The past 12 months have seen a sharp fall in new private equity business coming to Guernsey and little transaction activity in either acquisitions or exits for existing funds.
The past 12 months have seen a sharp fall in new private equity business coming to Guernsey and little transaction activity in either acquisitions or exits for existing funds. But for a fund services industry that little more than a year ago was struggling to accommodate the flood of new business beating a path to its door, the let-up in pressure is not an unqualified disaster, according to professionals on the island.
“When the economic maelstrom hit us and we started to see lower volumes, I told the industry this was an ideal time to take stock in a whole variety of areas, not least because the market had been frothy for many months if not years,” says Peter Niven, chief executive of promotional agency Guernsey Finance. “In some respects we could have been accused of overtrading in taking too much on and spreading ourselves too thinly, and risked losing our reputation for client service and satisfaction.”
“Now we have the respite to get ourselves back on track and prepare for when business really does come back, as I believe it will do. It won’t be tomorrow or next week, and it won’t be sudden – we’ll have a gradual return perhaps to the volumes we were seeing two or three years ago, but we’ll be better equipped to look after that business when it does start to come through.”
However, Niven believes this is also a good time to be out marketing Guernsey’s advantages and qualities. “Some of our competitors have gone into hibernation, cancelling events and keeping a relatively low profile, particularly in the UK,” he says. “We had a very successful event in London recently, even though people told me we shouldn’t do it and there were too many imponderables, including the EU Alternative Investment Fund Managers directive beating down on us. However, I felt it was important to tell clients and potential clients that we were still here and looking for business, not just picking work up when it’s easy, being there to help clients through the difficult times as well.”
He is echoed by Ernst & Young partner Mike Bane, who says: “In some ways the timing of the downturn has been slightly felicitous, in that the volume of products and number of deals in the market were making life really difficult for administrators. This damping down of deal-related activity and new fund-raising has given people a chance to put their houses in order, strengthen disciplines and stabilise businesses. So I’m not sure that the downturn hasn’t been quite a good thing for the industry.”
There’s no escaping that the times have been difficult for the private equity industry in Guernsey over the past year to 18 months, although almost all firms are now seeing signs that business is reviving or is about to do so. There has been a small number of redundancies among administrators, notably the disappearance of 50 jobs as a result of a restructuring of HSBC’s fund services operations in Europe, but Niven notes that even with the heat coming out of the market, there are no shortage of new opportunities for skilled and experienced staff.
Generally speaking, life in the downturn has been kinder to administrators with an established book of business than the large number of new entrants to the market over the past two or three years, which have included firms based in other jurisdictions, spin-offs from larger service providers and trust companies looking to extend their range of services to fund administration.
“Over the past 12 months activity has fallen dramatically, but in the past few months it has started to increase again,” says Barry McClay, operations director in Guernsey with specialist private equity fund administrator Ipes. “We have seen various changes with some of our clients. Investment activity levels dropped away in the first half of this year but picked over the summer, which is normally the quiet period.
“From a new business point of view we have still managed to win as many new clients in 2009 as we did last year, but getting them to a closing is taking longer. We’ve had 18 new funds launched over the past 12 months, although six of them will probably not do anything this year, which is a huge difference from the past.”
However, McClay cautions that some of the smaller and less established firms may be having more difficulty. “Some competitors have struggled to win new business this year,” he says. “The biggest plus for Ipes is that during the crisis we’re still getting word of mouth referrals. Private equity managers want to go with a company with a bigger name rather than niche providers, and we’ve benefited from having been in Guernsey for 11 years.”
Joe Truelove, head of business development for corporate clients with Kleinwort Benson, is also seeing signs of life. “The first half of 2009 has been pretty quiet in terms of new fund launches for us, which reflects the volume of new business in Guernsey as a whole, where there have been many fewer launches than during the previous 12 months,” he says. “Just before the summer break, however, we experienced a surge in new business enquiries for fund administration and custody.
“We have a number of fund launches in progress, some of which have been waiting some time for market conditions to improve, but there has also been consolidation within the industry. Some managers are moving business from one administrator or custodian (where required) to another.”
David Bailey, managing partner of Augentius Fund Administration, says his firm has seen a reasonable pick-up in business since March, but notes that much of it has been won from other administrators. “Quite a number of those pieces of new business have been transferred to us from other administrators, particularly some of the large US banks. That’s predominantly because we provide a very high-level tailor-made service rather than a mass production approach. We put in place service level agreements with every client and monitor our service quality very carefully.
“What’s happening is that many private equity firms are quieter than they have been in the past, and finance directors and CFOs have more time to think about the quality of all of their service providers. They may have put up with unsatisfactory fund administration during the times that they were busy, but now they are looking to see if this can be done better.”
Truelove adds: “Because conditions haven’t been very good for new launches and investment returns haven’t been very good either, managers have been looking at optimising returns from existing funds and reducing costs as another way of improving performance. Promoters have become more cost-conscious and fee-sensitive, and have had time to negotiate more keenly and obtain quotes from two or three other firms rather than just going to their existing provider. There are fewer funds around, so administrators have been keener to win the work and have greater capacity to take on more business.”
