This article was sponsored by RBC Investor & Treasury Services and appeared in the May 2019 issue of Private Debt Investor magazine.
ne of the key considerations when it comes to launching a new fund is which jurisdiction to opt for – and there is plenty of choice for managers, from Singapore, Canada and Australia, to Jersey, Guernsey and Ireland. Yet, as our survey shows, there remain three clear market leaders – Delaware, Cayman Islands and Luxembourg, all of which rank highly among respondents for regulatory and tax frameworks and the presence of local expertise.
We caught up with Dirk Holz, director and private capital lead at RBC Investor and Treasury Services, to discuss key trends in fund structuring and how service providers are assisting the growth of private debt strategies in new and existing markets.
Delaware, Cayman Islands and Luxembourg are the top three domiciles for our survey respondents’ next funds. Why are firms continuing to choose these locations?
They are all well-known jurisdictions and Delaware and the Cayman Islands, in particular, have a very long track record for institutional private capital. Both GPs and LPs are comfortable with these three. For LPs, the predictability of these jurisdictions and their familiarity with the processes and reporting means they can easily plug them into their internal processes and operational flows. LPs also view them as reliable jurisdictions over the long term, particularly given they are tying up their capital in largely illiquid vehicles. Delaware, Cayman and Luxembourg all have the right infrastructure with service providers and other third parties that are experts in handling private capital business.
The survey suggests that Luxembourg is gaining market share. Are you seeing this and if so, to what extent has AIFMD been responsible for this?
AIFMD was a trigger for Luxembourg to become a major fund structuring location. Delaware and the Cayman Islands used to account for around 80 percent of fund domiciles for institutional investors but that dominance has been reduced by Luxembourg. Through the launch of the RAIF (reserved alternative investment fund) vehicle in 2016, Luxembourg created a toolbox which enables fund managers to launch fund structures under AIFMD, which helps speed up the time to market. Its launch of the SCSp (special limited partnership) has also boosted the market as this effectively uses features from the established and familiar US and UK limited partnerships.
LPs’ concerns around reputation risk have also boosted Luxembourg as one of the jurisdictions of choice as the spotlight has been cast over other offshore jurisdictions’ tax schemes. Luxembourg’s status as a regulated market gives LPs the comfort they need. And finally, the uncertainty over Brexit has pushed many UK-based managers to use Luxembourg to ensure they retain access to the European market for investors and investments.
To what extent are you seeing complex structuring involving more than one jurisdiction among GPs?
We’ve seen a significant shift towards this over the past few years. This is particularly the case for US GPs with global operations. Where previously, their default might have been to opt for Delaware or Cayman structures, now they are also looking at parallel AIFMD-compliant platforms (which often means Luxembourg). Asian GPs are also establishing funds in Luxembourg with Delaware feeders. The picture is becoming more complex, especially when tax-driven special purpose vehicles are additionally being established as holding entities to ensure tax efficiency for investments and investors.
Given this complexity, the time to market you mentioned earlier must be more important than ever. How has this changed recently?
Time to market has changed considerably – and this is very important for private capital generally. Five years ago, it could take up to a year to get organised. Now, it’s more like three months. Part of this is down to institutional investor expectations. As many of them have shifted allocations away from liquid investments towards private capital strategies, investors have brought with them their expectations of faster turnaround times. For their part, as they build asset management businesses, private capital firms are reluctant to wait 12 months from planning a fund to launch. It’s a much more efficient process today.
What about some of the other jurisdictions? Do you see any particular trends on the horizon?
I think Jersey and Guernsey are jurisdictions to watch over the coming years. They have a lot of skilled and knowledgeable people with specific expertise in the private capital space and there are strong governance controls. The two jurisdictions could play an interesting role depending on the agreed final terms of the UK leaving the European Union. Additionally Ireland has the potential to compete with its main rival (Luxembourg) in a similar way that they do in the UCITS (mutual fund) space.
What regulatory developments are on the horizon? And how will these affect domicile and structuring choices for GPs?
We’ve seen some stabilisation in some regions, such as the jurisdictions covered by the AIFMD. Here, it is now clear that it is possible to regulate a fund manager rather than the entity, for example. I think we’ll see other markets shift towards this as a pragmatic move. AIFMD II is on the horizon and the hope is that this will clarify some points and make the process more efficient.
The Cayman Islands is in the process of tightening up its regulatory frameworks and last year introduced revisions to its anti-money laundering rules. This is a positive development as it will give investors more confidence that the jurisdiction is suitably regulated.
And finally, BEPS is still being implemented in certain jurisdictions including the EU. This is being supplemented by the Anti-Tax Avoidance Directive. While much of this work is directed at corporations rather than alternative asset managers, there is still the requirement for substance. That is driving a trend towards fund managers ensuring there is more manpower on the ground in their chosen domiciles.
Overall, the picture is one of rising complexity – of fund structuring, tighter regulation and increasing LP requirements. How are private debt funds responding to this?
In other alternatives, GPs are generally moving towards the outsourcing model of various functions to address increased LP expectations on reporting or perhaps to cover specific markets, such as where a manager has traditionally used Delaware or Cayman Islands but now might also use a parallel Luxembourg structure. In private debt, outsourcing can run even deeper through the organisation. Part of this is because it is a newer kid on the block. As such, managers have opted to outsource their non-core functions from day one – they don’t have legacy systems and investments that might otherwise tie them to having in-house functions.
Of course, many of the same drivers towards outsourcing seen in other alternatives also apply to private debt. LPs, for example, increasingly want standardised reporting across jurisdictions and so GPs are seeking out partners that can offer the same platform regardless of where the fund is domiciled. Added to this is the need to keep up with technological developments and the potential for disruption, which is leading GPs to partner with service providers that can give them a whole package and that have scale and global reach.
So are private debt funds a big area of growth for third-party service providers today?
Yes, particularly in Europe, where private debt funds have really capitalised on the constraints placed on banks by Basel III. I see this continuing as newer players continue to enter the market – much more so than other alternatives, such as real estate, where the need for large volumes of data and information create higher barriers to entry.
Yet private debt funds are not only outsourcing more of the standard functions, such as fund administration and accounting. We’re also seeing many move towards outsourcing loan servicing. Many of the larger, more established managers have traditionally done this in-house, but increasingly, we are seeing them looking at outsourcing the management, governance and daily accounts of their loan portfolios so they can see at a glance and in real time whether, for example, particular loans have been paid on time. This is enabling private debt fund managers to focus on their core capabilities, such as fundraising and originating loans.