There are currently a number of intersecting cross currents buffeting established manager and investor attitudes toward where best suits their often-complex fund formation needs. Here are some top considerations.
In Europe and the US, managers’ historical preference for establishing real estate asset holding companies in Luxembourg and Delaware, respectively, has meant it has made sense for them to also set up funds in those jurisdictions. However, as the tax landscape changes, it is firing up a trend to establish special purpose vehicles in local jurisdictions. In turn, this could influence where funds choose to domicile.
“In recent years, the market has moved against establishing holding structures purely based on tax treaties,” says Greenberg Traurig shareholder Steven Cowins. “Now, for instance in Europe, if you are investing in Italian property, you’ll use an Italian structure. And the UK has just overhauled its tax regime, so the benefits for an offshore [ie, Channel Islands] vehicle aren’t there anymore as property holding vehicles. In future, it will be interesting to see how that factors into choosing where to domicile the fund.”
Alternative sources of capital
Investor preference is a primary consideration when choosing a domicile. The “flavor of the month,” as one market participant refers to popular domicile choice, is often a reflection of a herd mentality among managers not wishing to stand out from the crowd. But it also mirrors the relative volumes of capital raised from particular geographies.
Asia is a case in point. Hong Kong and Singapore are cementing their role as global fund centers rising with the tide of new regional capital targeting alternatives. As competition to provide a home for that capital heats up, Hong Kong has enacted a new limited partnership law and Singapore has launched a variable capital company product to attract funds looking for a home.
At the same time, Middle East money from the likes of Qatar and other Gulf states, which in the past has favored the Channel Island’s structures as vehicles to invest in London real estate, has receded, redirected into local infrastructure schemes, says IQ-EQ group funds and institutional director Stuart Pinnington. “That has changed the dynamic over the past two years and could change where people domicile funds as they look at a new investor base.”
The UK’s 2016 decision to leave the EU has been a boon for Luxembourg and Ireland fund centers providing access to European investors, including expanding capital pools from the likes of the European Investment Bank. Currently, the uncertainty on the terms of the prospective EU-UK relationship and when those might be agreed means, unless you are a UK fund tapping UK-only investors, London is off the table.
But the future might look quite different. In apparent recognition of the opportunity to position itself as a competitive global domicile, in March the UK government announced a review of its funds regime, including VAT on management fees. In the same month, it launched a consultation on the tax treatment of asset holding companies in alternative fund structures, which is widely viewed as difficult to implement in its current format.
Market participants have welcomed both initiatives. “It’s a really positive move that the UK government is consulting on amendments to the UK asset holding regime and how to better compete with Luxembourg,” says Greenberg Traurig shareholder Charles Case. “If they can solve some of those practical problems, there is huge potential for the revival of UK fund structures and the UK as a domicile. That is particularly attractive for UK real estate and would provide a good hub for European real estate too.”
While not the deciding factor when selecting where to form a fund, implementation of the OECD’s Base Erosion and Profit Sharing actions and their impact need to be incorporated into any domicile assessment. Different jurisdictions interpret the 15 BEPs actions differently and are at varying stages of implementation.
“We are watching how tax treaties interact with BEPs to ensure funds can operate in the way they have in the past and to see whether there are any changes needed,” says IQ-EQ group head of funds Justin Partington. “The big picture question is whether BEPs will change or rewrite those rules entirely. Luxembourg, Ireland, Guernsey, Jersey and the Cayman Islands are all adopting substance requirements into their rules. It would be helpful if BEPs didn’t undo all that work in the way it is implemented.”
The EU regulation on sustainability-related disclosures in the financial sector was published at the end of last year and will apply from 2021. Across private markets, environmental, social and governance has been rising up the list of manager and investor priorities. In future, new ESG regulatory obligations and opportunities could influence where funds choose to domicile.
“We don’t know where the ESG agenda is going and how it will influence where investors invest or where fund structures will be based,” says Robert Mellor, PwC private funds partner.
One outcome might be that, as governments seek huge amounts of financing to meet sustainability commitments, they could create an “ESG-Advantaged” vehicle with certain tax incentives, he notes. Government initiatives and reporting requirements “could become the next factor to take in to account when you’re deciding on fund design, location and efficiency,” he adds, noting that for domiciles, that would create “a whole new battle ground.”
In response, service providers are “pivoting to look at providing the right ESG reporting products for clients in the right domiciles,” says Intertrust Group global head of product, Patrick O’Brien. “As the investment market grows, you will see allocation to domiciles with the right ESG environment.”
As the amount of capital allocated to private equity real estate continues to grow and domiciles compete to capture that funds business – not just regionally but globally – the funds environment, with its laws, regulations, products and structures, will continue to evolve. While jurisdictions on our list rise and fall in relative prominence as a result, a core feature of the landscape remains the same – barriers remain high to new entrants.
In addition to rule of law, tax efficiency, cost and ease of doing business, managers and investors will continue to be guided by reputation, credibility and track record.
For other jurisdictions seeking a slice of the global private funds business, these attributes will be hard to come by if they cannot get their foot in the door.