Apex in the News

What will the Future Look Like?

22 September 2010

Anthony O'Driscoll of Apex Malta believes that Malta is set for a period of growth, due to managers choosing to redomicile their funds to an onshore European-regulated jurisdiction

Predictions about global finance markets are always difficult to make particularly during periods of volatility. However, there are a few clear trends emerging among both funds and managers that provide an insight into how the industry is developing. These trends include: an increasing movement to new jurisdictions, increased demand for the Ucits product and changing operating environments. These trends are expected to act as the catalyst for a number of changes in how the key players operate and interact with one another.

One of the most significant forces for managers is to remain competitive and they are increasingly looking to their administrators to provide more middle- and back-office services. Consequently expectation is growing for administration services providers to meet the increasing demands from investors who are placing more emphasis on transparency, increased liquidity terms and funds structured in wellregulated jurisdictions.

Despite the turbulence experienced during 2009, there are a number of positives that can be drawn from the period for both managers and investors. In particular, many side-pocketed assets have bounced back as markets have improved. This has enabled some funds to reduce the big side pockets created last year to counter the unprecedented levels of illiquidity.

While the hangover of illiquid assets continues to weigh down on many managers, there has been some improvement. For example, managers are working out or liquidating some of these assets and investors, aided by a better understanding of the condition of their portfolios, and have adjusted their expectations to more realistic levels.

Already in 2010, hedge funds are showing signs of recovery. This, of course, is good for investors who are recouping losses and for managers who are earning their way back to or above high-water marks. Net outflows of assets have given way to steadily increasing net inflows. However, raising new capital still remains a challenge, but investors, albeit with a high degree of caution, are once again showing interest in the industry.

Challenges facing managers

For some managers, their 2009 performances may not have been strong enough to ensure their survival, particularly those managers that did not have meaningful inflows of new capital. As a result, during 2010 we may see more downsizing or closures if managers do not take action. In the UK managers have been quick to take the necessary steps to respond to the government's increase in top rate of tax and also to the streamlining of their business to reduce operating costs.

New managers continue to face start up barriers principally due to the level of resources required to meet investor demands, increased regulation and compliance. Overcoming investor concerns about operational and compliance risks is particularly acute for younger and smaller firms. While the number of start-up management companies is increasing, the number of platforms offering sound infrastructure and the availability of seed investors who focus on emerging managers are scarce.

Managers are also facing a change in attitude from investors who are now looking for funds that are domiciled in regulated jurisdictions, which offer greater transparency and reporting processes. This leaves managers with the dilemma of whether to go onshore or offshore and the subsequent increase in operating costs.

Finally, the impact of new regulation remains a relative unknown. On the legislative front, the industry has accepted the inevitable prospect of increased regulation and reporting. This is already in the process of being introduced in the US and Europe and will certainly mean increased compliance and regulatory costs - in whatever final format it takes.

This scenario creates exciting opportunities for jurisdictions such as Malta, which continues to grow as a domicile of choice. Increasingly, Malta is seen as a jurisdiction that offers solutions to the new challenges faced by managers.

Benefits of locating in Malta

Malta provides an ideal location as an EU domicile for both funds and management companies offering the following advantages:

  • Low set-up costs (a PIF can be setup for less than €20,000) and availability of high-quality professional resources;
  • A single regulator - the Malta Financial Services Authority (MFSA) allows for streamlined processes with flexibility and accessibility to allow for custom made solutions;
  • Fast-track approval processes;
  • Presence of quality global service providers;
  • Extensive double-tax treaty network, most recently with the US;
  • Being able to avail of the EU Passport and promote their funds in all EU member states;
  • Ability to use Special Purpose Vehicles;
  • Only EU member states with a full imputation system of taxation - for example, a Maltese fund manager that is incorporated as a company and tax resident in Malta will be subject to tax in Malta on its taxable profits on a worldwide basis at the flat tax rate of 35%. However, upon distribution of dividends to its non-resident shareholders, these shareholders would be entitled to a refund of six-sevenths of the advance corporation tax that has been paid (after the refund the actual tax paid would be of 5%, for example);
  • Cost-competitive centre where office space and human resources are two-thirds the cost of other European jurisdictions;
  • Highly qualified and multilingual staff;
  • A strong telecommunications network;
  • Strategic Eurozon Location

The redomiciliation of funds to Malta has become possible following the enactment of the Continuation of Companies Regulations (the "Regulations") in 2002. Redomiciliation results in time and cost savings while the management, ownership, structure and assets of the fund remain largely unaffected. The actual change that occurs is in the funds' domicile relevant legal system, regulator and taxation framework.

Two factors stand out that contribute to the attractiveness of Malta as a location for redomiciliation. Firstly, its regulator - which is known for its efficiency, approachability and commitment to the maintenance of high standards. Secondly, Malta is a low-cost jurisdiction that offers a highly favourable system of taxation for investor funds. This is due in part to the exemption of income tax and capital gains tax at the fund and non-resident investor level and its framework of double taxation treaties.

Fund choice

Malta offers two main investor routes in the form of the Ucits and the Professional Investor Fund (PIF) regime, which as the name implies is targeted towards professional investors that fall within the classes below. These funds target investors in accordance with their minimum investment threshold. The funds are non-retail and are therefore not subject to the some of the usual restrictions on their investment or borrowing powers as normal retail funds.

The PIF has three investor classes:

1. Experienced investors with a minimum investment of €15,000 (€10,000 when certain investment restriction at the portfolio level are met),

2. Qualifying investors €75,000 and

3. Extraordinary investors €750,000.

Collective investment schemes carry an exemption from income tax and capital gains tax at fund level and at nonresident investor level and may be set up as an incorporated open or close-ended investment company (Sicav or INVCO respectively), a limited partnership or a unit trust.

Even though not as popular as PIFs and Ucits, Malta also offers other types of funds such as Private Schemes, Specialist Schemes (which target special sectors such as venture capital, money market funds, property funds, futures and options funds) and retail funds.

Middle- and back-office services

Market conditions have forced managers towards funds, with multi-prime broker models. Even though the implementation of such models would spread counterparty risk, managers would still be required to support multiple execution platforms, complex reconciliation, trade allocation and counterparty risk. As a result, managers would need to have bigger middle-office functions.

Some managers are undoubtedly finding it both easier and more cost-effective to outsource these activities to administrators who can provide not only post-trade services but also pre-settlement trade processing and support, position and trade reconciliation, fund accounting and riskmanagement reporting.

In addition, as compliance and regulator reporting increases, medium and small managers should consider outsourcing these tasks to specialist service providers. This will reduce risk levels as well as driving further cost savings.

In summary, Malta is in a prime position to take advantage of the changes that the whole industry is facing and to become the domicile of choice for funds who wish to move to onshore European-regulated jurisdictions. With a strong proactive regulator, flexible service providers and a highly educated workforce with a "can-do" attitude towards the industry, Malta is well positioned to see continued growth.