With the final adoption of the new Alternative Investment Fund Managers Directive (AIFMD), mandatory registration and disclosure to regulators is expected to be transposed into national law by Member States in 2013. A new passport regime giving managers access to professional investors across the EU with a single registration will be available to EU-domiciled funds from 2013 and non-EU-domiciled funds from 2015. National ‘Private Placement’ regimes for the marketing of funds, which allow hedge funds to apply to sell into EU markets on a country-by-country basis, will continue to exist up until 2018, although their future beyond this point will depend on further industry and regulatory debate involving the European Securities and Markets Authority (ESMA).
In this context, RBC Dexia Investor Services and KPMG decided to work together to conduct a study of hedge fund managers to explore the trends regarding the redomiciliation of their hedge funds, three months after the final AIFMD rules were approved.
The purpose of the study was to gain a better understanding of the main factors contributing to the redomiciliation of hedge funds into the EU. Our research gathered the views of a broad range of hedge fund managers on the reasons for domiciling hedge funds in both the EU and offshore. The study was designed to build a better understanding of how and why hedge fund managers establish EU hedge funds.
Surveying both managers that had set up EU hedge funds and those who intend to establish EU hedge funds in the future, we explored their reasons for redomiciliation, preferred EU fund structures, the methods they used to move hedge funds to an EU domicile, the strategies they manage in EU hedge funds and their choice of EU fund domicile. We also asked hedge fund managers who currently had no plans to redomicile what they saw as the advantages of remaining offshore.
The report’s findings are based on a two-step approach, with the study data drawn from an online questionnaire of 49 hedge fund managers conducted during January and February 2011, followed by structured in-depth interviews with senior executives from a number of hedge fund firms. For the purposes of this research the term “onshore” was defined as encompassing EU Member States only.
The survey challenges the notion that onshore domiciles could rival the supremacy of the Cayman Islands amongst hedge fund managers. Only a quarter (24%) of hedge fund managers said that they had already brought offshore funds onshore. Of those, more than half (55%) said they opted for co-domiciliation by creating onshore clone funds to complement their existing Cayman or other offshore offerings. Less than 5% of those with onshore funds said they had decided to transfer the domicile of their funds to the EU outright. The trend for hedge funds to create more EU-regulated funds seems set to continue however, with 27% of respondents stating that they are considering doing so.
The survey shows that EU fund domiciles are becoming more and more relevant to the hedge fund community, and that they respond to a real need amongst clients for more liquidity and transparency. Co-domiciliation allows hedge fund managers to cater to investors that are not authorised to buy into Cayman funds with onshore products while retaining their existing offshore strategies.
The prominence of co-domiciliation could be short lived however due to uncertainty over the AIFM Directive: most hedge fund managers considering domiciling their funds in the EU said they would do so before the implementation of the AIFM Directive in 2013, and fully 69% of them said they were considering doing so by transferring the domicile of their existing funds to the EU.
The research also shows that the UCITS framework, which some respondents said was an effective marketing tool to stem outflows during the financial crisis, has lost some of its appeal amongst hedge fund managers. Indeed, whereas those polled were just as likely to set up UCITS funds as other regulated structures, such as Irish QIFs and Luxembourg SIFs, in the past, 77% of those considering creating an onshore structure in the future now say they would prefer QIFs and SIFs instead.
The market is starting to realise that even though 90% of alternative strategies can be replicated under UCITS, specialised structures such as SIFs and QIFs offer more flexible liquidity and transparency rules for hedge funds. UCITS still offers very robust protection for investors, but clearly the wholesale shift into alternative UCITS some had been predicting has not taken place.
Overall, in summary, our research indicates that traditional offshore centres remain an extremely popular option for hedge fund managers. While market interest in EU-regulated funds are attracting interest and raising regularly new assets for a broad range of investors, it seems likely that these structures will evolve as complementary to, as opposed to replacing, offshore hedge funds in the longer term.
Some respondents mentioned that the main reason for not having set up hedge funds in the EU was the fact that they could not run their hedge strategy in a UCITS. While UCITS funds can support a wide range of alternative strategies, it was perceived that they could not cater for the varied needs of all hedge fund managers. This was also an issue for hedge fund managers who had already redomiciled or were considering doing so – although RBC Dexia research has indicated that in fact 90% of hedge fund strategies can be replicated in a UCITS.
Very few of the hedge fund managers in our study had fully redomiciled their hedge funds away from offshore hedge fund jurisdictions such as the Cayman Islands. The traditional offshore hedge fund centres were still widely considered to be the right choice and the offshore hedge fund continues to work well for a large number of
existing investors.
In recent years, managers have noted some dissent among certain European institutional investors regarding offshore funds. But among those managers planning to set up hedge funds in the EU in the near future, only a small number of our respondents intended to close their offshore fund range and fully redomicile their activity to the EU.
Against this, as corroborated by the percentage of respondents who had made the choice to set up funds in EU domiciles (24%) or who were considering this option in the near future (27%) – taken together with the very high degree of satisfaction of respondents who had redomiciled – suggest that there are some strong arguments for setting up an onshore structure.
The optimum solution for hedge fund managers may be to co-domicile, i.e., to retain offshore funds for investors who prefer and benefit from them, whilst setting up EU-domiciled funds to address issues from investors who prefer a greater degree of regulation and security. It also seems likely that offshore hedge funds will remain, but onshore funds will continue to grow in order to satisfy the needs of investors who have concerns about offshore jurisdictions.
