12 minute read
Fund structures
LanD of opportunity
Channel Islands fund regimes promise speed to market, robust regulation and straightforward banking common law. With their focus on real estate, private equity, debt and infrastructure asset specialisms, the uncertain regulatory and political landscape is creating opportunities in Jersey, Guernsey and beyond
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Words:
Alexa Robertson
THERE ARE JUST over 150 miles between London and the Channel Islands, but as the British government continues to wrangle with the EU over what life could look like post-Brexit – and struggles to get a handle on the global pandemic – the Channel Islands and London feel, on some levels, much further apart.
The islands’ flexible funds regime and their pragmatic regulation – as well as their independence from both the UK and the EU – already hold a strong appeal for investors.
“Part of Jersey’s success is being able to develop and adapt to changes in the industry,” explains James Mulholland, a Partner in Carey Olsen’s Investment Funds team in Jersey. “A key feature is its flexible funds regime.”
Mulholland points to the Jersey Private Fund, which has proved popular with managers looking to develop their products and investment strategy. Jersey’s accessibility has, he says, created a thriving investment community.
“A key attraction for many fund managers is our position outside the EU,” Mulholland continues. “It means that managers of Jersey funds are not subject to all the onerous and expensive provisions of the Alternative Investment Fund Managers Directive, but have the ability to market within the EU on a selective basis.”
And, rather than competing with European funds, the Channel Islands have developed an offering that often complements them.
“If a manager wants to market on a pan-European basis or to the retail market, they will need to go to an onshore European jurisdiction,” says Elliot Refson, Head of Funds at Jersey Finance. “However, if they are one of the 97% of all managers who do not market into more than three European countries, then Jersey offers a cheaper, faster and more efficient alternative.
“In today’s environment, businesses and investors are operating across borders and need specialist centres like Jersey to help them operate on a global scale.”
JOINING THE COLLECTIVE
The Channel Islands have historically been a popular location for inward investment into the UK, both from non-UK entities and from UK entities joining forces in club-like funds.
Philip Hendy, Head of Real Estate at Intertrust, says the jurisdiction offers excellent opportunities for such collective schemes.
“Many pension funds want exposure to certain kinds of property assets, but some of them come in fairly large monetary sizes,” he says. “Even if you’re a large company, you probably don’t want to put millions of pounds into a single asset.
“If you join forces with lots of other pension funds, you can collectively own parts of these types of properties. ▼
“Jersey and Guernsey, through the funds regime, provide an opportunity for those types of pension investors. They have a fitfor-purpose regulatory environment where you’re dealing with sophisticated investors, with no double tax leakage on the way through.”
Company law in the Channel Islands is also based on solvency rather than capital structure rules, as it is in the UK, thereby reducing restrictions around distributable and non-distributable capital.
“From a corporate point of view, it makes the process a lot easier because you’re not having to worry about maintaining certain capital accounts or having to go to court to get permission to distribute them,” explains Norman Amey, a Director at Ocorian.
“It is purely about making a distribution in some way, shape or form, but making sure it is done in a strong judiciary environment where the directors are personally liable if a distribution is made insolvently.
“That in itself is a big plus point for Guernsey, particularly for a fund structure that involves – usually – quarterly distributions. It makes the process a lot more straightforward and streamlined.”
TAX REFRESH
One area of growing opportunity on the Channel Islands is in debt funds, as a result of the refreshed Double Taxation Agreement set up between Jersey, Guernsey and the UK.
The renegotiated treaty came into effect in 2019, bringing changes to the previous withholding tax requirements.
“Going forward, you’ll start to see Jersey and Guernsey being looked at as a more favourable jurisdiction for these kinds of debt funds,” says Hendy. “While there’s an increasing amount of interest in debt, with
interest rates being so low, people aren’t sitting on cash but are looking at different types of investment media.”
In late 2019, in the face of Britain’s looming exit from the EU and before coronavirus had even hit the headlines, Jersey Finance commissioned a survey exploring the key trends in fund domiciliation.
