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Optionality and substance in a world with AIFMD

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With Guernsey’s new opt-in AIFMD equivalent regime effective from 2 January 2014, Fiona Le Poidevin, chief executive of Guernsey Finance, explores how the island offers optionality and substance to fund managers.

There is no escaping from the fact that the EU’s AIFMD presents one of the biggest regulatory challenges the European orientated investment management community has seen in recent times.
Indeed, the upcoming 12 to 18 months will prove pivotal in determining the implementation of the AIFMD and the implications for investment houses and their client bases, particularly as European Economic Area (EEA) member states begin to interpret the Directive’s many provisions.
From a Guernsey perspective we have been gearing up for the AIFMD for some time, consistently engaging with the European authorities as the Directive was constructed over the past few years. Of course, Guernsey is not in the EU and therefore, is not required to implement the AIFMD.
However, with Europe still one of our biggest markets and a large proportion of our business relating to the EU in some form, ensuring that Guernsey continues to effectively service EU business, as well as that of non-EU business, is of paramount importance.
Dual regime
Therefore, Guernsey evolved its regime to ensure that we can continue to service both EU and non-EU business. Managers and funds with no connection to the EU continue to be able to use the existing regulatory regime in Guernsey which is completely free from the requirements associated with the AIFMD, which will have significant operational and cost benefits. Secondly, Guernsey’s position as a third country means that we have not immediately had to introduce a fully equivalent AIFMD regime to maintain access to EU markets.
Back in July, the Guernsey Financial Services Commission (GFSC) signed bilateral co-operation agreements with 27 securities regulators from the EU and EEA, including the UK, Germany and France. The agreements meant Guernsey funds would continue – as had always been the case – to be able to market to appropriately qualified investors in these European countries through their National Private Placement (NPP) regimes.
It is anticipated that a full passporting regime for non- EU managers will be implemented from July 2015 and Guernsey intends to ensure that managers will be ideally placed to take advantage of being able to market alternative investment funds (AIFs) on a pan-European basis with a single authorisation. Indeed, the GFSC has published details of Guernsey’s opt-in AIFMD equivalent regime, which will be effective from 2 January 2014 – well ahead of the anticipated July 2015 date for the implementation of a passporting regime for third countries.
The point I made earlier in relation to how member states will begin to interpret the Directive’s many provisions was in fact highlighted in an October survey conducted by the Alternative Investment Management Association (AIMA) and EY. Entitled ‘AIFMD: The Road to Implementation’, the survey sought to develop an understanding of EU member states’ actual readiness to implement the AIFMD. It found that some key European markets are ‘gold-plating’ the marketing requirements for NPP regimes over and above those required by the AIFMD.
It will obviously take some time to establish how certain countries will choose to impose additional requirements, if at all, on non-domestic fund managers – particularly in relation to the issue of ’substance’, but Guernsey managers are well placed to continue marketing their funds into EU markets.
Having signed 27 co-operation agreements, our regulator the GFSC, has continued bilateral discussions with all its regulatory counterparts in the EU to clarify the process that managers will need to go through to ensure that they can market into those countries.
An attractive option
It could be argued that our position as a ‘third country’ even adds to our attractiveness as a domicile for the structuring and establishment of funds. A June 2013 survey of European asset managers by fund software provider Multifonds showed 77 per cent of respondents were considering establishing funds for their non-EU investors off shore to put them outside the scope of the Directive.
However, this can only be achieved if there is sufficient substance in the non-EU jurisdiction to demonstrate that not just the fund but also the manager can be genuinely considered to be based outside the EU and therefore out of the scope of the AIFMD. This would also apply to managers of AIFs for EU investors who are looking to avail of the continuing NPP regimes. One option might be for a non-EU AIF to opt to be self-managed and therefore itself become a non-EU AIFM but this will be subject to proving sufficient substance to the arrangements.
So called ‘letter box’ entities cannot claim to be managers and substance will be required where a manager is claiming to be domiciled. Similarly, the extent to which activities such as portfolio and risk management can be outsourced must be considered and care must be taken to ensure that the real decision-making powers lie with the entity that is claiming to be the manager. This might, in certain circumstances, encourage investment houses to build their presence offshore and take back in-house some of the previously outsourced functions.
Guernsey has a huge advantage as a fund domicile in the existing standards regarding oversight and due to the substance already present in existing Guernsey-domiciled structures. Guernsey already plays host to major managers, such as Apax, BC Partners, BlueCrest, Man Group, Mid Europa, Permira and Terra Firma which all have offices and staff in the Island.
Support services
There are also fund administrators, ranging from major international names to boutique, independent operations, coupled with a significant pool of qualified non-executive directors who not only provide support to in-house teams but also third-party services. Quality of service is evidenced by the fact that Guernsey providers now manage or administer nearly GBP100bn worth of assets from open-ended funds which are domiciled in other jurisdictions.
The AIFMD not only requires depositaries to provide extra oversight to structures but it also introduces the concept of a depositary for the first time for many asset classes, such as private equity and real estate. Unlike many competitor jurisdictions, Guernsey already has well-established custody providers. They provide dealing and settlement and also offer services over and above traditional custody services to encompass robust support for corporate governance, often performing a fiduciary role.
Much of Guernsey’s core business of closed-ended private equity and real estate funds will be able to access the AIFMD’s lighter touch regime for non-financial assets that permits a wider range of entities, such as lawyers and registrars, to carry out custody functions, thus benefitting from cost and operational advantages of not requiring a formal custodian.
We are also seeing Guernsey-based administrators setting up depositary functions. They are targeted at the likes of private equity and real estate clients who are new to the requirement for a depositary and may be most likely to favour a bespoke ‘one-stop shop’ for third-party administration and depositary services. Having said that, there is also a need to consider the fact that there are also established custodians who already provide a specialist service, including independent oversight.
It is clear that Guernsey has an existing operating model which means it can provide sufficient substance and oversight in terms of management, administration and depositary functions so that investment houses have a choice of providers to meet their specific needs and can be comfortable that they will meet both regulatory obligations and tax requirements.
Guernsey’s pedigree as a leading funds domicile relies on its ability to continually meet the demands of fund managers and their investor base. The AIFMD is just another of the many challenges that our industry has adapted and responded to. Our ability to do so is evidenced by the growth of our funds industry in recent years. Figures to the end of June 2013 show that the value of funds under management and administration in Guernsey reached £286bn – an increase of 5.6 per cent on a year previous, and an increase of more than 25 per cent on the same time three years ago.
To conclude, Guernsey’s position as a third country, its regulatory regime and its infrastructure and expertise mean that as a domicile it ultimately offers optionality for the international fund community. The way in which it has dealt with the AIFMD demonstrates that Guernsey has recognised not only the importance of the EU market but also the truly global nature of its investor base.
An original version of this article was published in HFM Week, AIFM Directive Update, November 2013.

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