As part of our series of quick start guides for first time managers (our previous article is available here), in this article we review the pros and cons of some of the primary European and non-European jurisdictions for hedge fund structures.
When deciding on the most favourable jurisdiction for the fund, there are a number of key considerations. One of the primary drivers is the location and preference of the investors, both seed and target market. The fundamental legal aspect to consider is where the manager intends to market the fund, as to market non-European funds to investors in certain European jurisdictions is more challenging than it is to market a European fund.
We assume for this article that our hypothetical manager, as a first time manager, will not have sufficient assets under management (in the short to medium term after launch) for the manager to be a ‘full-scope’ AIFM (the threshold is described in our prior article). Further, we assume that the fund’s investment strategy is such that regulation under the UCITS regime is unsuitable.
Also, ‘European’ in this article means countries within the European Economic Area (and so excludes the Channel Islands).
The Cayman Islands are the classic hedge fund jurisdiction. The laws and structures are familiar to investors both in Europe and the United States. According to recent research by GPP and AIMA, 50% of hedge funds launched are established in the Cayman Islands.
The Cayman Islands as a funds jurisdiction has the benefit of mature supporting industries of directors, corporate secretarial services and other key providers that benefit from scale and so help lower the Fund’s operating expenses.
Cayman Islands funds can be limited partnerships or corporations, and segregated sub-fund structures are also available if a manager wishes to manage multiple investment strategies under one structure with isolated liabilities.
UK managers with AUM below the AIFMD threshold are able to manage Cayman Islands funds without having to be a full-scope AIFM, lowering operating expenses for the fund and the compliance costs of the manager.
The inconsistent implementation of AIFMD in European states means that the ability to easily market Cayman Islands funds is uncertain in a number of jurisdictions. Advice should be take on a case by case basis.
ESMA, the European regulator, has consulted on extending the AIFMD marketing passport to certain non-European jurisdictions, which would allow, for example, a UK manager with a Cayman Islands fund to market that fund more easily. However that exercise has effectively been put on hold pending the resolution of the Brexit negotiations.
Ireland has a well-established and well-founded reputation as a jurisdiction to where a lot of hedge fund back office practice could be outsourced. In recent years, it has also taken legislative initiatives to improve the attractiveness of its fund structures; most recently introducing the Irish Collective Asset-Management Vehicle (or ICAV).
The ICAV offers a lot of structural flexibility: it can be used as a standalone fund vehicle, as part of a master-feeder structure (with a feeder fund that ‘checks the box’ for US tax purposes, making it attractive to US taxable investors), or it can establish segregated sub-funds that isolate the liability of one sub-fund from another.
UK managers are able to take advantage of the AIFMD marketing passport to market their funds across Europe without the hindrance of the differing private placement laws that are in place across European states.
In order to do so however, the manager must be a full-scope AIFM. Further, even if the manager only intended to market the fund in European countries where the private placement laws are relatively easy to comply with (such as the UK and Luxembourg), it would still need to be a full-scope AIFM in order to be able to manage the fund on a cross-border basis.
Luxembourg has a number of legal structures that can be established that are suitable for hedge funds.
Luxembourg has recently implemented a new regulatory framework for investment funds: the reserved alternative investment fund (or RAIF). One of the key advantages is that RAIFs are not subject to approval of the Luxembourg regulatory before launch, significantly improving the time-to-market compared with other Luxembourg regulatory frameworks.
It also possible to set up segregated sub-fund structures under the RAIF framework with different investment strategies.
The issues raised in the context of a UK manager managing an Irish fund apply equally to Luxembourg funds: managing a fund on a cross-border basis requires the manager to become a full-scope AIFM. Further, a sub-threshold AIFM cannot manage a RAIF in any circumstances.
Other European jurisdictions (including the Netherlands, Malta, Cyprus and Gibraltar) have fund structures that are suitable for first time hedge fund managers. The primary shortcoming of Irish and Luxembourg structures – the requirement for a full-scope AIFM – applies equally to such jurisdictions.
The advantages of the new regulatory regimes in the Channel Islands for managers are discussed in MJ Hudson’s Alternative Insight for June 2017.
Generally speaking, managing a European fund on a cross border basis is only possible if the manager is a full-scope AIFM. As we discussed last month, a regulatory host can be appointed to act as a full-scope AIFM to ease the compliance burden for a manager.
The hosting platform service is a cost usually borne by the manager. These costs however do cover compliance and capital adequacy costs (which are greater than the fees) and appointing a platform service increases the speed to market. There will still be a cost for the fund for appointing a depositary.
Most of the benefits of a hosting platform also apply to first time managers who wish to set up a Cayman fund, except for the marketing passport.
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