A foot in both camps

Read our article in the Cayman Financial Review Magazine, eversion 

There is an enduring perception that the established European domiciles such as Ireland and Luxembourg are in direct competition with the leading offshore domiciles such as Cayman. This perception has transcended reality to the extent that leading participants in both camps deem it necessary to fight their corner. 

Whilst there are several parties with vested interests in one camp, it is their absence from the second camp that has determined the need to assume such an approach. This is something that has struck the author personally in his time with dms Management (dms).

Once a staunch advocate of the orthodox European model, I can now speak to dms’ global client base with full knowledge and ability to offer the southpaw offshore model and work with the investment manager to determine the correct fight plan.

The paradox orthodox
This fluid style is befitting of the Irish fund industry when you look at the composition of the 9,000 plus people working in the sector in Ireland. According to the Irish Funds Industry Association (IFIA), the total asset value of funds domiciled in Ireland as at 31 May, 2011 was circa $1,400 billion (€987 billion).

This is circa 54 per cent of the total value of funds under administration in Ireland. The other 46 per cent of funds under administration is related to the servicing of funds domiciled in offshore jurisdictions, principally Cayman.

The servicing of this circa $1,190 billion (€828 billion) book of business employs a disproportionate share of the 9,000 plus fund industry professionals in Ireland. Whilst difficult to make an accurate assessment of the percentage of fund sector workforce engaged in the servicing of offshore funds, it is estimated at over 60 per cent.

The reasons for this are multiple, but in short the servicing of long only UCITS funds can be highly automated for portfolio reconciliation and pricing. Furthermore, a significant percentage of these functions are derogated to operational support offices in Asia (principally India), Poland and other lower cost centres.

The servicing of the more complex strategies employed in offshore domiciled funds require greater manual intervention and the involvement of more experienced staff. Thus, allied to accounting for the greater proportion of the workforce, the offshore domiciled funds necessitate the training and reward of senior, high earning staff.

In truth, a significant number of the administration companies in Ireland rely solely on the servicing of offshore funds for 100 per cent of their income. This is due to the requirement for a trustee to be appointed to all Irish funds. Trustees are the custodians of the fund and are responsible for the safe keeping of the fund’s assets.

The large administration companies such as BNY Mellon, State Street, HSBC, JP Morgan, CitiGroup, Deutsche Bank are able to offer trustee and administration in a package. The smaller administration companies need to have a competitor offer them the trustee product to ally to their administration offering. This has obvious challenges and often sees the smaller operators priced out of bidding for the servicing of Irish regulated products.

The straight-up orthodox
In contrast to Ireland, the Luxembourg fund industry is principally involved in the servicing of Luxembourg domiciled funds.

This is understandable when you look at the determining factors prevalent in the Luxembourgish funds sector. The total value of funds domiciled in Luxembourg is circa $2,800 billion (€1,950 billion). This is a significant book of business, pretty much equal to the total value of funds under administration in Ireland.

Factor in then the serious constraints that the population has on both availability of staff and the knock-on effect on the cost of the available staff. As such Luxembourg is rarely perceived to be a viable option from a cost perspective for the servicing of non- Luxembourgish funds.

Determining the fight plan
To determine the correct stance for an investment manager looking to plan their fund, one must first be conscious of their goals.

The first consideration is, what are the investment manager’s strengths, in effect; what is his strategy? Whilst the Qualifying Investor Fund (QIF) in Ireland and the Specialised Investment Fund (SIF) in Luxembourg can accommodate most alternative strategies, UCITS is not designed for the more alternative strategies.

The second consideration is determining the weight class, for smaller investment managers the cost of establishing a regulated European product can be prohibitive. As such an investment manager should be conscious of what cost they can carry and choose a domicile which accommodates their parameters.

The third consideration and perhaps the most relevant for any investment manager is where will they generate the bigger purse. This is the primary consideration leading hitherto offshore managers to launch European assaults.

The robust risk management underlying the UCITS product is of considerable comfort to institutional and high net worth individuals alike. This risk management framework incorporates rules on risk, service providers, safe guarding of assets and stringent fund governance.

This has seen investors increasingly disposed to funds carrying the UCITS badge and hence the UCITS product is currently delivering the bigger purse for the investment manager who is willing to take on the greater monitoring and transparency required by a European regulated product.

This has seen both the investment manager and the investor achieve their primary goals of capital raising and investment protection (not to be confused with capital protection).

Throwing a combination
So what is the correct strategy to employ, the orthodox European model or the southpaw offshore? As any pugilist will tell you, “you have to throw those combinations”. This is the approach being taken by a number of investment managers.

Whereas early commentary to the economic crisis suggested a return to the orthodox approach, few managers were willing to completely change lead and retained their southpaw stance. Redomiciliation was a strong theme and there are certainly examples that the people who fight a certain corner will point to. But these tend to be exceptions as opposed to the rule.

Managers with sufficient scale and operational capacity have instead decided to throw a left (offshore) and a right (European) by launching a European domiciled fund. In the main these have tended to be UCITS funds.

That UCITS is a successful product is a given, that UCITS is the correct choice for all investment managers looking to replicate an offshore strategy in a European product is not. As discussed in determining the fight plan, UCITS is not designed for alternative strategies and beyond long-only strategies, alterations to the existing investment strategy may be required to meet UCITS requirements.

A development that I anticipate receiving considerable coverage over the coming year is the role out of the AIFM Directive. The directive is, at its simplest designed to allow alternative managers a European regulated product that can be more widely distributed. This is a positive for Ireland as a self-managed company established as a QIF complies with the alternative investment fund requirements of the Directive.

The result
The result for the correct domicile will always be a split decision. This is as it should be, no one solution will ever work for everyone, nor should it. The judges (investors, investment managers, regulators) will look for different strengths, traits and parameters.

Given one domicile cannot offer universal approval, why not learn to lead off both feet. dms have!