Through the Storm
This article was first published in a Special Report on Regulation in Private Fund Manager, July 2014.
Not only has Jersey come through the regulation hurricane that is AIFMD unscathed, the offshore fund domicile is actually one of few countries that can offer locals both safe harbor from the full impact of the EU directive as well as an investment vehicle designed to pass EU regulators’ smell test on outside managers wanting in.
by NICHOLAS DONATO
Ben Robins says he doesn’t worry about the EU’s Alternative Investment Fund Managers Directive (AIFMD) as much as he once did.
As chairman of the Jersey Funds Association it’s part of his job to monitor regulatory developments on the EU mainland and elsewhere around the world that can impact the offshore island’s funds industry. And so as EU policymakers and individual member states begin placing the final touches on the AIFMD – Europe’s grand project to harmonize and strengthen fund regulation across the continent that goes into effect this month– Robins has been keeping close watch.
His assessment today? “Things will be business as usual here in Jersey.”
That certainly wasn’t the case a short four years ago. Back then EU policymakers were writing the first drafts of the directive in the wake of a financial crisis that stirred politicians and regulators into a frenzy. At the time there was a real concern that overregulation would effectively erect a ring-fence between EU investors and outside managers seeking their capital, an alarming possibility for Jersey’s funds industry, which is just 85 miles south of the English coast.
“Fortunately cooler heads prevailed and we now sit in a position where Jersey can offer GPs some optionality on their European marketing,” Robins tells pfm in a keynote interview on the topic.
Robins explains that Jersey’s own policymakers underwent a number of preparations and new rulemaking to keep pace with the directive’s requirements as it was advancing along the EU’s cumbersome legislative process. By the end of it all Jersey was able to create an "opt-in" regulatory regime for managers wanting to market in Europe under full AIFMD compliance to obtain a Europe-wide marketing passport. The happy result then is Jersey can offer GPs a tax neutral platform – something uncontroversial but important to LPs of different tax profiles – and still all but guarantee access to European investors in the new AIFMD era.
Or, alternatively, as a non-EU country Jersey “can be a safe haven for GPs struggling to meet the directive’s requirements,” says Robins. “That’s because Jersey funds for the time being can continue using individual member states’ private placement regimes for marketing purposes in compliance with the directive's transparency provisions.”
ON THE HORIZON
But Jersey isn’t exactly in the clear on everything just yet. For one, GPs based in Jersey that go through the hassle of becoming fully AIFMD-approved won’t receive immediately the main benefit of doing so: a pan-EU marketing passport. It’s not until July 2015 that EU regulators will actually consider allowing non-EU managers the ability to seamless hop across EU borders during fundraising, operating in full compliance with the directive.
And then there’s the risk that certain EU member states will “gold-plate” the directive, meaning make it tougher, when transposing its language into national law. However, like the entire directive itself, Robins says initial fears here were overblown too. “The good news is we haven’t seen much evidence of member states making their private placement regimes more difficult to access or going much above and beyond the directive’s original text.”
Looking ahead Robins warns that may change, specifically citing France and Germany as two countries that may “possibly show some divergence” from the UK which is positioning itself as an “enlightened” regulator on AIFMD. One possible result of that, if so, is third country managers, like those in Jersey, having to appoint a depositary to oversee their fund's procedures and safe-keep assets where they market in Germany, even though they aren’t (yet) provided that EU-wide marketing passport gift for doing so.
Then again it’s “not a huge burden” if this does end up happening, says Robins. “Jersey has plenty of fund administration firms, both institutional and independent, that the directive suggests could act as depositaries for closed-ended funds like private equity and real estate. It’s really by no means an insurmountable task.”
The other big question on the horizon relates to how non-EU countries regulate their own funds industry. What EU regulators want to a certain extent is for their counterparts around the world to match the AIFMD's requirements or keep their fund managers out of Europe.
This, says Robins, is “where Jersey may have an incredible advantage over other larger and less nimble third-countries like the US, Singapore and Hong Kong.” Because Jersey has already created the option of a fund regime that completely mirrors the AIFMD, they’re sure to pass this regulatory “equivalency test”.
It’s also a big question that seems to have been given little thought, at least for now. But next year it’s these types of issues EU regulators will be wrestling with, says Robins, and it’s not exactly safe to assume that major economies like the US will be given a free pass because of their reputation and size.
“Yes the US now tells its private fund advisors to register with its Securities and Exchange Commission. But that doesn’t, for example, mean they meet the AIFMD’s requirement for managers to appoint a depositary. It would seem incredible that the EU blocks US funds because of any failure to meet this equivalency test, but you’re going to see a lot of GPs in Luxembourg, Ireland and elsewhere in Europe cry foul that they that they have to meet these strict AIFMD requirements where GPs coming in from the US or Hong Kong don’t. It would place them at a significant competitive disadvantage.”
Either way, one thing third-country regulators will absolutely have to do is sign cooperation agreements with each EU member state they wish to provide their local managers access to. Many non-EU countries are still in the process of finalizing these agreements but Jersey has “these agreements in place with the vast majority of EU member states save for some small gaps,” says Robins. “And those gaps are in places like Spain and Italy where there is no current private placement regime anyway. Instead GPs will seek to rely on the status quo of reverse solicitation to admit investors from those countries.”
Lastly, Jersey managers have achieved their “business as usual” status due to their ability to demonstrate substance, notes Robins. Fund managers looking to escape the directive’s reach that set up shop in Jersey must, for local regulatory purposes, actually be able to prove the fund is controlled and managed in the Channel Islands and not just be a “letter-box entity”, he explains.
Jersey-based managers demonstrate this in a few ways, not least of which is the requirement that a regulated fund’s managing board features at least two experienced Jersey resident directors. What’s more is that these directors have primary responsibility for actual portfolio management and risk supervision duties, says Robins and delegation of functions to third party service providers is monitored.
“If you take a look at the hard numbers we’ve got about 1400 regulated funds in Jersey and around 385 individuals locally who, personally or through a financial services employer, are regulated and able to act as fund directors. On a crude, notional application of that ratio of local directors to funds each director is overseeing fewer than four funds. These are real directors, vetted by the local regulator, who know and understand the asset class well.”
Looking down further ahead in the AIFMD timeline Robins say’s the next major milestone date comes in 2017, “the time when ESMA reviews the market and decides if private placement regimes are eliminated.” And while he doesn’t believe this will turn out to be the case, he says with a note of confidence that “Jersey will be sure to monitor and prepare for” whatever regulatory moves its mainland neighbor takes.
EVCA statistics for European buy-out fund marketing in 2013 versus 2012 indicate increased fund raising from investors in the UK, U.S., Asia and the rest of the world and declining fund raising in Germany, France and other western European countries. Against that backdrop, being entirely unfettered by AIFMD restrictions when marketing outside Europe only underlines Jersey's continuing appeal as a domicile for GPs.