Onshore or offshore: the PE dilemma

Written by: Amy Carroll Posted: 23/09/2019

BL64_PE dilemmaPrivate equity firms are coming under growing pressure from investors to move onshore. But the case for the Channel Islands remains compelling

The Channel Islands have been playing host to a who’s who of private equity since the asset class was in its infancy in the early 1980s. Many of the industry’s biggest and most successful brands have grown up on the shores of Jersey and Guernsey, including Apax, Permira, KKR, Cinven, BC Partners and Coller Capital.

However, populist rhetoric and negative media coverage – including the recent publication of the Tax Justice Network’s Corporate Tax Haven Index – have rallied public opinion in opposition to offshore centres. As a result, investors in private equity funds are increasingly piling pressure on managers to relocate. 

A small but growing number of firms, including Nordic star Altor, have retrenched to home territories. More commonly, however, firms have packed their bags for Luxembourg.

The reality is that these relocations are all about optics, and there is no rational reason for investors to favour onshore jurisdictions. 

“The Channel Islands are not tax havens, we do not offer preferential tax regimes and we don’t facilitate tax avoidance,” says Annette Alexander, a Guernsey-based Partner at law firm Carey Olsen. 

“We are market leaders in terms of tax transparency and are on the OECD white list. Most recently, the European Union [EU] has confirmed that we have met their concerns regarding economic substance requirements. We’re often more compliant than the onshore EU alternatives.” 

Andy Sloan, Deputy Chief Executive, Strategy, at Guernsey Finance, says: “The issue is that populist opinion is a couple of decades behind reality. We have the highest anti-money laundering ratings on the planet. We are at the forefront of tax transparency. According to the facts of the day, all this should be put to bed as a non-issue. Certain political campaigners are acting as if it’s 1999, not 2019.”

But this is a public relations battle, first and foremost. And it’s one that the Channel Islands’ rivals are waging without mercy.

Passport to success

The biggest beneficiary of the onshore trend has undoubtedly been Luxembourg, with its well-oiled PR machine advocating the advantages of its onshore EU location, and, in particular, its compliance with the Alternative Investment Fund Managers Directive (AIFMD). 

Luxembourg may be a relative newcomer, but it is already the second most popular domicile for private equity funds. Indeed, the Association of the Luxembourg Fund Industry estimates that there is somewhere in the region of €400bn of private equity funds now residing within its borders. 

The much vaunted AIFMD fundraising ‘passport’, however, has not been the panacea that it was widely expected to be. Passporting was intended to allow private equity funds to market in any European country without having to gain separate approval from each country’s regulator.

But the process is not entirely seamless. Some regulators have imposed additional compliance and fee requirements on top of existing charges, so friction remains. 

Many find the current Luxembourg relocations all the more flummoxing, given the heavy regulatory burden that has befallen EU-domiciled funds since AIFMD was implemented six years ago. The cost of a Jersey or Guernsey structure is understood to be around 40% lower than a structure that’s AIFMD compliant and, contrary to the Luxembourg marketing spiel, they do not restrict a manager’s ability to market funds in Europe.

The fact is, only 3% of private equity firms are registered to market in more than three countries. And Switzerland, the UK and the Netherlands alone represent two thirds of private equity fundraising, according to Preqin. Most managers simply don’t require access to every single European jurisdiction, significantly diluting the stated benefits of the passport.  

The national private placement regime (NPPR) used by Jersey and Guernsey allows access to 22 of the 28 EU member states on a bilateral agreement basis, and without the punitive compliance overhead that comes with administering in Luxembourg. 

Furthermore, both Jersey and Guernsey were among the small handful of jurisdictions to be given an ‘unqualified and positive assessment’ by the European Securities and Markets Authority, meaning they will be at the front of the queue once the third-country passporting regime is finally activated. 

“The NPPR is proven, smarter and faster. The benefits of the passport were always far more myth than actuality,” says Sloan. “Investors often don’t appreciate the regulatory costs of a Luxembourg structure – or the lower service levels. 

“People like dealing with a familiar business environment. They understand our common law approach. In fact, research we conducted this year showed that more than two thirds of managers would disaggregate their global and European distribution to reduce costs. They are starting to recognise that a one-stop onshore model is a more expensive and inflexible approach.”

“There is a misperception that the only viable way to market alternative funds in Europe is through an AIFMD passport,” adds Elliot Refson, Director of Funds at Jersey Finance. “That misperception stems from a misunderstanding of the proposition offered by NPPR regimes and a lack of awareness about how private fund placement works – and how well it works.”

Carey Olsen’s Alexander says private equity firms are increasingly requesting that NPPR not be turned off when third-country passporting becomes available, as originally planned. “NPPR is a valuable and effective alternative and as inefficiencies with the passport become apparent, managers are increasingly appreciating its virtues.”

Home or away?

There is no denying the pressure that private equity firms are facing to move their business onshore – although there are many who would argue that Luxembourg does not truly fulfil onshore criteria for investors concerned about reputation. 

“It is an offshore jurisdiction in an onshore location,” says Alexander. “Some onshore financial centres are becoming more like a tax haven. Some firms are in Luxembourg, for example, just to gain access to an extensive network of tax treaties and to take advantage of low effective tax rates that can be achieved through obtaining tax rulings.”

Indeed, despite continuing calls for onshore migration, the Channel Islands have a compelling story to tell. Well established as a jurisdiction of substance, Jersey and Guernsey provide a proportionate, stable and supportive regulatory regime. The funds industry is integral to the region’s prosperity and a perennial priority for rule makers.

Expertise and service levels are also superlative, while there are those who believe that Luxembourg is struggling to keep up with the pace of demand. 

“The Channel Islands are a key jurisdiction for the domiciliation, management and administration of private equity funds, offering flexible investment structures, expertise and an ease of doing business,” says Refson. 

“We are also a jurisdiction where you can put the government, regulators and industry in one room, which leads to a collaborative and innovative environment. 

“At the end of 2018, Jersey was administering almost €320bn – a 15% increase year on year. Thinking about this in terms of onshore and offshore is a complete distraction. Managers need to be thinking about where the expertise and appropriate regulatory environment can be found. The Channel Islands provide that solution.”

Sloan concludes: “We are living in an era of global populism and, increasingly, we are having to fight the corner not of offshore, or financial services, but of capitalism and free trade itself. 

“But I think the pendulum will swing. The public will recognise the reality of where we have been for a long time. And private equity firms will continue to take advantage of the flexible, proportionate and cost-effective administration that the Channel Islands can offer.” 

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