In a low-interest rate environment and a perceived capital markets bubble, however, investors continue turning to alternative funds to gain reliable returns. This investor demand incentivises managers to grow existing funds and launch new ones. Many of these funds are established across borders, as managers look to access new markets.
As Anastasia Williams, Business Development Director (Alternative Investments), explains: “Once a US-headquartered fund exceeds the $2 billion mark, it invariably looks at ways to deploy and access capital outside of the US. And tapping into foreign investors is a way of diversifying as well as growing its investor base.”
Yet despite strong investor appetite, managers who want to establish a fund in a new country face significant challenges. This holds true for a US-based manager looking to expand into Europe, a Singapore-based manager looking to set up in South America, and a manager in virtually any other similar situation.
While challenges are inevitable, they are not evenly distributed. Fund managers must choose their target destinations carefully and understand their unique benefits and risks.
Domicile of choice
Choosing a domicile is a critical decision. Locations such as Luxembourg, Jersey and Guernsey have been well regulated for some time, but reporting and registration requirements are becoming more stringent across all jurisdictions.
Regulations are tightening to protect investors, in part by promoting transparency around how and where money is invested. Regulations also generally seek to provide assurances on liquidity, risk management, compliance, sustainability and governance.
A jurisdiction choice will often depend on how the investment manager wants the fund to be structured. It can be a stand-alone fund, umbrella fund, private equity vehicle and so on. The choice will also be dictated by the flexibility of the structures that are available, such as the Jersey Private Fund or the Luxembourg Reserved Alternative Investment Fund (RAIF). Factors including tax, cost, culture and investor base also come into play.
As Tamara Sablic, Director of Business Development, explains: “Putting all preferred jurisdictions side by side can provide a valuable appraisal of which location is most suitable for the investment manager and the investors they want to attract.”
On-the-ground knowledge of a jurisdiction and its regulations is also critical. Each jurisdiction has its own unique set of rules, and those rules are often opaque and always subject to change. Without local expertise, therefore, fund managers risk failing to keep abreast of regulatory change and falling foul of new requirements.
Maria Scofield, Director, Relationship Management, points out that a US manager may be quite at home setting up funds in Cayman, for example, but when they are told, “we need you to set up a new fund in Luxembourg,” they need to proceed with caution.
“In essence a ‘fund is a fund,’ but it is a different regulatory environment in Europe, and there are different rules to factor in,” she says. “With certain funds there, you need a depository, and you need an alternative investment fund manager [AIFM] who is regulated and approved by the local regulator. These don’t exist in quite the same way in the US.”
Fund managers also must understand how a “physical presence” is determined in a target jurisdiction. EU economic substance laws are designed to discourage the use of “brass plate” companies that have no substantial presence in a jurisdiction.
There are variations on how each jurisdiction legislates to address economic substance concerns. For a US manager expanding into Europe, for example, the EU’s relatively stringent rules on substance — dictating how many feet you need on the ground — can mean significantly higher costs related to recruitment, payroll and office space.
Speaking a different language
Compliance requirements are not only unique to each jurisdiction, sometimes the terminology used to describe requirements varies, adding another layer of complexity for fund managers. Sablic says that in Europe, for example, a manager will often be asked for a “certified document,” which is not a widely understood term in the US. By contrast, the US has the concept of notaries, which are common and inexpensive (or free) to use. In the UK, there are very few notaries, and it is expensive to get a document notarised.
“Everyone knows they need to do KYC [a know-your-customer check] to be compliant, but how does that really work on the ground?” Sablic says. “What is the document? Who signs off on it? Interpreting this back and forth is quite a feat.”
How funds are promoted and marketed also pose challenges across borders. In each European country where managers would like to market their funds, for example, there are different regulations to contend with. Sablic points out how, for example, in Spain you must be registered with the local authority, and you will be regulated by the CSSF in Luxembourg. To take another example, if you want to sell your funds in Germany, you must adhere to country-specific tax filing requirements.
It should be emphasised that many people in the US see Europe as a homogenous group of countries, and it certainly is not. The ways in which regulations can vary in each country is extensive. These variations can affect investment and borrowing powers, capital requirements, permission to trade, training requirements and regulatory reporting.
Convoluted contract process
While many regard Luxembourg as the gateway to the European funds market, the reality for many investment managers is that setting up a fund there can be a drawn-out process.
As a case in point, Sablic refers to a Vistra client in the US who recently launched a fund. In the US, launching a fund typically involves a single contract. But in Luxembourg, the client had to sign six different contracts. There are reasons why separate services need different terms and conditions — primarily because in Luxembourg, services are provided by different legal entities at the fund-administration level. This nicely illustrates the differences and complexities of establishing funds across borders.
Of course, once a fund is set up, it needs to be managed. Not surprisingly, managing a fund brings its own challenges, such as coping with local compliance obligations related to board meetings, accounting standards and more.
It is feasible, but certainly not a given, for a fund manager to understand how things work in another country and follow all the compliance regulations in the target countries. But as Williams stresses, it takes time, money and long-term commitment to build expertise in a jurisdiction, not to mention the resources it takes to keep abreast of changing regulations.
The preference for many managers — especially those in boutique firms — looking to establish cross-border funds is to use the services of a global administrator who knows the target territory and the fund requirements of other jurisdictions. The logic here is straightforward. These experienced administrators are perfectly placed to deal with not just the cross-border structure of the business, but the cross-border structure of all their investments.
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