Despite rules making it easier for hedge funds to leave their offshore bases and settle in Ireland under the AIFMD regulations, only a few have done so. Nicholas Pratt asks what has happened to Ireland's hopes for increased alternative funds business.
In the wake of the financial crisis and the search for scapegoats, the alternative funds industry was identified as a chief culprit. Though later vindicated from causing the 2007/08 turmoil, a huge focus on hedge fund processes had begun under the lens of the Alternative Investment Fund Managers Directive (AIFMD). The directive’s aim was to provide protection for European investors under the umbrella of regulation – a good thing that might even increase institutional participation.
A prevailing view in Ireland, which has a deep history of servicing European and offshore hedge funds, was that it would lead to more funds in offshore centres, such as the Cayman Islands, moving onshore to take advantage of Europe’s AIFMD “brand”. Ireland was expecting to be a major beneficiary. In 2010, the Irish Funds Industry Association claimed that approximately 206 funds and sub-funds with an asset value in excess of €60 billion were lined up, waiting to avail of the new redomiciling legislation.
To help things along, Ireland passed the Companies (Miscellaneous Provisions) Act 2009 into law. The act contained a framework for streamlining the redomiciliation process of fund companies into, and out of, Ireland. Meanwhile a number of international law firms bolstered their Dublin practices. Dechert opened its Dublin office in June 2010, hiring industry figure Declan O’Sullivan to head the new practice and it was joined later that year by offshore specialist law firm Walkers. Meanwhile, the funds industry embarked on a promotional programme as the groundwork was laid for a wave of relocating funds.
Except that the wave has not come – at least not yet. The most high profile defection to date, when Marshall Wace moved its hedge fund range from Cayman to Ireland, actually happened in early 2010 before the new legislation was enacted. Meanwhile, a 2010 study by KPMG shows limited appetite for relocating, with 81% of institutional investors stating that domiciles had little impact on asset allocation decisions.
And since then, the AIFMD has become more benign in its rules for non-EU-based managers – for example, by allowing the private placement of non-EU funds. This retards one of the expected drivers for redomiciliation. A regular check of the Irish Companies Registration Office’s weekly gazette, which publishes the arrival of newly incorporated funds in Ireland, shows there has been a drip rather than a deluge.
“Anyone who expects thousands of funds to migrate overnight when migration legislation is enacted is not being realistic,” says Donnacha O’Connor, partner at Irish law firm Dillon Eustace.
“As soon as the legislation was introduced, there was a significant number of applications and since then there has been a steady flow. But the legislation is not a panacea: it’s one necessary feature of a well-developed funds domicile,” he adds.
REASONS TO MOVE
Redomiciling generally requires specific reasons relating to investor demand, such as where a new investor will only invest in an EU-regulated fund, O’Connor says. Else managers might want an EU domicile to obtain cross-border marketing “passports” under the Ucits or AIFMD rules.
Furthermore, some managers could set up one fund in Ireland and then re-domicile all of their funds to Ireland to create efficiencies and reduce costs by reducing the number of service providers they need.
But as helpful as Ireland’s legislative change may be in facilitating redomiciliations, there are still complications for hedge fund firms. “Clearly, a fund won’t be allowed to change its domicile to Ireland without adequate shareholder and creditor protection,” says O’Connor.
“Migration requires shareholder approval and a declaration of solvency by the fund directors. There are good reasons why the Irish government thought these requirements were necessary. And there are similar rules in other jurisdictions such as Cayman.” Jennifer Wood, head of asset management regulation at the Alternative Investment Management Association, also highlights why redomiciliation is a major step, despite the potentially helpful legislative changes in Ireland. “There are tax implications. The fund may have to realise any gains or losses at the time of the change. Also, redomiciling is asking people to make a new investment decision.”
There are other options available to alternative managers, says Wood. “Parallel funds are a useful possibility, as might be European feeders into an offshore master so the manager can continue to pool the investments at the master level. Such European feeder funds can be privately placed in the EU under Article 36 of the Directive, rather than Article 42, but cannot be passported.”
Nevertheless, the argument for an EU fund domicile remains strong under AIFMD says O’Connor, the lawyer.
“Right now it’s the only way to have a pan-European marketing [passport] which gets you into markets like Germany, France and Italy which are otherwise more or less closed.”
However, the passport may be of limited interest to sophisticated and non-institutional investors in UK and Switzerland where private placement will likely continue.
And while current activity may be limited, the question of whether to redomicile may become more acute as we see the next developments in terms of private placement and passports. In 2015, the European passport is set to be introduced. And in 2018, the European Securities and Markets Authority is due to make a ruling on whether private placement can continue.
The other major issue on the redomiciling debate is how it has affected relations between the different domiciles. The Irish funds industry’s publicity campaign that followed the 2009 legislative change did cause some umbrage with the likes of Luxembourg, which already had the same legislative process in place, and Cayman Islands where industry spokespeople were quick to point out that offshore islands still housed the vast majority of the world’s hedge funds.
There has always been that competitive tension between the onshore and offshore fund centres but it has yet to come to a head, says Wood. “The regulations and its implications were not as stark as they could have been if Germany, Netherlands and other EU states had said no to private placement. However, should private placement be no longer an option in 2018, it may well reopen the debate about redomiciling.”
In the Cayman Islands, they are not so sure. “If there were people in Ireland expecting thousands of funds to redomicile from Cayman, then that clearly has not happened,” says Gonzalo Jalles, chief executive of Cayman Finance, the Island’s development agency for the financial services industry. “The AIFMD may facilitate selling to European investors but it also imposes significant restrictions in other areas such as the disclosure of remuneration.”
Different funds will take different decisions according to their investor base, says Jalles. There are still several outstanding issues, particularly for non-EU funds with EU investors. For example, will passports be required? Will private placement continue and if so where? And will reverse solicitation ever be a viable option given that any further guidance will come via court cases rather than a central bank.
“The problem is that the AIFMD adds inefficiency, restrictions and cost,” says Jalles. “And I do not think the EU is a big enough market to impose these on non-EU investors.”
Rather than creating mass redomiciliation, the AIFMD is likely to segment the market between those non-EU sophisticated investors satisfied with offshore funds, and institutional EU investors who prefer a regulated product, says Jalles. Or, given that the redomiciliation agreements work both ways, there may well be sophisticated EU investors that prefer the “less costly and more efficient” offshore funds, comments Jalles.
What is more likely is that managers that do not embed themselves deeper in their offshore domicile will instead choose to launch a new fund structure that can operate in the AIFMD environment. Ireland should therefore ensure that it is able to develop the best model for capturing and servicing these new fund types that will result from the AIFMD, Jalles says.
Jalles says it is not the case that Ireland’s efforts to make redomiciling easier had created any tension between the two fund centres. “We have been actually working with [Ireland’s] International Development Agency on a number of initiatives. The reality is that there is not so much competition between the two jurisdictions and there are more areas where we can cooperate, such as addressing the G7 and OECD concerns about tax and transparency.”