HFMWeek Ireland Roundtable
This Roundtable discussion was first published in HFMWeek in August 2012.
HFMWeek talk to Peter Stapleton, Maples and Calder, Tony McDonnell, HSBC Security Services and Michael Hartwell, Deloitte Ireland, about the challenges and opportunities found in the Irish hedge fund space.
HFMWeek (HFM): Last year was a difficult period for hedge funds. What was the biggest impact for the Irish industry in terms of funds and service providers?
Peter Stapleton (PS): From an Irish perspective, the industry continued to grow quite strongly both on the UCITS side and on the non-UCITS side. On the non-UCITS side, this growth stemmed from a preference of some EU pension funds and insurance companies to invest in Irish managed account platforms, resulting in greater pension fund and insurance company allocations to onshore EU products. AIFMD, Solvency II, increasing focus on double taxation treaty access and the reputation of Ireland as Europe’s premier jurisdiction for the servicing of both Irish domiciled and non-Irish domiciled funds (e.g. Cayman and BVI) saw strong growth across both sectors.
Michael Hartwell (MH): I agree with Peter about the key drivers of growth over the past 12 months within the Irish industry. The global hedge fund community places a great deal of value on the quality of the operational infrastructure that resides in Ireland. Given the ever-increasing focus on the effective management of risks, there has been continued momentum towards a centre like Ireland, where quality and cost competitiveness of hedge fund administration is compelling.
Tony McDonnell (TM): The volatile market conditions of last year had a tangible impact on service providers in that competition for new business is fierce, often leading to severe downward pressure on fees to secure mandates and administrators have had to re-examine their cost base, ultimately resulting in increased consolidation. Whereas some banks have historically offered administration on the back of other product offerings, this won’t continue into the future and will undoubtedly lead to more consolidation, as some banks decide to offload administration businesses failing to hit CIR targets. Likewise, we are starting to see more consolidation in the independent administrator space, a trend that will likely continue. HSBC restructured some of the operating platforms and moved the service production element to our Dublin office, which will establish that office as the hub for alternative fund services globally.
(HFM): Ireland has long been a popular destination for hedge funds. To what extent have re-domiciliation trends continued to justify this reputation?
TM: It’s a well known fact that Ireland-based administrators service more than 40% of the world’s hedge funds. That’s testament to the way the industry in Ireland has positioned itself over the last twenty years and the body of experience that has been developed. I see that trend continuing. The trend around re-domiciliation, or lack of it, is an altogether different debate. Clearly there has been a significant increase in funds establishing themselves in Ireland; however, most have been via initial launch rather than re-domiciliation. While there have been a few high profile moves, the fact is that the expected wave of re-domiciliation from the Hurricane Belt has been slow. In my experience, managers have favoured a diversified approach, launching a new product in Ireland to enable them to appeal to the investor that requires a more regulated product. The continued growth in Cayman domiciled funds would tend to support this.
MH: I would agree with that and in fact in situations where we have worked with clients that have redomiciled, the key reasons for taking that route have been different. It can take time before managers adopt redomiciliation strategies, so it’s a little early to make grand statements around the success of that process. What is clearer is that the level of uncertainty arising from the changing regulatory environment is making it far more difficult for managers to plan, and as a result many are taking more well-trodden approaches.
PS: We are not seeing pure re-domiciliation to any great degree and certainly less than has been widely reported. However, we are seeing Ireland emerge as a preferred domicile for co-domiciliation to complement traditional offshore offerings. We are fortunate to have large offices in leading offshore and onshore fund jurisdictions to cater for clients looking at both. While some well known hedge fund managers and institutions have completely re-domiciled their investment fund offerings, most of our clients are continuing to strategically evaluate both onshore and offshore options, taking a number of factors including treaty access, investor domicile, regulatory benefits and costs of operating the fund into account when building their platforms. We expect this trend to continue, and possibly for there to be another wave or restructuring following the introduction of Irish ‘check-the-box’ corporate structures at the end of the year and during the run-up to AIFMD.
(HFM): The AIFMD is poised to make a significant impact on EU jurisdictions, especially in regards to depository provisions. What has the reaction been like in Ireland?
MH: In a recent survey conducted by Deloitte with London-based hedge fund managers, the most pressing concern in relation to the AIFMD was depositary costs. There is no doubt there will be plenty of managers looking for cost-effective solutions in this area. However, it is not the only issue; -72% of respondents more generally viewed AIFMD as a business threat. Overall. the conclusion was that while many welcome the increased transparency and investor protection the Directive may bring, there is a significant concern that this will be outbalanced by less choice and competition in the market. Hedge fund managers are looking for solutions to the challenges that the directive may bring.
PS: Ireland already requires the mandatory appointment of depositories for UCITS and non-UCITS funds. As a result, there is a world-class list of leading depositories with large presences in Ireland carrying out a similar function for QIFs and other alternative funds. However, there has been vocal disappointment from these entities that the agreed Level 1 AIFMD standards of depositary liability and technical advice from ESMA are in danger of being materially deviated from, if the proposed draft level 2 AIFMD regulations are transposed in their current form. All eyes are now fixed on the final depositary terms, costs and the likely restructuring of existing models particularly in the areas of depositary and prime brokerage relationships (some of which has already been mooted in the latest draft AIFMD text).
