Based on the views of alternative managers, law firms, advisors and some of the world’s largest investors in alternatives from across the UK and the US, the research found that key drivers including Brexit, BEPS, substance and transparency have shot up the agenda when it comes to domiciliation – and they are themes that are likely to influence decision making for some years to come.
Whilst the fieldwork for the study was undertaken prior to the coronavirus crisis, its findings look set to be even more pertinent now as alternative fund professionals grapple with the fallout of the pandemic. In a world that was already defined by uncertainty and volatility and is even more so now, the indications are that stability and certainty will be vital both in the short term, and the long-term too.
It’s clear that, with the fund domiciliation landscape becoming more competitive and more complicated than ever, international finance centres (IFCs) need to be alive to the significance of these key themes, and have a thorough understanding of what is driving the long-term future of fund structuring, so they can be equipped to continue to support the alternative fund management community.
The picture is a complex one, as geopolitical, market and economic forces continue to exert themselves, and it will be the IFCs that are prepared to take a deep dive and look under the bonnet of what is happening that will be successful.
It is perhaps no surprise that the singular most important determinant in domicile selection, according to the research, comes down to investors familiarity with the fund domicile and compliance with international standards expertise. If a jurisdiction is respected by investors, then this gives managers confidence. In a world of uncertainty and volatility, both managers and investors are drawn towards stability and certainty.
Critically, investors want a stable jurisdiction with no regulatory, legal or economic surprises – and Jersey ticks those boxes.
Being able to provide this stability and certainty requires a high-quality infrastructure, a tried-and-tested legal and regulatory environment, and a clear commitment to specialist expertise and high-quality service. From a Jersey perspective, it’s why we have seen such strong year-on-year growth in private equity and real estate fund activity – Jersey is a well-trodden path for these asset classes and success breeds success.
In particular, Jersey has a long-standing assumption towards substance, which has provided managers and investors with certainty. This was heightened further by Jersey being a first mover on economic substance legislation last year, being lauded as such by the EU. In March 2019, Jersey was assessed as a cooperative jurisdiction by EU finance ministers regarding the business taxation initiative from the EU Code of Conduct Group (COCG). The EU’s positive assessment came as a result of the Island’s collaborative dialogue with the COCG, which was tasked by the EU Council with assessing jurisdictions in tax transparency, fair taxation and compliance with anti-base erosion and profit shifting (BEPS) measures. In response, Jersey introduced new legislation, which was subsequently assessed by EU finance ministers as meeting the requirements for demonstrating economic substance.
In this new era of fund domiciliation, however, IFCs will have to be clearer than ever about their unique selling point, be able to demonstrate their expertise and evidence their quality of service if they are to continue to attract that business.
Substance, cost and agility
Nurturing a stable domestic environment underpinned by expertise is one thing, but being able to manage the constantly evolving global regulatory landscape, as well as market shocks like COVID-19, is another – managers clearly value those IFCs that are underpinned by substance and are reactive, according to this survey.
The implementation of BEPS and the introduction of new substance rules are examples of areas where managers are looking to IFCs for reassurance and expert support. A significant number of managers believed, for example, that BEPS and the EU’s substance requirements could have an effect on domiciliation decisions in the future, in a number of ways.
While it was widely felt that BEPS will impact all alternative fund domiciles, there was a clear feeling that jurisdictions in the EU, such as Luxembourg, whose funds rely heavily on tax treaties, would be impacted the most. With the tax treatment of funds in EU domiciles likely to be reviewed this year in order to ensure compliance with BEPS, there are certainly questions for tax treaty-reliant domiciles.
In addition, IFCs are having to manage significant change programs to meet the requirements of BEPS and new substance laws, as well as improved regulation and reporting. Managers, according to this survey, are nervous about the rising costs jurisdictions, particularly in the EU and Caribbean, are levying in order to undertake these programs – programs which are not felt to offer any perceived benefit by investors or fund managers.
At the same time, managers clearly felt that the ability of IFCs to react nimbly to market trends, which has long been a key attraction, is gradually being restricted by global regulatory and policy moves. Enforcing jurisdictions to bring in new legislation such as substance rules is considered to be undermining established models, especially in those jurisdictions where substance is limited and where a low regulatory barrier was seen as attractive.
Against this backdrop, IFCs will have to be increasingly sensitive to their cost and fee structures balanced against their functionality, ability to meet international standards, and agility in responding to international requirements. To a certain extent, this question mark over costs and agility will be played out in European jurisdictions as the Brexit transition period unfolds. Much depends on how passporting for third countries, delegation rules, and market integration evolve – all of which were major concerns for managers.
It’s worth noting, for instance, that according to the EU’s own figures, only 3% of managers market into more than three EU countries – something that should underline the appeal of private placement through a jurisdiction like Jersey, that can offer significantly better cost-effectiveness, flexibility and speed to market compared to potentially unnecessary blanket passporting.
What is clear from the research is that allocations to alternatives look set to continue to rise in the long term (notwithstanding the major market impact of the coronavirus in the short to medium term), as institutional investors seek to diversify their portfolios and seek returns.
Certainly in Jersey we’ve seen a sustained rise in the value of total fund assets serviced in the jurisdiction, the latest figures show an all-time high of over £345bn – a figure that does not include the additional £43bn (as at June 2019) held in Jersey Private Funds. This has gone hand in hand with a growing proportion of our funds business being in the alternatives space – around 85% of funds business conducted through Jersey now is alternatives, including private equity, real estate and hedge, while there is also a steadily growing pool of fund managers (currently 172) bulking out their presence in the jurisdiction.
Looking to the future, all IFCs will need to be smart, pragmatic, nimble and sensitive as they respond to the key drivers shaping the industry if they are to continue to be successful. Currently the Channel Islands combined have a 12% share of European alternatives business – that’s on a par with Luxembourg (12%) with Ireland slightly behind (11%). But the coming years could provide an interesting shake-up of the alternatives landscape in Europe as domiciliation decisions come of age.
The landscape is a complicated one – made even more so by COVID-19 – and it will be those IFCs that can be forward-looking with regards to specialist skills and expertise, developing innovative solutions to keep costs down, while respecting global regulatory requirements and reacting quickly to market trends, that will succeed.
For its part, Jersey’s key strengths of stability, its ability to offer a familiar, future-proof and complementary solution for cross-border alternatives, and its forward-thinking stance that have put it ahead of the game in embracing regulatory change, would all point to a positive future as a fund domicile and the potential to increase its market share as other jurisdictions play catch up.