Learning to swim in alpha-bet soup

(c) 05-04-09 Phill HuntThere are few industries in this world that take to acronyms more than hedge funds. So, how do you avoid drowning in the alpha-bet soup describing offshore hedge fund structures?

AIFMD, UCITS, NEWCITS, QIFs, SIFs, ETFs Fatca – there is no shortage of letter combinations that offer ways to talk about everything from new regulatory requirements to tax structures to investment strategies, and ensure that your mother doesn’t have a clue what you’re saying.

A recent report co-published by RBC Dexia and KPMG provides context on what EU-based hedge fund managers expect to do in terms of structuring their offshore funds.

The report (click here to download) focuses both on what options hedge fund managers are exploring in terms of re-domiciling, as well as the reasons behind their choices of how they plan to structure their re-domiciled funds for their investors.

Of the managers surveyed, 27% said they were considering creating EU-regulated funds, while 24% had already brought offshore funds onshore. Of those, 55% had opted for co-domiciling by creating onshore clone funds to complement their existing offshore offerings. Less than 5% of those with onshore funds said they had decided to transfer the domicile of their funds to the EU outright.

Acronyms aside, what the report suggests is that hedge fund managers are looking at a variety of different ways to accommodate new AIFMD rules that stipulate being domiciled in the EU as well as more stringent expectations among investors of liquidity and transparency (the chart below shows the top reasons behind managers’ decisions to redomicile their hedge funds to the EU).

The findings also indicate that hedge fund managers aren’t just looking at UCITS as the way to do it. Indeed, the findings of the survey seem to suggest that the bloom may be off the rose for UCITS structures. Whereas in past surveys, hedge fund managers were as likely to consider setting up a UCITS fund as an Irish QIF or a Luxembourg SIF, the current study shows 77% of those considering onshore structures prefer QIFs or SIFs.

“The market is starting to realize that even though 90% of alternative strategies can be replicated under UCITS, specialized structures such as SIFs and QIFs offer more flexible liquidity and transparency rules for hedge funds,” says Tom Brown, KPMG head of investment management for the EMEA region. “UCITS still offers very robust protection for investors, but clearly the wholesale shift into alternative UCITS some had been predicting has not taken place.”

Uncertainty surrounding marketing restrictions on the sale of non-EU hedge funds to EU investors in the final version of the AIFMD was bottom of the list of drivers among managers who had already re-domiciled to the EU. However it was among the top three for managers who were considering re-domiciliation down the road.

Of those who had already redomiciled their funds back to the EU, more than half (55%) said they set up clone funds to complement existing offshore funds (see chart below).

To be sure, managers surveyed noted a lot of challenges with redomiciling, in particular figuring out the differences in Know Your Client (KYC) and anti-money laundering (AML) rules between EU jurisdictions and offshore jurisdictions.

Other challenging aspects included tax issues relating to underlying investments in offshore hedge funds or to the investors’ tax status, the process and requirements for transferring the ownership of the portfolio of investments between the old and the new fund structure and difficulties getting shareholder approval to move the hedge fund to an EU domicile and handling shareholders who did not meet minimum investment thresholds onshore.

Some managers also mentioned that the overall legal costs and administration costs involved in the process proved to be very high.

Still, for the most part the majority of respondents indicated the challenges weren’t enough to stop them for redomiciling.

The key takeaway from the report is that the best solution for hedge fund managers is to co-domicile, i.e. retain offshore funds for investors who prefer and benefit from them while setting up EU-domiciled funds to address issues from investors who prefer a greater degree of regulation and security.

An interesting finding that we suspect will eventually garner its own acronym: CDEUHFs, or co-domiciled European Union hedge funds.

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