How is more regulation impacting fund distribution?
22 January 2015
Dominic Wheatley, Chief Executive of Guernsey Finance, looks at the impact of regulations such as AIFMD have impacted the funds industry.
Since the global financial crisis there has been a plethora of new regulation and legislation coming down the pipeline which, to a greater or lesser degree, is impacting international asset management.
This includes the U.S. Foreign Account Tax Compliance Act (FATCA), measures from Organisation of Economic Cooperation and Development (OECD), such as the Common Reporting Standard (CRS) and the Base Erosion and Profit Shifting (BEPS) project, and the European Union’s Markets in Financial Instruments Directive (MiFID) and Alternative Investment Fund Managers Directive (AIFMD).
It was this combined amount of new regulation and legislation which prompted Guernsey Finance to host a technical masterclass in London this January to showcase how Guernsey is responding positively to these developments to ensure that it will continue to prosper as a fund domicile and service centre in the future.
Of the new regulation and legislation, it is AIFMD which at the moment is most directly impacting fund distribution. AIFMD seeks to regulate EU-based Alternative Investment Fund Managers (AIFMs), managers of EU established Alternative Investment Funds (AIFs) and managers that market AIFs into the EU. So, in essence, if either the manager or the fund has a relationship with the EU then the Directive comes into play.
The initial ‘deadline’ for full legislative transposition of AIFMD was 22 July 2013. However a report by the Alternative Investment Management Association (AIMA), together with EY, showed that by that date only 12 out of 31 EU and European Economic Area (EEA) Member States had done so.1 In October of that year, AIMA and EY published the results of a further survey which showed the inconsistency in approach from EU and EEA national regulators in how they were implementing AIFMD.
The transitional year ended on 22 July 2014 and a report from KPMG showed that at that time only 23 of the 31 EU and EEA Member States had implemented full legislative transposition of AIFMD. Spain is one such jurisdiction which has since transposed AIFMD into national law however others have still not done so.
As such, even European fund managers cannot distribute funds into some EU/EEA Member States and we have also heard that the inconsistency of approach between national regulators is making life difficult for those using the passport. In this climate, it is no wonder that non-EU fund managers believe that not only has AIFMD imposed extra cost on distributing funds into Europe but that the inconsistency of approach between national regulators is confusing and bureaucratic.
Feedback from an event we attended in the U.S. last year was that AIFMD is too burdensome, with some citing it as creating ‘fortress Europe’ and therefore, they would not be distributing funds into the EU.
The Guernsey solution
Guernsey is not in the EU (although it is in the European time zone) and therefore, is not required to implement AIFMD.
However, with Europe still one of our biggest markets, a large proportion of business relates to the EU in some form. Yet we also have a substantial amount of funds business which originates outside of Europe and does not touch the EU at all.
As such, the Island has introduced a dual regulatory regime so that it is possible to continue to distribute Guernsey funds into both EU and non-EU countries: the existing regime remains for those investors and managers not requiring an AIFMD fund, including those using EU National Private Placement (NPP) regimes and those marketing to non-EU investors; and there is an opt-in regime which is fully AIFMD compliant.
Guernsey’s opt-in equivalent regime which has been in place since January 2014 is appropriate for funds requiring full AIFMD compliance. However, Guernsey’s position as a third country means our managers and funds who want to access Europe continue to be able to use NPP regimes. The Guernsey Financial Services Commission (GFSC) has signed bilateral cooperation agreements with 27 securities regulators from the EU and the EEA, including the UK, Germany and France. These agreements mean that Guernsey funds continue to be able to market to appropriately qualified investors in these European countries through their NPP regimes.
Many have continued to use NPP regimes due to the reduced burden in comparison with AIFMD and they are working well. Figures from the GFSC show that 34 Guernsey managers promoted funds into 15 EU countries using their NPP regimes during the transitional year for the implementation of AIFMD.
Indeed, it is understood that several Cayman Islands domiciled funds are being migrated to Guernsey to take advantage of the effectiveness of our route for distribution into EU countries using NPP regimes. NPP regimes are expected to remain until at least 2018, while full passporting for non-EU managers is expected from July 2015. Guernsey has been liaising extensively with the European Securities and Markets Authority (ESMA) and is doing its utmost to ensure that the Island is part of the first wave of approved jurisdictions when the third country passport comes into effect.
