23 Dec 2010, Ken McCarney, Butterfield Fulcrum, Hedge Funds Review
In the aftermath of recent crises in the financial services industry, there has been a change of focus when establishing a fund. With keen awareness that prospective investors in the current market environment will demand stronger oversight and regulation along with greater transparency, managers have become less focused on taking the most convenient route to set-up their fund and instead are more apt to follow a model that will make their current and potential investors more comfortable.
Ireland, with its strong regulatory framework overseen by the Central Bank of Ireland, is a jurisdiction that can provide investors with confidence that the fund will adhere to industry best practices.
There are numerous characteristics that make Ireland a highly desirable choice as a fund domicile. The first is its business-friendly approach that enables efficient fund and promoter approvals. It is possible for certain types of funds to be authorised in just 24 hours.
Accessibility to all major service providers (such as administrators, lawyers, promoters, accountants and custodians) is made easy given that all the major industry participants have a presence in Ireland. While these companies compete against each other for business, they also work closely together to create a premium brand through participation in bodies such as the Irish Funds Industry Association (IFIA).
There are no taxes on Irish funds and no taxes applied to non-Irish resident investors. For corporate entities there is a corporation tax rate of just 12.5%.
Ireland is a member of the eurozone, the European Union (EU), the Organisation for Economic Co-operation and Development (OECD) and the Financial Action Task Force (FATF). It has a legislative structure based on common law similar to both the UK and the US.
Ireland is also a major centre for the cross-border distribution of funds. This is an important consideration given the concerns around the alternative investment fund managers (AIFM) directive and the potential restriction of access to EU investors from non-EU fund sponsors.
Having selected Ireland as a jurisdiction, a manager must decide on the category of regulatory status required for their fund. The categorisation will be based on factors such as portfolio composition, liquidity, transparency and ability to market.
The two main categories of regulatory status which can be granted in Ireland are Ucits (Undertakings for Collective Investment in Transferable Securities) and non-Ucits.
Ucits is by far the most common category, representing approximately 80% of Irish-domiciled funds. Ucits funds are established under the EU Ucits legislation which has seen a number of iterations over the years. The latest version, Ucits IV, is due to be implemented in July 2011.
Ucits are highly regulated entities with specific rules regarding transparency, liquidity and risk management. Initially, portfolio composition for a Ucits fund was restricted to long-only listed securities. However, subsequent amendments extended the scope of permitted financial instruments to facilitate the use of derivatives and limited leverage.
These changes have made Ucits a viable structure for alternative investment managers. Ucits that trade derivatives are required to register themselves as ‘sophisticated funds’ while those using long-only strategies are referred to as ‘non-sophisticated funds’.
Ucits are made more attractive by their marketability. Once a Ucits fund has been approved by a regulatory body in any EU member state, it can apply to seek permission to market the fund to investors, both retail and institutional, in all other EU member states without having to seek approval in each individual country. This opens the fund to investors across borders – a practice commonly referred to as ‘passporting’.
Non-Ucits funds are established under domestic Irish law rather than EU law. So, although they cannot exploit the passporting provisions that allow Ucits funds to be distributed/sold in other EU countries, they do benefit from a more flexible regulatory regime under the local regulator.
Non-Ucits generally fall under one of three common structures: retail funds, professional investor funds (PIFs) or qualified investor funds (QIFs). By far the most popular of these is the QIF. This was essentially set up for alternative investment funds wishing to be domiciled in Ireland. It provides appropriate regulatory oversight but has no portfolio content restrictions, making it attractive to asset managers with hedge fund strategies.
Another attractive attribute of the QIF is that funds can be approved by the Central Bank within 24 hours, as long as both the investment manager and promoter have already been approved and the fund’s legal advisors certify that all necessary requirements are in place.
The first thing a fund manager looking to set-up a fund in Ireland must do is select a legal advisor. The legal advisors can then assist and guide the fund manager through the establishment of the structure and ultimately approval by the Central Bank.
The next step is the selection of a suitable promoter and having both the promoter and investment manager approved by the Central Bank (the promoter and the investment manager can be one and the same entity). The approval process involves submitting to the Central Bank an application form and sufficient background information to enable it to be satisfied that the applicant has the appropriate personnel, experience, financial resources and requisite regulatory status to perform the role.
For the fund to be approved, the Central Bank will require a business plan, risk management procedures and the relevant legal documentation including the offering documents, custody agreement and administration agreement.
The approval process for promoters and investment managers takes on average five to six weeks. Ucits are typically approved within six to eight weeks or if fast-tracked as little as one week while a QIF can be approved within 24 hours.
Regulations dictate that an Irish domiciled fund must appoint an Irish administrator, custodian/trustee and auditor. The administrator and custodian/trustee must be independent legal entities with independent boards, although they can be part of the same group.
A minimum of two of the fund directors must also be Irish. Each director must be approved by the Central Bank by passing their ‘fit and proper’ test, in terms of competence and capability, honesty, integrity, fairness and ethical behaviour and financial soundness.
Ireland is the largest hedge fund administration centre in the world with approximately 40% of all hedge fund assets globally serviced out of Ireland. The industry is now a mature one, having grown significantly since the first administration companies began to establish a presence in Dublin over 20 years ago. The workforce in addition to being highly educated has considerable expertise readily available to cater for the most complex of financial instruments and fund structures.
Several qualities differentiate one administrator from another. There are also several features a manager launching an Irish hedge fund should look for when choosing an administrator.
First, certain jurisdictional regulatory requirements must be met. To offer administration services in Ireland, a provider must be authorised by the Central Bank of Ireland to administer collective investment schemes (Irish domiciled and non-Irish domiciled, Ucits and non-Ucits) under the Investment Intermediary Act, 1995.
Besides being properly authorised, administrators of Irish funds must demonstrate a strong control environment, enabled by a combination of superior technology and a skilled and experienced workforce. An administrator who has successfully passed a Statement on Auditing Standards 70 (SAS 70) audit can point to that certification as proof that its back-office processes and controls meet international standards and are effective.
However, managers (and even the fund’s investors) wishing to analyse the control environment more closely may opt to visit the administrator’s office and interview accounting, operations and investor services personnel in an effort to understand how client deliverables are prepared, reviewed and distributed to clients.
The administrator’s offering must be supported by a robust technology infrastructure. Whether purchased from external vendors or developed in-house, the systems used by the administrator will require constant appraisal and investment to keep pace with developments in the hedge fund industry. The bifurcation of the Irish funds marketplace into Ucits and non-Ucits products means administrators need to be capable of handling the more frequent trading cycles and cross-border trading dynamics of the Ucits funds as well as the more standard monthly-dealing funds.
Without excellent people an administrator’s processes and technology are largely immaterial. An exceptional administrator will be staffed by seasoned industry professionals with backgrounds in asset management, audit or with past experience at other administration companies.
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