Some firms note that any provider whose revenues are directly tied to their assets under administration, rather than consisting at least in part of time-based fees, will have suffered particularly during the downturn. Says Niven: “Many firms, though not necessarily in Guernsey, work on an ad valorem fee basis, and with NAVs continuing to go south, their income streams are declining markedly. Fortunately we in Guernsey have a much larger spread of time-costed and fixed fees in addition to ad valorem fees, so the industry is not seeing as much pressure as elsewhere.”
He adds that some of the newcomers to the industry are rethinking their presence and suggests that this is not necessarily a bad thing. “We’ve seen a number of trust companies move into fund administration, but I sense that a number of them made the move too late,” he says. “They have looked at what the business is all about, and decided it isn’t really for them.
“They’ve made the decision to stick with what they know best: fiduciary business, private wealth, trusts and foundations. That’s probably a good thing. We still have strength in depth in terms of an extensive menu of options for promoters, but we haven’t got firms dabbling at the periphery that potentially could get you a poor name for service quality.”
Andrew Boyce, a partner in the corporate and finance group in Guernsey with law firm Carey Olsen, adds: “Some of the smaller administrators are starting to feel the pinch. Guernsey went through a phase as the industry got bigger and the larger firms like Northern Trust and Kleinwort Benson saw a lot of people spinning out to offer bespoke administration services. However, the smaller ones don’t have the existing client base behind them to be able to rely on annuity income.”
Law firms in Guernsey may have seen a temporary drop-off in new fund structuring business, but they have had plenty of other issues to keep them occupied. “We have had restructuring work and had enquiries from investors about what they can do to get themselves out of positions or investments,” says Darren Bacon, head of the Guernsey office of Mourant du Feu & Jeune.
“We’ve also been involved with some of the bigger listed permanent capital vehicles, many of which are trading at a very big discount to net asset value. In some cases activist and hostile shareholders have bought up positions at a very low price and sought to remove the boards and managers or to liquidate the funds. And a lot of entities are looking to their banks to refinance or renegotiate terms. Loan to value ratios, particularly for property funds, may have triggered thresholds in the original financing facilities when they are revalued, but so far we have not seen banks wanting to take control of the assets. Clearly they don’t want to take all of them onto their own books.”
Boyce has also seen a lot of restructuring activity, although he says the emergency steps taken when the crisis first hit have tailed off and now restructuring is a more proactive process aimed at positioning funds for the new market environment. “One result of the credit crunch is that limited partners are looking at whether they want to honour their commitments, and we’re seeing restructuring of how their commitments may be called, including the introduction of caps on individual calls,” he says.
“So far this has been a reasonably friendly process, largely because the funds themselves are just sitting there and haven’t had to put their investors on the spot to stump up. For instance, some commitments are being made in the form of a loan note issue rather than an actual direct commitment.”
Says McClay: “Some of the more recently launched funds may be looking at their commitment sizes, but we haven’t seen an increase in defaulting investors, although we have see a significant increase in transfers of interests, often within institutions. In addition, agents have been able to help to broker deals in the secondary market because an investor doesn’t want the stigma of default.”
Another trend that has probably been enhanced by the downturn, and the attendant focus on both corporate governance and tax domicile issues, is greater demand for high-quality non-executive directors to sit on the boards of general partners. “This aims to provide appropriate decision-making weight offshore, whereas historically management of the general partner has been done through administrators,” Bane says.
“It is increasingly seen as important to have more non-execs, which adds a layer of costs but also a higher degree of credibility in terms of both mind and management and the tax position. This also reflects changes in the quoted world, where there has also been a switch from non-execs who were directors or employees of administration businesses or other functionaries in the industry.”
Truelove says: “With fewer fund launches and some funds wound up, the island’s non-executive directors also have more capacity. In addition, more people are entering the non-exec director market as they get toward the end of their careers and have been made redundant or decided to take semi-retirement. These kinds of non-execs have been useful to the industry in bringing independence to boards as well as experience that an administrator can’t necessarily provide.”
The private equity sector is waiting for Guernsey’s new limited partnerships law, revising legislation dating back to the mid-1990s, which is due to be passed later this year but is fighting for legislative attention with other important measures. Says Boyce: “Our limited partnerships law is already very flexible, but the proposed amendments should increase its effectiveness. Carey Olsen has played an important role in shaping the legislation because the number of private equity funds we’ve created using limited partnerships has given us a good insight into the practical difficulties with the existing law.
The key changes, he says, shore up the safe harbour provisions for limited partners, clarifying and extending how much they can get involved in the business of the partnership. “With the credit crunch and the fallout from the likes of Madoff, limited partners are much more keyed up about what they want to be doing,” Boyce says. “Gone are the days of ‘Trust me and I’ll get you 25 per cent’ – today they are very involved in the investment process.
“The other bits are largely practical, such as the lifetime of the partnership and the registration requirements. The private equity industry in Guernsey took off in the early 1990s and the early funds largely had 10-year lifespans, so a lot of them are coming to the end or using extension provisions that are raising slight issues with the practical workings of the law. The new legislation will take the opportunity to fix those.”
