Jurisdictions are competing for private equity asset servicing business. But, discovers Nicholas Pratt, in such a conservative market, emerging domiciles face an uphill task when challenging the old guard.
There were few products, instruments, markets, domiciles or fund types that enjoyed the financial crisis, but some endured it better than others. The private equity industry certainly fared more favourably than other alternative investments such as real estate or hedge funds.
One of the consequences of this difference in relative fortunes is that private equity funds have become the focus of attention for service providers – both the asset servicing firms and, more notably, various jurisdictions.
The European private equity fund administration survey conducted by Ernst & Young in May 2011 showed that 35% of its respondents had opened new offices. The most popular places into which administrators had expanded were Luxembourg (four launches), Asia and the Far East (three) as well as the UK, Ireland, Mauritius and Germany (two each), while the Channel Islands, the US, the Middle East, the Caymans, Malta, Belgium, Poland and Bermuda made up the rest.
Yet despite the expansion into new territories, the tried and tested jurisdictions still appear to be the most popular choices for private equity fund servicing. A survey commissioned by State Street found that chief financial officers overwhelmingly favoured Guernsey as their jurisdiction of choice (61%) with London and Jersey the choice of 15% and Luxembourg selected by 7.7%.
According to Ian Armitage, chairman of LPEQ, an industry association for listed private equity funds, the private equity world is fairly conservative when it comes to the choice of domiciles. “Managers stick with what they know. They pick a domicile and as long as it works, they will continue to have their funds based and serviced there.”
The Channel Islands
The private equity industry’s innate conservatism has been especially convenient for Guernsey, which has become one of the most popular private equity domiciles. “Many private equity houses, including KKR, Carlyle and EQT have been coming to Guernsey for 15 years and this has led others to follow their example,” says Karen Haith, operations director at Ipes Guernsey.
But Guernsey and Jersey do face challenges. The first of these is regulatory, most notably with the Alternative Investment Fund Managers Directive (AIFMD). “There has been a delay in fund launches in the Channel Islands over the last two years due to uncertainty over the AIFMD and some firms have chosen to hedge their bets by domiciling in Luxembourg,” says Spencer Wells, associate director of offshore law firm Ogier.
However, Wells believes that the Channel Islands will easily tick the various boxes required by the directive to qualify for third-country passport status and that once the directive is finalised, things could swing back in the Channel Islands favour.
The region’s close relationship with the EU allows it to be flexible enough to offer full AIFMD compliance or to operate completely outside the EU or work with private placement. This flexibility is already making it a popular choice with private equity funds concerned about upcoming regulation, says Haith, of Ipes. “We spend a lot of time with London lawyers and, where appropriate, they are advising firms to go offshore.”
Another challenge the Channel Islands faces is that of resources. “Private equity funds are becoming increasingly complex and international and this creates an intellectual demand,” says Iain Stokes, head of private equity Emea at State Street Global Services. “How will the Channel Islands be able to develop or import that talent?”
According to Kevin Gilley, managing director of Jersey-based fund administrator Moore Group, the resources challenge is one that faces every offshore jurisdiction and he is confident that Guernsey and Jersey are equipped to deal with it. “There are constraints but there is a structure to address it. The big four audit firms are here as are the top banks and law firms.”
While home-grown talent may be a finite resource, the plan is to attract people like university graduates that are looking to establish skills in one specific area like private equity servicing before branching out.
And while complexity may be increasing in terms of private equity fund structures, the relatively conservative nature of the market should mean that capacity concerns are some way off, says Nigel Strachan of the Jersey Funds Association. “Jersey is generally not a domicile that deals in high-volume funds – most private equity vehicles are close-ended funds with a ten-year investment cycle, they are not high-volume, high-frequency processing products.”
If any of the concerns around regulation, governance or resources in the offshore jurisdictions prove to have any substance, Luxembourg may be thought of as the domicile most likely to benefit. For example, says Ogier’s Wells, a number of private equity funds are choosing to operate both onshore and offshore by having a Channel Islands presence and then an onshore presence in Luxembourg.
According to Dermot Crean, managing partner at Acanthus Advisers, a placement agent, the so-called ethics debate is an increasing focus for some continental institutional investors. “There is definitely some resistance to offshore domiciles in some quarters. France is particularly sharp on the issue, although it is a difficult sentiment to calibrate.”
But, says State Street’s Stokes, Luxembourg could be a victim of its own success. Just as Luxembourg gained its initial foothold as a fund centre by taking on the overspill from an under-resourced Dublin in the 1990s, it may now face the same overspill issues. “Luxembourg has got more resources than the Channel Islands but somewhat bizarrely it is so popular as a jurisdiction that is potentially having problems keeping up with the demand.”
Hervé Schunke, head of private equity and real estate servicing at Caceis, says that Luxembourg also faces cultural challenges from North American investors. “Old ties and historical links still prevail in the private equity world. For those funds looking to move from the British Virgin Islands or the Caymans, they will go to Ireland not Luxembourg because of these links.
Malta/Cyprus/Isle of Man
There are other jurisdictions in Europe that are looking to benefit from any Luxembourg overspill. Malta is promoting itself heavily, the Isle of Man has the same tax regime as the Channel Islands, and Cyprus is attracting Russian private equity funds.
Tax transparency and reliability are still the primary requirements from a private equity fund jurisdiction but the ability to respond to changes in regulation and provide detailed and granular reporting will be important. “If you are in a jurisdiction where there is not the turnaround, transparency and technology around the reporting process, it will be a problem,” says Crean.
This view is supported by State Street’s Stokes who sees private equity funds maturing as a result of investors’ demands for more information on their underlying assets in order to better manage any concentration risk they may be exposed to. “I would characterise our industry as less and less of being third-party administrators and more of being information providers,” he says.
It may even have some influence on choices of jurisdiction for servicing firms, says Stokes, if it leads to a change in firms’ operating models, as has happened in other asset classes where core processing tasks move to low-cost centres while value-added services remain in a select number of specialist jurisdictions.
Then again, it may not. Although it could be argued that such a change to the operating model is based on boosting technology capability rather than reducing cost, many see it as simply outsourcing – something which has the potential to cause unnecessary concern in the conservative world of private equity.
“Outsourcing does save money but it also creates execution risk,” says LPEQ’s Armitage. “Why run the risk of upsetting your clients? We spend tens of thousands servicing funds worth hundreds of millions so the level of service is much more important than cost. In the managers’ mind, they are buying reliability."
©2011 funds europe