Winning over managers outside Europe will be crucial to the success of the Alternative Investment Fund Managers Directive, but offshore domiciles such as the Cayman Islands are still going strong. Stefanie Eschenbacher reports.
In Europe there’s long been an assumption, or perhaps wishful thinking, that the Alternative Investment Fund Managers Directive (AIFMD) would put an end to offshore fund domiciles.
Data provided by Eurekahedge, however, shows the Cayman Islands are still going strong. The British Overseas Territory is home to 29% of hedge funds worldwide.
Half of its managers are based in the US or UK, and 28% are based in the European Union.
The AIFMD aims to create a comprehensive regulatory and supervisory framework for the managers of these funds. It currently applies to those in the European Union, regardless of where their funds are domiciled, and those that market or manage funds in a European Union member state.
Managers outside the European Union are subject to the national private placement regimes of the member states in which they market the funds.
This may change at a later stage, when harmonised regulatory standards, greater transparency and investor protection may also be applied managers outside the European Union if they sell their funds into the market.
The European Securities and Markets Authority says managers that do not wish to comply with the AIFMD in its entirety will be able to use private placement until the end of 2015 or early 2016.
They may have to choose between both private placement and the passport between that date and end of 2018 or early 2019.
By 2019, all managers may be subject to the same rules, putting an end to the national private placement regimes.
Their only other option is reverse solicitation, which is outside the scope of the AIFMD, although future rulings may place restrictions on this route.
Charles Muller, a partner at KPMG, says some managers have no choice, but those that do are not keen on AIFMD-compliant products. “These funds offer more safeguards [for investors], but those safeguards are expensive,” he says of AIFMD-compliant funds.
The biggest-selling points of regulated hedge funds in Europe are these safeguards – transparency, requirements for risk management, and reporting.
Cayman Islands-based Ian Gobin, partner and global head of funds at law firm Appleby, says he is sceptical.
Gobin says many investors do not rely on regulators when it comes to making sure the manager does what they claim they do – and institutional investors are already highly sophisticated when it comes to due diligence.
“When they make an investment in a fund, are they relying on the regulation of the fund? Or are they relying on their own operational due diligence?”
Institutional investors place little trust in regulators – “nobody was relying on them to do a good job”, as Gobin puts it – and the failings during the financial crisis has reinforced their attitude.
“Appetite in Cayman structures from European managers is increasing, in the rest of the world it never went away,” he says.
Gobin says he is advising a European fund manager on re-domiciling funds back to Cayman, having re-domiciled from there to Luxembourg in 2008.
“It went well for a few years, but right now many European fund managers are saying that the cost of doing business in either Dublin or Luxembourg is prohibitive,” he says. “They are returning to the Cayman Islands.”
Service provider fees, legal fees and depositary fees are the main cost drivers in Europe.
“The reason these fees are so high is because of the overly burdensome regulatory environment,” he says. “There is a regulatory paranoia in Europe, and this is played out in Luxembourg and Dublin.”
Muller says hedge fund managers specifically, but also private equity managers, “could live with the AIFMD, but not with the fact that their pay is disclosed” under the directive.
Gobin recalls that the initial expectation in Europe was that the AIFMD and the opportunities to passport funds would make it so popular that it would lead to the end of offshore jurisdictions.
“The dust has now settled and it is becoming obvious that this is not going to be the case,” Gobin says.
Cayman Islands-based Ingrid Pierce, a global managing partner at law firm Walkers, says fund numbers have held up relatively steady in recent years.
Pierce says asset managers continue to form new funds in the key Caribbean offshore domiciles, such as the Cayman Islands and British Virgin Islands.
“We remain busy with new launches both from established managers and some new start-ups,” she adds. “We have not seen any kind of exodus of funds leaving the Cayman Islands or the British Virgin Islands in favour of a European Union domicile.”
At the same time, there is no evidence of European domiciles suffering an exodus of funds.
Pierce says the European market is “too big to ignore” and many of the larger managers are already complying with the AIFMD.
However, the majority of asset managers outside Europe have been quite slow to react to the directive and are only now beginning to face the reality of selling their products in Europe under the new regime.
“If the European Union is a key source of capital for them, they need to assess their options pretty swiftly,” Pierce says, adding they may need an AIFMD-compliant product to attract European capital via the AIFMD passport.
Anouk Agnes, the deputy director general at the Association of the Luxembourg Fund Industry, says that a number of third-country managers have applied for a licence in Luxembourg.
Agnes says while there has been no rush of hedge funds to Europe, the number of applications is rising. “Managers that so far have operated in the Cayman Islands are considering to replicate a structure in Europe to give investors a choice,” she adds.“Yes, regulation costs, but regulation is difficult to compare and some investors no longer want Cayman Islands funds.”
One option for asset managers is to set up one structure in Luxembourg or Ireland for European investors, and a separate one in the Cayman Islands. Both funds will pursue the same strategy, but Gobin says the returns for investors in the Cayman Islands structure will be greater as the costs are lower.
Bill Salus, the new chief executive officer of Apex Fund Services, which is based in the US, says the Cayman Islands are still valued for its infrastructure, the quality of its auditors, lawyers, accountants and fund administrators – which are all driving an increase in funds.
He highlights the regulatory environment, where managers do not need pre-approval before launching a fund, the legal system, which is based on English Common Law, and tax neutrality.
The Organisation for Economic Cooperation and Development recently singled out the Cayman Islands as one jurisdiction that has substantially improved its tax standards, which should help with its image problems.
“The impact of the AIFMD on the Cayman Islands has not taken hold because of the delay of the directive,” he says. “It is still a transit period that could last until 2018 before any impact on the Cayman Islands will be felt.”
Mohammad Hassan, an analyst at Singapore-based Eurekahedge, says it is too early to see a significant change when it comes to hedge fund domiciles.
Hassan says Luxembourg and Ireland have seen an increase in capital allocations this year and last, adding that they are important domiciles in terms of asset allocation, assets under management and number of funds. “The growth [of those two jurisdictions] was much higher than that in the Cayman Islands in the 2013 and 2014,” he says. “[But] it is not that investors are putting their money into these funds because the fund is based there – a lot of factors come into play.”
Both the Association of Luxembourg Fund Industry and the Irish Fund Industry Association have stepped up their marketing efforts. The success of the AIFMD will depend on whether it can attract managers from outside Europe. The main concern, however, is that Lithuania, Poland, Portugal, Romania, Slovenia and Spain have still not implemented the AIFMD.
Comparing the Cayman Islands with European jurisdictions is difficult, not only because fund structures vary but also because the Cayman Islands Monetary Authority has been slow to release fund statistics.
At the end of 2012, the net assets of funds registered, administered and licensed stood at $1,860 billion, compared to $1,798 billion in the previous year. Redemptions increased to $562 billion, from $548 billion, while subscriptions decreased from $687 billion to $570 billion. It was a substantial rise in net income – from to $138 billion, from $14 billion – that pushed up the total net assets.
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