Feeder and parallel funds
The attraction of Guernsey for fund managers wishing to market into Europe is that it can provide a European platform but one which is not actually in the EU and therefore can offer a variety of options.
For those marketing into Europe, the NPP route will likely be favoured by many due to the depth and breadth of requirements that fund managers will have to satisfy under AIFMD. Indeed, it is expected that full-blown AIFMD compliance will only be sought if there are particular reasons to do so.
For example, it makes commercial sense for a fund manager marketing almost exclusively to Europe to have a fully AIFMD compliant platform. However, this does not have to be based in a mainland European domicile and, indeed, it could be a Guernsey platform because the Island has also introduced a fully equivalent, opt-in AIFMD route to market.
However, managers should look carefully at whether the pan-European passport offered is relevant to their investor base. Many managers have increasingly geographically diverse investors and therefore it is essential to have a platform which suits all. European Directives – such as AIFMD but also the Undertakings for Collective Investment in Transferable Securities (UCITS) Directive – cater for European investors; as such, if you do not need UCITS/AIFMD or only need limited access to them for certain investors, then it is advisable (and possible) to structure in a way that will greatly reduce the compliance obligations and costs that come with those regimes.
For those managers with elements of EU and non-EU business, the potentially onerous administration burden and costly compliance with AIFMD will mean that parallel structures are likely to be given serious consideration. It will be possible to break the non-EU business away into a parallel or feeder structure for which AIFMD compliance would neither be required nor necessary.
Conversely, if a manager has a platform in a mainland European domicile then it will have to comply fully with AIFMD even if there were a large proportion of non-EU investors. European mainland platforms do not offer the ability to separate the reporting obligations away from non-EU investors, as with a Guernsey platform.
In addition, managers and funds with no connection to the EU continue to be able to use Guernsey’s regulatory regime which is completely free from the requirements associated with AIFMD and as such, it will have significant operational and cost benefits. For example, Investec Asset Management recently re-domiciled a U.S.$1.2 billion fund focused solely on non-EU investors from Ireland to Guernsey to take advantage of our dual regime response to AIFMD.
A June 2013 survey of European asset managers by fund software provider Multifonds showed that 77% of respondents were considering establishing AIFs for non-EU investors ‘offshore’ as a way to put them outside the scope of the Directive. One option might be for a non-EU AIF to opt to be self-managed and therefore a non-EU AIFM but this will be subject to proving sufficient substance to the arrangements. Guernsey has a huge advantage as a fund domicile in the existing standards we already employ regarding oversight and due to the substance which is already present in existing Guernsey domiciled structures. There are more than 50 fund managers, administrators and custodians servicing assets valued at nearly half a trillion U.S. Dollars.
Guernsey already plays host to a number of major asset managers, such as Apax, BC Partners, Investec, Man Group, Mid Europa, Permira and Terra Firma which all have offices and staff on the Island. The Island also offers a range of fund administrators, from major international names such as Citco, Northern Trust and State Street to boutique, independent operations, coupled with a significant pool of qualified Non-Executive Directors who are experienced in providing management functions.
Quality of service is evidenced by the fact that Guernsey providers now not only administer or manage assets of Guernsey open and closed ended funds but also U.S.$130 billion worth of assets from open-ended funds which are domiciled in other jurisdictions, typically the Cayman Islands, where there may be local substance challenges. Unlike many competitor jurisdictions, Guernsey also already has well-established custody businesses. They are increasingly being complemented by administrators who are setting up depositary functions to service private equity and real estate clients new to the requirement for a depositary under AIFMD.
However, it should be noted that those taking advantage of NPP regimes are able to access a lighter touch regime for nonfinancial assets compared to that which would be required under full blown AIFMD.
AIFMD is just one piece of regulation which has come down the pipeline and there are plenty more on their way. However, it is extremely important for the international asset management community and is having an impact on fund distribution. Guernsey’s position as a third country, the Island’s dual regulatory regime and our experience and expertise is proving an attractive option for global fund managers. With new fund approvals up by a third in the year to the end of September 2014 compared to the previous 12 month period, it is clear that there is a continuing confidence in Guernsey as an international funds centre of the future.
An original version of this article was first published in Clear Path Analysis’ Fund Formation, Domiciling and Distribution 2015 report.Back to News
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