Little country, big problem

Private equity folk can factor in most risks to their analysis, but the collapse of a banking system, or indeed a country, falls a little outside their scope. So it is of little surprise that when the proposed €10 billion bailout of Cyprus became common knowledge last weekend, it sparked a fair amount of concern.

Global fund administration firms and other corporate service providers are reporting that clients have been contacting them in droves. One partner in the Cyprus office of a global firm with a roster of international private equity firms said: “Ever since the situation broke out on Saturday, there has been a lot of interaction with our clients.”

It is hardly surprising firms urgently have been checking their fund structures in a hurried spot of risk management. Cyprus has become a popular domicile for basing special-purpose vehicles (SPVs) for investment into places such as Russia, Poland, Ukraine and India because of the country’s low tax regime, thanks to double taxation treaties. The good news, though, is that, if firms have an existing structure in Cyprus, chances are they are using an international bank rather than a domestic one and cash should have flowed through their bank accounts just fine, unless they got very unlucky.

Still, the shock of Cyprus has rippled widely. In Luxembourg, a tax expert reports how his global firm was being asked by funds on the fundraising trail about altering plans to use Cyprus as part of the global structure for new funds.

In Moscow, where most SPVs used for local real estate deals are located in Cyprus, the phones have been ringing too. “Right now, because of this Cyprus crisis, people are scratching their heads how to either restructure their projects or refinance them. That’s the real problem,” said the Moscow head of a prominent law firm.“This problem obviously will slow down investments on the side of private equity firms, but also other investors as well, because one needs to find a suitable jurisdiction for acquisition vehicles.” A partner at the same firm said she took questions from her clients about Singapore as a jurisdiction because it is not in Europe.

Advisors, though, generally are telling clients not to panic. Even if they do find cash trapped in the country, there is nothing they can do about it. Further, a Limassol-based professional argued that, even if a firm were contemplating shifting jurisdictions, it might crystallise a loss or a gain, which could result in a tax event – something that a private equity firm certainly would wish to avoid.

Of course, it is hard to evaluate the upshot of the situation beyond these things, and analysis may be premature. After all, reports today suggest the country is “hours away” from an economic catastrophe. It needs to find €5.8 billion by Monday to quality for €10 billion from the European Commission, the European Central Bank and the International Monetary Fund. On the other hand, come Monday, everything could be okay.  

If this is indeed just a banking crisis and it ends, the corporate services industry in Cyprus and the fund administration business will not be affected. If it is worse than that, then serious questions will be asked.

Generally speaking, investors outside of Europe were just getting comfortable again with the Continent’s stability. Cyprus will not have helped perceptions.