The
Statistically speaking
The number of new European hedge fund launches reached record levels in the first half of 2006, according to a survey compiled by HedgeFund Intelligence, collectively raising assets of $11.4bn (£5.9bn). It is estimated, however, that around 80% of the world’s hedge funds are domiciled in the
Similarly, the European-funded collateralised debt obligation (CDO) volume grew by close to 60% in 2006, reaching Ä60bn (£31bn) by year end, and figures from Europrospectus on the basis of filings suggest that the European asset-backed and CDO markets have grown by 235% and 310% respectively since 2003. However, these tables show that Cayman’s growth has also increased in these areas (albeit not so dramatically) during the same period. In addition, these figures ignore the much larger
In our view, and that of many of our clients, the conclusion to be drawn from the current figures is that, as the funds and capital markets sectors continue to grow, certain European onshore financial centres have successfully positioned themselves to benefit from the increased appetite for products in these areas. Principal among those who have recognised the opportunities are
The Economist puts
In addition, the Grand Duchy has recently introduced new legislation for institutional investor funds. The new law on Specialised Investment Funds (SIFs) came into effect on 13 February, 2007, and provides a regulated vehicle, which is subject to regulatory supervision, but greatly extends the range of eligible investors and the organisational flexibility of the fund structure itself.
SIFs are not subject to specific investment restrictions — instead they must maintain an adequate spread of investment risk — and they allow for investment in a wider range of asset classes, presenting opportunities for hedge funds, real estate, private equity and other alternative investment strategies.
This move is indicative of the general trend we are seeing towards a more institutionalised European hedge fund industry, both in terms of the promoters of products and the investors in those products. Increasingly, hedge funds are becoming more accepted as mainstream investment vehicles, and onshore regulators are actively embracing the kind of products which, just a few years ago, they were resisting.
The Irish experience also reflects this trend. During the 1990s, considerable effort was put into attracting leading international fund administrators, custodians and trustees to Ireland, and to Dublin in particular, with low rates of corporate tax providing an incentive for businesses to establish their headquarters in (or move them to) the jurisdiction. This, coupled with an appropriate legal and regulatory environment, an industry that has capability to support the business and geographical proximity to and a common language and timezone with London (where the majority of Europe’s hedge fund assets are managed) has led to enormous growth in recent years in the number of non-Irish domiciled hedge funds that have chosen to be administered and serviced in Ireland.
In order to encourage the homegrown hedge funds industry too, the Irish Financial Regulator (FR), after extensive industry lobbying, was persuaded to issue draft guidance notes (in April 2000, revised in June 2004) providing for the conditions under which certain types of Irish authorised funds (professional investor funds and qualifying investor funds) may enter into prime brokerage agreements. This guidance has been relied upon by the funds industry since its release as the basis for the establishment of Irish hedge funds utilising prime brokers. The FR has now agreed to re-assess in 2007 the requirement for an Irish custodian to be appointed to an Irish prime brokerage fund, and industry pressure is mounting to have the FR remove this requirement.
Another significant development in
- created the general framework for the common contractual fund (CCF), which extends the legal framework of the CCF to all fund types (both UCITS and non-UCITS);
- included provisions to allow the segregation of liability at sub-fund level to remove cross-contamination risk across sub-funds within an umbrella structure; and
- permitted sub-funds to cross-invest in each other within an umbrella structure.
In addition, the Finance Act 2005 introduced provisions to ensure that CCFs are viewed as tax-transparent vehicles, and it extended the eligible investors within the structure beyond pension funds to all institutional investors.
Like
The securitisation and structured finance market in
- imposition of withholding taxes on payments in relation to European assets;
- marketing restrictions on debt securities of Cayman issuers or other non-OECD issuers; and
- investor perception fuelled by international scandals (e.g. Enron and Parmalat).
There is also a feeling among some that acquiring the necessary ratings to penetrate the more conservative pension fund and institutional products markets is more easily achieved with an onshore EU jurisdiction, although this is entirely unsubstantiated by the rating agencies.
Many of the onshore ‘tax havens’, principally Ireland, Luxembourg and the Netherlands, have picked up this business and overcome the structuring difficulty of establishing special purpose vehicles in taxing jurisdictions by adjusting their domestic tax rules to achieve an effective zero tax rate for vehicles participating in securitisations and structured finance transactions. In Ireland, for example, section 110 of the Taxes Consolidation Act 1997 provides for a ‘qualifying company’ involved in the holding or management of ‘qualifying assets’ to be taxed as if it was carrying on a trade so as to allow it to deduct most, if not all, of its expenses.
Another recent example of the introduction of legislation designed to facilitate the establishment of securitisation and structured finance vehicles is the Irish Investment Funds, Companies and Miscellaneous Provisions Act 2006, which permits a private company to issue bonds to the public if the issue falls within certain exemptions, including bonds with a minimum denomination of Ä50,000 (£26,000). Using a private company avoids public limited company capitalisation requirements and allows for a single shareholder.
The tax regimes of the onshore ‘tax havens’ therefore place the taxing jurisdictions in the same position as the offshore jurisdictions from the point of view of the taxation of the vehicle but, unlike vehicles established in the Cayman Islands and many of the other offshore zero tax jurisdictions, the vehicle in the taxing jurisdiction also benefits from the domestic tax treaty network which allows it to receive income and other payments on European assets gross, or to claim back any tax withheld.
Vehicles established in the
Nevertheless, for transactions where tax treaties are not required because, for example, the underlying assets pay gross, the
Cayman’s prime work source in this sector has therefore been the North American and Asian markets.
Offshore response
As mentioned above, traditional OFCs such as Cayman are seeing no diminution in the amount of funds and capital markets work being done in the jurisdiction, rather the opposite.
Although as a jurisdiction the Cayman Islands is theoretically interchangeable with any number of zero tax jurisdictions, the
The
This aspect of ‘offshore work’ has yet to find its way fully into the traditional onshore jurisdictions doing offshore work, such as Ireland and Luxembourg, but as the volume of work grows and the market demands greater efficiency and cheaper products, the need to tailor laws and develop structures that allow volume and commoditisation will grow.
Charles Jennings is the managing partner and Jeremy Bomford an associate in the