fund SICAVs with their own underlying sub-funds for example. This provides better segregation between each IC and protects the end investors. 

"There are four RICCs registered here at the moment. We are currently working on one RICC application at the moment and we are seeing interest build from outside the EU." 

Camilleri Preziosi's Dr de Gabriele believes that uptake in the RICC looks set to increase: "Indeed, in view of the enhanced costs occasioned by new regulation under the umbrella of the AIFMD, the RICC model is looking increasingly attractive as it allows several funds to co-exist under the RICC, whilst benefitting from the `administrative' services thereof."

All told, it would appear that Malta is prospering under the AIFMD. 

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