Private equity folk can factor most risks into their analysis, but the bankruptcy of a banking system can be outside their scope. Therefore, it is little surprise that the precarious €10 billion bailout of Cyprus last month sparked a fair amount of anxiety.
Fund administration firms in Cyprus reported to PERE how clients had been contacting them in significant numbers seeking advice and reassurance. Alter Domus, for example, has a number of global private equity clients that route investments in Russia, Poland, Ukraine and India through the stricken country. In the hours after the first bailout was rejected by the Cypriot government, George Rologis, Alter Domus’ managing director in Nicosia, said: “Ever since the situation broke out, there has been a lot of interaction with our clients.”
The tremors from Cyprus also were felt much farther afield than just the island nation. In Russia, for example, Dmitri
Nikiforov said the phones had been ringing as well. “We need to see how Cyprus will resolve this issue,” said the chair of the Moscow office of law firm Debevoise & Plimpton. “People are concerned since most of the real estate projects in Russia are structured as share deals, and a lot of property in Russia is held by special-purpose companies in Cyprus.”
Nikiforov noted that he was having numerous discussions about developers needing to restructure their projects in Russia. “In order to develop property via offshore companies, such as a Cyprus company, they borrow from both Russian and international banks on behalf of the project company. Right now, because of this crisis, people are scratching their heads about how to either restructure their projects or refinance them. That’s the real problem.”
Alyona Kucher, a Debevoise & Plimpton partner in Moscow who counts real estate as one of her specialist areas, reported how clients were asking about alternative jurisdictions within hours of the bailout proposition and the threatened banking collapse. “Even [just prior to the bailout agreement], I took questions from my clients about Singapore [as a jurisdiction] because it is not in Europe,” she said.
It is no surprise such concern was sparked. After all, a whole fund administration industry has grown up in Cyprus. It has a low tax regime as well as a hitherto stable banking system. As such, the country has become a very popular domicile for special-purpose vehicles (SPVs) and partnership structures, as well as for routing carry schemes. Furthermore, Cyprus remains a favored country for real estate deals in Russia, despite a renegotiated tax treaty between Russia and Cyprus that was just ratified late last year. That new double-taxation treaty took Cyprus off Russia’s ‘black list’ of tax havens and dictated that any real estate transaction in Russia should be taxed in Russia itself, Kucher explained.
Indeed, Cyprus’ biggest advantage is that it has a double-tax treaty with 44 countries. Through such a treaty, capital gains taxes on money repatriated back to a fund can be successfully limited, with experts suggesting the effective rate can be between zero and 10 percent, depending on the circumstances.
Cyprus also has become a sought-after location because the legal system is based upon English law, given that Cyrus was an English colony until 1960. It also possesses ‘softer’ advantages, such as a small time zone difference with western European countries and a developed banking, legal and tax industry.
Speaking before the country finally negotiated a bailout on March 25, Alter Domus’ Rologis said his clients’ SPVs in Cyprus remained unaffected. The majority of those clients banked with international players such as The Bank of New York Mellon, Barclays, JPMorgan and Royal Bank of Scotland, which provide a range of additional services such as lending and foreign exchange, he noted. Those clients do not use local Cypriot banks, which remained closed while the bailout was negotiated.
“Because this is a Cyprus banking crisis and not a crisis that affects anything else at the moment, alternative asset managers have not made any moves to make any changes,” Rologis said.
There is another reason why, at the height of the crisis, clients did not panic and try to relocate their structures – firms likely spent considerable resources deciding upon using the country in the first place, Rologis noted. Unpicking a structure can either crystallise a loss or a gain, which could result in a tax event – something that private equity firms clearly do not want.
“If clients still see Cyprus as being the most optimal in terms of tax structuring, they will use it,” said Rologis. “Going through anywhere else might not be as efficient.”
Recent draft legislation in Cyprus proposing tax changes have, for the most part, left alternative asset managers unaffected. The only significant change is that Cyprus has recommended an increase in the corporate tax rate from 10 percent to 12.5 percent, which is the same as that of Ireland. Regardless, that should not affect private equity firms because they are not trading companies, but simply holding or financing entities.
Rologis said: “Speaking with them over the last few days, private equity firms obviously have remained cautious and are watching the developments unfold, but they haven’t needed to make any moves.”
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