A greater emphasis on substance

November 24, 2015

Recent years have seen International Finance Centres (IFCs) having to contend with a growing raft of global regulation and international policy initiatives.

As well as tax information reporting initiatives coming into play via the OECD through the Common Reporting Standard and via the US through FATCA, professionals in the funds space in particular have also had to assess the detail of the EU Alternative Investment Fund Managers Directive (AIFMD).

Nevertheless, macro trends continue to suggest that those IFCs that specialise in funds business and that can demonstrate a mature, appropriate and nimble response to regulatory and market changes have the opportunity to play an increasingly important role in global fund structuring.

Estimates indicate, for instance, that the global asset management industry will grow to in excess of US$100trn within the next five years and that alternative investments specifically will exceed US$13trn (‘Asset Management 2020’, PwC). Emerging markets in particular are witnessing growth in wealth and wealth creators, and this is driving the demand for sophisticated investment support across the globe including across the alternative asset classes.

Further, a shifting business environment for fund managers and recent recommendations from the OECD relating to Base Erosion and Profit Shifting (BEPS), are prompting some consideration amongst hedge fund managers of where to domicile both themselves and their funds. With this in mind, the feeling is that Jersey’s commitment to transparency initiatives and its standing as a jurisdiction of substance is likely to have a positive impact on its long-term future as a funds domicile.

Against this backdrop, Jersey’s funds industry has continued to perform well. The latest figures (June 2015) show that the net asset value (NAV) of regulated funds being administered in Jersey grew 9% year-on-year to stand at £218.7bn, the third highest level since 2009.

The alternative asset classes, which account for around 70% of Jersey’s total funds business, continued to do particularly well, with total alternatives business including hedge as well as private equity, real estate, infrastructure and debt funds growing annually by 15%. Fundraising through Jersey, by both established and new promoters, has been very active again in 2015 with lots of new funds coming close to launch.

Market Access

There are a number of reasons for this ongoing success. Jersey has without doubt benefitted from being subject to more certain economic, political and regulatory conditions in recent years than other fund domiciles specialising in alternative fund servicing, reflected in its AA+ rating by Standards and Poor’s.

Moreover, although a proven supporting domicile to a growing number of the world's best known asset managers, Jersey is not, and does not hold itself out as, a ‘volume player’. Its success is not built on aggressive leveraging of economies of scale, but is rooted in its focus on high-end fund business reliant on stability, reliability, flexibility and user-friendliness, and this is having a positive impact in attracting high quality hedge fund business.

In addition, a key issue in recent years has been that of market access, particularly in Europe, and Jersey is incredibly well positioned in this respect. Utilising National Private Placement Regimes (NPPRs) through Jersey to access Europe is working incredibly well, with being able to access the continent remaining important. Hedge funds with a European focus increased from representing 1% of launches in the second quarter of 2015 to 6% in quarter three (Preqin Hedge Fund Quarterly Update, October 2015).

As at June 2015, according to figures from Jersey’s regulator the Jersey Financial Services Commission, 84 Jersey fund managers had received private placement authorisation from the JFSC, and 205 Jersey funds were being marketed into Europe through NPPRs. It’s clear that the private placement option is giving hedge fund managers a welcome element of flexibility, without the complications and costs of reporting under full AIFMD ‘passporting’ compliance.

Further, with ESMA recommending in July that Jersey should in due course be granted the EU-wide passport option, managers can be confident that the optionality Jersey offers stands them in good stead. There’s no doubt that being approved so early in the process has given Jersey a great level of comfort and certainty as to its long-term sustainability.

Recent announcements from ESMA clarifying that the passport and NPPR will run in parallel with the passport once granted for three years will provide real added confidence. Other non-EU centres will have to play the waiting game until 2016 at the earliest to be assessed and then see if they too receive ESMA’s recommendation.

Meanwhile, Jersey’s ability to offer a ‘rest of the world’ regime outside the scope of the AIFMD has also positioned it strongly and uniquely as a European time-zone jurisdiction that can cater for funds targeting both assets and investors in non-EU growth markets.

This is particularly pertinent against the backdrop of global shifts in wealth around the world to emerging markets, with investors in markets stretching from the US to the Middle East to Asia increasingly seeking efficient means of deploying investment capital into diverse areas and markets. This is absolutely a trend Jersey is witnessing and poses some significant opportunities for alternative managers using the jurisdiction.