TM: The general reaction has been regulation is coming and we need to practically design workable models to implement the requirements for our clients. In that respect, it is generally accepted that Ireland’s QIF product is already considered to meet many of the mandatory provisions of the AIFMD. The relationship between the depositary and the prime brokers has not yet been fully defined and this is an area that will certainly impact how managers operate today. Obviously as a large universal bank with a substantial network of sub-custodians, we are well placed to deal with the liability requirements as many of our own HSBC entities are acting as sub-custodians, so we feel we have an interesting story to tell in that regard.
(HFM): With regulators continuing to shore up their regulatory frameworks, what Ireland-specific changes have been introduced and how have they been received?
TM: While there have been some high profile changes, such as the new corporate structure for Irish SICAVs that meets United States check-the-box taxation rules, other initiatives have been implemented that will stand to reinforce the regulated environment in which Irish administrators operate. One example is the recently published proposed amendments to the Criminal Justice Act, the CJA Amendments Bill 2012, which will provide comfort to investors that the funds in which they invest in operate to the highest level of AML standards. Another example is an Enhanced Fitness and Probity Regime whereby there is now a requirement for approved persons to be deemed fit and proper by the Central Bank to perform certain core functions and duties. These are enhancements that will benefit any hedge fund appointing an Irish administrator, irrespective of fund domicile.
PS: Ireland has an excellent regulatory framework for the establishment of onshore alternative investment funds. This industry flourished in the early 1990s and has been continuously updated to take account of market demand. The full range of product offerings, from corporates, trusts, and contractual to partnership funds are available. To build on this success, a series of regulatory initiatives are being proposed. Before the end of the year, Ireland will introduce a “check-the-box” corporate fund to enhance the attractiveness of Irish offerings for US taxable investors. With AIFMD looming large, Ireland has gone out very early in terms of preparing draft legislation to implement the level 1 directive. Industry consultation and dialogue with the Central Bank of Ireland and Government has been active since the beginning of the year with the agreed aim to use best endeavours to meet a 31 December implementation deadline for AIFMD and a reform of existing non-UCITS fund rules. If this is achieved, sponsors will be able to begin setting up EU AIFs, EU AIFMs or internally managed AIFs over six months before the July, 2013 implementation deadline. This will also give time for the Irish framework to be well tried and tested by the time the grandfathering provisions for AIFM run out in 2014.
MH: The general infrastructure in place for alternative investment funds in Ireland has been a good platform for responding to the AIFMD. However, there are other issues that are not specific to Ireland but are equally important. For example, FATCA, the US tax reporting regime, will introduce a strict set of rules and reporting requirements for funds and other foreign institutions. The United States, together with France, Germany, Italy, Spain and the United Kingdom has released a "Model Intergovernmental Agreement to Improve Tax Compliance and Implement FATCA". The agreement establishes a framework for the automatic exchange of information between the "FATCA Partner" country and the United States, using existing bilateral income tax treaties or tax information exchange agreements. At a high level, both the reciprocal and non-reciprocal versions of the agreement should help financial institutions reach important FATCA objectives, while potentially reducing costs to comply. Ireland is currently in discussions with US officials over adopting the FATCA Partner model.
(HFM): What growth opportunities and challenges does the next 12 months hold for the Irish hedge fund industry?
MH: We are confident that future growth will be due to the ability of the hedge fund industry in Ireland to offer compelling solutions to the wave of challenges that are being presented by the regulatory changes that will be introduced. Ireland is in a unique position given its heritage in this particular market space. While there are threats, there are also opportunities. For example, 41% of the respondents to our survey intend to take advantage of the EU passport to extend fund distribution. One third of managers planned to use their funds administrators to assist in meeting some of the requirements, and on balance Ireland is the leading location for hedge funds administration. Finally, the depth of expertise in hedge fund servicing in Ireland is something the global hedge fund industry has continued to value throughout the global financial crises and we have not seen any evidence that this support will change in the future.
TM: Regulatory change will bring inherent opportunities and challenges. An organisation’s ability to manage that change effectively and engage proactively with its client base on the impact of those changes will set it apart from the competition. The key for the Irish hedge fund industry is to ensure its administrators continue to capture market share in the alternatives service offering space. That way, there is only up-side with respect to the changes ahead.
PS: We are bullish on the potential for growth over the next 12 months. There are some challenges ahead, in particular a risk that some managers (both EU and non-EU) will perceive AIFMD to be too strict and will move funds to other jurisdictions. However, with regard to the large asset allocators, pension funds, insurance companies and other EU investors, the AIFMD ready QIF product with the addition of the passport is likely to become more attractive. It would appear that Ireland is well poised to extend its lead over other European domiciles in the area of alternatives.