While Brexit, BEPS, substance and transparency had all climbed up the agenda, there was one clear concern among fund managers.
“The number one takeaway was that investors want jurisdictions that can offer expertise and political and fiscal stability with a no-change outlook from a regulatory, legal or economic perspective,” says Refson.
Hendy agrees, illustrating the strong position of the Channel Islands as a result of an agreement drawn up between the UK’s Financial Conduct Authority (FCA), the Jersey Financial Services Commission {JFSC) and the Guernsey Financial Services Commission (GFSC) in 2019.
“It provided a level of certainty that funds from Jersey and Guernsey would still have access to UK investors and capital after Brexit, when effectively EU law would then cease to apply throughout the UK,” says Hendy.
“If you look at where everyone sits in the Brexit scenario, you’ve got funds in the UK that might only be able to access the UK; funds coming from the EU that might be able to access the UK subject to complying with certain changes; or funds from Jersey and Guernsey that have a memorandum of understanding between the FCA, JFSC and GFSC.
“And these funds already have a wellestablished route into the EU through the national private placement regime.
“What it means is that you probably have a better level of access from Jersey and Guernsey into the UK and EU nexus than you have from the UK into the EU, and vice versa.”
SUSTAINABLE FUTURE
With political upheaval ahead and an uncertain regulatory future for both the UK and the EU, investment specialists in the Channel Islands believe the jurisdiction is in a position to tap into unique – and possibly unprecedented – opportunities.
“In a post-Covid world,” Refson says, “the importance of centres like Jersey is becoming only more evident.
“We have seen how governments worldwide have had to take extraordinary measures to support their economies with emergency support. And the question those governments will now need to answer is how to finance future growth.
“These measures were necessary but, over the longer term, unsustainable. Investment through equity is clearly what is needed, and our funds industry will be able to demonstrate its important role and will help economies grow.
“Businesses are facing unprecedented challenges and will need expertise and investment. Jersey’s fund sector is ideally placed to help achieve this.” n
A tale of three funds
From fraud to unforeseen financial crises, there are any number of reasons why funds collapse. Ogier Partners Craig Cordle and Bryan de Verneuil-Smith take a look at three high-profile cases and explore the lessons for directors and fund managers
Bryan de Verneuil-Smith Craig Cordle THE REASONS BEHIND the collapses of 1MDB, Carlyle and Abraaj and the high-profile cases that followed them are very different, but in each case the lessons that can be learned are broadly similar – and rooted in robust corporate governance. 1MDB (1Malaysia Development Berhad) was founded in 2009 as a Malaysian state investment fund, established to develop the nation’s tourism and green energy by the then Prime Minister, Najib Razak. It raised billions of dollars from the Middle East and leading banks such as Goldman Sachs, ostensibly for infrastructure projects.
However, the US Department of Justice has alleged that from 2009 to 2014, $4.5bn was diverted to shell companies and offshore accounts to enrich corrupt government officials.
The money was spent on an array of eye-watering purchases, including $275m on luxury goods including watches and jewellery, $100m into funding Hollywood movie production The Wolf of Wall Street and $85m in Las Vegas gambling.
A number of techniques were used to defraud the creditors. Funds were transferred back and forth through different legal entities with the same beneficial owner to obscure the nature, source, location and control of the original funds.
Bank accounts whose names mimicked those of legitimate companies, such as BlackRock, were created and money was transferred into the client accounts of US law firms to avoid due diligence/antimoney laundering checks. 1MDB’s articles of association allowed the management team to control transactions in priority to the board of directors. The board was kept in the dark regarding the key details of deals and, on other occasions, management ignored instructions and queries from the board.
IGNORANCE NO EXCUSE
While it appears that management hid its fraudulent actions from the board – and the structure of the company allowed management to do this – ignorance does not exonerate directors from breaching their duties. There are criminal investigations in more than 10 jurisdictions, including the US, Singapore and the UK.
Carlyle Capital Corporation (CCC) was an investment fund set up as a Guernsey company by the US private equity group Carlyle. It went into insolvency in 2008, losing all of its $1bn of capital. CCC had invested mainly in US residential mortgagebacked securities (RMBS).