Equally, hedge fund managers based in Europe fell to representing 18% of launches in the third quarter of this year from 22% the previous quarter, reflecting the activity there is amongst managers in non-EU markets (Preqin, October 2015) and the potential there is for Jersey to support them in their global strategies.


These ongoing strengths are good news for hedge fund managers currently using or considering using Jersey, but a number of additional developments are putting the issue of ‘substance’ increasingly at the heart of the decisions being made by managers, and these developments are likely to make Jersey’s appeal even stronger.

It is notable, for instance, that far from the AIFMD causing a movement away, the trend evidenced in Jersey has been one of building significant future management substance and a number of recent and high profile manager relocations have demonstrated the clear substance that exists in Jersey. The confidence managers such as Brevan Howard and BlueCrest are having in Jersey is extremely welcome, whilst the jurisdiction is now home to around 125 fund promoters, up from 70 five years ago, at least 24 of these managing in excess of US$1bn.

Whilst the AIFMD brought the issue of substance into the spotlight, the 15 point action plan since set out by the OECD as part of the ‘BEPS’ agenda is likely to result in further fundamental changes to international tax standards. Its scope is broad and means that hedge fund managers may well be impacted to some extent.

The action points related to substance will place a greater emphasis on managers being able to demonstrate substance in the jurisdictions in which they operate. There is also likely to be an impact arising from changes in the approach of tax authorities, and as a result fund managers can expect greater scrutiny of their activities, particularly those that benefit from access to Double Taxation Agreements.

With substance having long been a major factor in the success of Jersey’s finance industry, and in light of both AIFMD and the BEPS initiative, the jurisdiction is well placed to meet the challenge of demonstrating substance around fund management activity.

In fact, the recommendations emerging from the BEPS project are likely to provide significant opportunities where Jersey is concerned. Hedge fund managers could benefit hugely from relocating to Jersey as they factor BEPS into the other benefits of the jurisdiction, such as tax transparency and its stance on AIFMD.

Jersey can boast, for instance, a very healthy corporate governance ratio set against its 1,300 or so regulated funds, whilst other jurisdictions may well find themselves needing to re-configure their operating model. In addition, with managers needing to demonstrate that they maintain genuine responsibility for their portfolio or risk management functions, the unrivalled network of service provider, custody, tax and legal support available in Jersey with decades of alternative asset management experience and expertise will be hugely beneficial in supporting managers’ needs to organise and evidence their enhanced governance arrangements.

Away from BEPS, recent months have also seen sizeable changes in the UK taxation treatment of hedge fund managers and this too is prompting managers to re-think where they are located.

For example, tax changes in the UK relating to fund management and performance fees and whether they be treated for tax purposes as capital gains (28%) or income (up to 45%) are causing some uncertainty, whilst non-domiciled individuals have seen a considerable change in their UK effective tax rate with the introduction of Carried Interest legislation.

Combined, these changes mean not only that tax rates will inevitably rise, but that the taxation of aspects of a fund is becoming more complex, leaving fund managers reviewing the potential impact.

Given that Jersey provides a simple and attractive tax environment, with no Capital Gains Tax and a dedicated regime for ‘high value residents’, it has a very clear edge as a result of these changes. Moreover, being close to the main hedge fund hubs in the UK and Europe but outside of the EU has given rise to the expectation that greater numbers of managers will relocate to the jurisdiction in the coming months, a trend already manifesting itself.


In an increasingly complex landscape where substance will undoubtedly grow in importance for managers, Jersey has positioned itself strongly not only as a preferred hedge fund servicing centre in Europe but also as an ideal choice for fund management too.

With the shifting environment prompting hedge fund managers to re-assess their location options, Jersey is finding that its business proposition, with its tried and tested hedge fund experience and robust business and communications infrastructure, including the roll-out of an island-wide fibre optic network making Jersey one of the best-connected places in the world for high-speed data transfer, is increasingly fitting the bill.

At the same time, the personal quality of life it offers managers is also proving attractive. Jersey benefits from a first class education and health service, a quality of life that is second to none, and a stock of housing that ranges from country houses to cutting edge urban developments, all within a one hour flight from London.

This overall package is providing a compelling proposition for asset managers who, in today's persistent turbulent markets and uncertain environment, are increasingly drawing on Jersey to ensure they can continue to tap into and generate solid returns for their discerning investors in the long-term.

This article was first published in Preqin's Hedge Fund Spotlight, November 2015.