Against the background of the looming European directive on alternative investment fund managers and the upcoming fourth instalment of the Ucits legislation governing cross-border investment products, financial centres in Europe and further afield are trading the first punches in the latest round of the regulatory arbitrage contest.
Their handling of business around Ucits III and Ucits IV provisions – the former defining investment powers and the latter allowing funds to merge and run more efficient operations – have left Ireland and Luxembourg once more as prime movers.
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The European Commission expects EU fund houses to save €6bn (£5.4bn, $8bn) through increased efficiencies under the latest rules, to be enforced from June 2011. But it is the exploitation of existing Ucits III regulations by hedge funds that is attracting most attention in the closely-watched financial centres beauty parade.
Hedge funds are usually based offshore, typically in the Cayman Islands or British Virgin Islands. However, an estimated $35bn has flowed into the Ucits alternative space, following launches in the past 18 months. “Newcits”, as these funds have been dubbed, are set up mainly in Luxembourg and Dublin.
The current thinking, according to Michael Barr, partner in the investment funds unit at Dublin-based lawyers A&L Goodbody, is for managers to keep their hardcore hedge strategy in a Caribbean-based fund, and then establish a Dublin “lite” version for European consumption. “Managers will say ‘here is my core strategy. Now can I tone it down a bit and fit it into a Ucits structure, and run it side by side?’ It doesn’t have to be either/or.”
Both Dublin and Luxembourg are seeking non-Ucits alternative investment fund business, to cater for funds that want an EU base but do not need, or cannot fit into, the relatively restrictive Ucits structure.
Dublin’s asset management community – currently employing 10,000 people – is fighting hard to maintain and increase its share of the cake. Recent regulations include measures to speed up redomiciliation of funds, particularly targeting Caribbean hedge products.
“Cayman still has a dominant position and it’s not unregulated, even though its percentage of assets is falling,” says Ian Headon, head of product development in Northern Trust’s global alternatives business. “Launching an Irish hedge fund is quicker, but it comes with an extra oversight process with extra costs.”
Dublin stalwarts also warn of the threat from new entrants. Since Dublin muscled in on Luxembourg’s cross-border funds monopoly in the early 1990s, there has been a tacit agreement from both centres to share the spoils. But today, Malta, a more recent entrant to the European Union, is busy building an increasing reputation as a sharply regulated and marketed funds centre.
“Malta may be small in terms of infrastructure, numbers of lawyers and accountants, but people are beginning to launch Maltese funds,” warns Peter O’Dwyer, director at Trinity Fund Administration in Dublin.
The costs of setting up and running a fund management operation in Malta are approximately one-third to a half of what they would be in Luxembourg or Ireland, according to Andre Zerafa, partner at legal firm Ganado & Associates in the Maltese capital of Valletta. His clients are refugees from investment banks, launching hedge funds running between €500m and €3bn, wishing to devolve some functions to a cheaper, but well regulated centre.
“This is not a Cayman Islands type structure where you have 300 managers in the same building, with everything outsourced to New York or the UK,” says Mr Zerafa. “There must be a level of activity happening in Malta with directors, a company secretary and back office function here.” The next step for the island is to recruit a big investment servicing organisation, with regulators believed to be in talks with BNP Paribas and State Street.
“Servicing hedge funds has to be a priority,” says Joe Bannister, chairman of the Malta Financial Services Authority. “But custody has to have substance and that means bringing jobs. Ucits legislation requires custodians to be in the domicile.”
One consultant, working with some big hedge fund clients, says smaller EU countries may be punished by London regulators if they try to sell funds into the UK. “The FSA will take a dim view of people establishing in a smaller member state because it’s quicker and easier and then passporting products into the UK,” says the consultant. “Regulatory arbitrage exists as a possibility, but there is not much evidence of it in reality so far.”
This notion of a battle of wits between regulators is also played down by Willie Slattery, head of European offshore domiciles at State Street.
However, Mr Slattery was regulatory boss between 1987 and 1995 in Dublin’s formative years as a financial centre and his current role also involves evaluating new entrants for their attractiveness to fund groups and banks that service them.
“In Europe now, the regulatory environment is overseen by Cesr [Committee of European Securities Regulators], to which individual countries’ authorities are answerable. That is a good check on developments which people might be concerned about in terms of regulatory competition,” says Mr Slattery.
Financial centres vie for slice of hedge fund pie