The directors were accused of breaching their duties to CCC because they failed to insist or recommend that CCC take urgent steps to sell down its RMBS assets or to raise additional equity capital or conduct an orderly winding down of CCC from the end of July 2007.
Ogier acted for three of the defendants in the Royal Court of Guernsey, which concluded (and the conclusion was upheld by the Guernsey Court of Appeal at which Ogier acted for the investment manager) that there was no breach of the duty of care of the directors or the investment managers.
It also ruled that, without the benefit of hindsight, their actions had been rational and reasonable. The failure was beyond the control of any board of directors and the result of unforeseen and unforeseeable circumstances.
They were cleared of all 187 charges brought by the liquidators.
The Abraaj Group was the largest private equity investment house in the Middle East and at one point purported to manage more than $14bn in assets across emerging markets.
In 2018, Abraaj Holdings, the holding company of the group, and Abraaj Investment Management, the central investment manager entity, were placed
into provisional liquidation, after a group of investors commissioned an independent audit into the alleged mismanagement of its $1bn healthcare fund.
According to PwC, the liquidator of Abraaj Holdings, the group’s expenditure exceeded its revenue for years and debt was used to fund the operating expenses.
Pleadings filed by the US Department of Justice and the Dubai and US regulatory authorities included allegations that money from certain funds had been misused to try to alleviate cashflow problems and that assets had been overvalued and investors’ funds misappropriated to hide the dismal financial condition of the group accounts.
The allegations also cited weak governance, especially a lack of adequate oversight controls.
Two Abraaj Group companies were fined a combined $315m for deceiving investors and misappropriating funds.
The founder denies intentional wrongdoing and is fighting extradition to the US on charges of the theft of hundreds of millions of dollars and misrepresenting the value of the Abraaj Group’s holdings.
FUND RED FLAGS
Ogier acts in respect of a substantial Abraaj fund and, particularly, for its independent director appointed during the immediate fall-out of the Abraaj collapse.
These three funds collapsed for different reasons but red flags, which could indicate problems in the management of any fund, were apparent from the allegations (or judicial findings), including: • One dominant individual in a key decision-making role • No clear management structure and no chain of accountability (or any such processes not adequately adhered to) • Poor communication between those running the fund, its investors and other relevant parties • Delays in responding to requests for clarification and responses inadequate or lacking in any substantive independent verification • Defensive or secretive senior management • Too much emphasis and focus on the outcome for the fund, rather than the process of running it. Maintaining strong corporate governance is vitally important. The board of directors must be involved in the checks and balances of decision-making to prevent management misconduct and the misappropriation of assets.
In light of the directors’ fiduciary obligations to the fund, the board of directors should always be the ultimate decision-maker, not management.
Good corporate governance will provide directors with a strong defence when funds collapse due to unforeseen financial crises and they are sued for having allowed the fund to collapse.
Fund directors concerned that their funds are approaching the zone of insolvency, should seek independent legal and accountancy advice to mitigate the risks of facing allegations for having breached their duties.
Early transparency with the regulatory authorities of funds and managers that are facing difficulties is also of paramount importance. Fund managers and directors should: • Ensure decision-making is subject to systematic (and, where appropriate, independent) checks and balances • Insist on visibility on cash flows and the deployment of drawdowns • Ensure there is fund manager due diligence and that it is kept up to date • Where appropriate and possible, obtain external third-party reviews of valuations • Maintain good and timely communications with all relevant parties and investors • Consider undertaking periodic governance reviews conducted by an independent third party • Ensure cohesive and contemporaneous records are kept of all meetings and decisions. While the intention is not to stifle the ability of fund managers to do what they do best, they should seek to conduct their affairs defensively.
The courts, regulators and investors will always have benefit of hindsight when reviewing a fund and its manager’s actions, and so managers are well advised not to overlook the importance of maintaining strong governance procedures. n
FIND OUT MORE
For further information or to find out more about our investment funds expertise, go to www.ogier.com or contact one of our team.
