This article was sponsored by RBC Investor & Treasury Services and appeared in the May 2019 issue of PERE magazine.
One of the key considerations when it comes to launching a new fund is which jurisdiction to opt for – and there is plenty of choice for managers, from Singapore, Canada and Australia to Jersey, Guernsey and Ireland. Yet, as our survey shows, there remain three clear market leaders: Delaware, Cayman Islands and Luxembourg, all of which rank highly among respondents for regulatory and tax frameworks and the presence of local expertise.
We caught up with Dirk Holz, director and private capital lead at RBC Investor & Treasury Services, to discuss key trends in fund structuring and how private real estate firms can optimize their portfolios through data capture and analysis.
PERE: Delaware, Cayman Islands and Luxembourg are the top three domiciles for our survey respondents’ next funds. Why are firms continuing to choose these locations?
Dirk Holz: They are all well-known jurisdictions, and Delaware and the Cayman Islands in particular have a very long track record for institutional private capital. Both managers and investors are comfortable with these three. For investors, the predictability of these jurisdictions and their familiarity with the processes and reporting means they can easily plug them into their internal processes and operational flows. Investors also view them as reliable jurisdictions over the long term, particularly given they are tying up their capital in largely illiquid vehicles. Delaware, Cayman and Luxembourg all have the right infrastructure with service providers and other third parties that are experts in handling private capital business.
PERE: The survey suggests that Luxembourg is gaining market share. Are you seeing this, and if so, to what extent has AIFMD been responsible for this?
DH: AIFMD was a trigger for Luxembourg to become a major fund structuring location. Delaware and the Cayman Islands used to account for around 80 percent of fund domiciles for institutional investors but that dominance has been reduced by Luxembourg. Through the launch of the RAIF (Reserved Alternative Investment Fund) vehicle in 2016, Luxembourg created a toolbox that enables fund managers to launch fund structures under AIFMD, which helps speed up the time to market. Its launch of the SCSp (special limited partnership) has also boosted the market as this effectively uses features from the established and familiar US and UK limited partnerships.
Investors’ concerns around reputation risk have also boosted Luxembourg as one of the jurisdictions of choice as the spotlight has been cast over other offshore jurisdictions’ tax schemes. Luxembourg’s status as a regulated market gives investors the comfort they need. And finally, the uncertainty over Brexit has pushed many UK-based managers to use Luxembourg to ensure they retain access to the European market for investors and investments.
PERE: To what extent are you seeing complex structuring involving more than one jurisdiction among managers?
DH: We have seen a significant shift toward this over the past few years. This is particularly the case for US managers with global operations. Where previously, their default might have been to opt for Delaware or Cayman structures, now they are also looking at parallel AIFMD-compliant platforms, which often means Luxembourg. Asian managers are also establishing funds in Luxembourg with Delaware feeders.
The picture is becoming more complex, especially when tax-driven special purpose vehicles are additionally being established as holding entities to ensure tax efficiency for investments and investors.
PERE: Given this complexity, the time to market you mentioned earlier must be more important than ever. How has this changed recently?
DH: Time to market has changed considerably, and this is very important for private capital generally. Five years ago, it could take up to a year to get organized. Now, it is more like three months. Part of this is down to institutional investor expectations. As many of them have shifted allocations away from liquid investments toward private capital strategies, investors have brought with them their expectations of faster turnaround times. For their part, as they build asset management businesses, private capital firms are reluctant to wait 12 months from planning a fund to launch. It is a much more efficient process today.
PERE: What about some of the other jurisdictions? Do you see any particular trends on the horizon?
DH: I think Jersey and Guernsey are jurisdictions to watch over the coming years. They have a lot of skilled and knowledgeable people with specific expertise in the private capital space and there are strong governance controls. The two jurisdictions could play an interesting role depending on the agreed final terms of the UK leaving the European Union. Additionally, Ireland has the potential to compete with its main rival, Luxembourg, in a similar way that they do in the UCITS (mutual fund) space.
PERE: Overall, the picture is one of rising complexity – of fund structuring, tighter regulation and increasing investor requirements. What effect is that having on manager operating models?
DH: If we take the example of a US manager that previously used only the Delaware or Cayman Islands jurisdictions, it was perfectly feasible and efficient to run most functions in-house. This has clearly changed, in particular as many investors – especially those more accustomed to liquid assets, where they have access to real-time valuations and exposures – are pushing for more granular and timely information from their managers.
Managers are increasingly thinking about where their core competencies lie and what differentiates them. They are therefore focusing on their relationships with investors, identifying and closing deals and managing their assets. The US manager I gave as an example probably now has parallel fund structures in Delaware/ Cayman and in Luxembourg. The manager may retain its Delaware/Cayman fund services in-house, but will most likely outsource the services needed for the Luxembourg structure. In the long term, we believe that managers will outsource most of their middle and back office tasks to stay competitive.
Yet the overall outsourcing trend is far broader than that. Investors increasingly want standardized reporting across jurisdictions, so managers are seeking out partners that can offer the same platform regardless of where the fund is domiciled. Added to this is the need to keep up with technological developments and the potential for disruption, which is leading them to partner with service providers that can deliver a whole package with scale and global reach.
PERE: How are private real estate firms responding to this?
“Real estate is a highly data-rich asset class, where you can capture information on rental income, yields, service charges, space usage, energy usage, etc, with relative ease, if you have the right technology in place”
DH: Fund managers tend to be more hands-on than their private equity and private debt counterparts. Yet their operating models are going to have to change. Private real estate funds have raised large amounts of capital and that has led them to extend beyond the more traditional office and retail space investments into more opportunistic investment categories, including more specialist areas such as social housing and student accommodation as well as value-add refurbishment opportunities. The logistics of managing this array of real estate has become more complex.
The fact is that real estate is a highly data-rich asset class, where you can capture information on rental income, yields, service charges, space usage, energy usage, etc, with relative ease, if you have the right technology in place. The development of smart buildings adds significantly to the amount of data you can collect and leverage. At the same time, there are new trends in how spaces are used and managed – businesses moving toward hot-desking, for example. You need the right information to be agile enough to respond to these kinds of trends and optimize your portfolio while also creating a lot of value for tenants and investors
PERE: So will we continue to see more outsourcing among firms?
DH: Private real estate firms are increasingly seeing the value in finding the right partners to help them provide the best service to investors and stay ahead of trends in new technology in an effort to improve returns. The costs of building and maintaining an in-house IT system that can manage all the data points required to report to investors and to manage real estate portfolios effectively are increasing, and yet these functions are becoming ever more critical to success. We will see more outsourcing as private real estate firms embrace the benefits of automation and analytical tools that enable them to focus on their core competencies.