The roots of E&Y’s award winning European hedge fund tax practice go back to the late 1990s. At that time, Robin Aitchison made it a priority for E&Y to get in on the ground floor with a high number of the then new breed of hedge fund managers that were setting up in London. The foundations erected over a decade ago have provided a sturdy base for E&Y to build its dominant position over the years in advising hedge funds on tax.
“Robin built the hedge fund tax practice, beginning in the mid 1990s,” says Jon Hanifan, Director with E&Y. “The aim was to get in on the ground floor with as many hedge fund managers as possible. He positioned us to be involved and to partner with hedge fund clients from day one. And so as our hedge fund clients have grown, we have grown.”
The approach means that E&Y helps firms, from start-ups to some of the biggest global players, plan five years or more into the future on matters like structuring and tax efficiency. The aim is to assess different options, consider the risk appetite of managers and put together something that works for a hedge fund firm commercially.
“We talk to our clients about more than just tax,” says Hanifan. “The E&Y team operates in an environment with entrepreneurial people. It is actively commercial and applies tax advice in a way that non-tax people can understand.”
The firm’s hunger for new business is all encompassing. For his part, Hanifan is matter of fact about the business focus. “We want to work with the best start ups out there,” he says. “We aim for a 70% win rate and have sustained this on average over the life of the European business. This will help us work with the fastest growing and entrepreneurial firms in the future.”
E&Y has built a very strong team across the tax practice. In the UK alone, there are in excess of 30 staff who focus entirely on the tax affairs of hedge funds and of hedge fund managers. The firm has additional senior tax practice staff in the Channel Islands, Malta, Switzerland and across the Europe, Middle East, India and Africa (“EMEIA”) region.
“That gives us an advantage,” says Hanifan. “People across the grades take ownership for the level of service they deliver to clients and seek to provide exceptional standards of service. This creates a virtuous circle with people coming up through the ranks and avoids a key man situation.”
Organising the set-up
With a start-up hedge fund manager, one of the first issues to be determined is the corporate organisation. At issue is whether it is best to run the UK business through a limited liability partnership or through a company structure.
E&Y guides hedge fund firms through an understanding of the tax differences, possible remuneration structures as well as the commercial basis and substance for a particular business structure. This is important for hedge fund managers as the UK tax authorities increasingly require a taxpayer’s structure to show a commercial logic and not just a tax outcome.
“We aim to have an open discussion about what the client wants,” says Hanifan. “There is no one size fits all. It fact one size doesn’t fit anyone any more. Everything is much more bespoke and that makes it even more interesting for us on the technical side.”
Large hedge funds with a loyal investor base, superior investment talent and, above all, a proprietary edge are attractive targets for acquirers. But preparation for an eventual transaction needs to start well before any sale negotiations begin.
“Hedge funds need to think about the best way to structure their businesses for example, taking into consideration the sort of partnership the owner(s) want to have with the purchaser of a stake in their firm,” says Julian Young, leader of the Ernst & Young Hedge Fund practice in EMEIA. This can determine factors like ownership entitlements, profit shares or employee agreements, for example. From the outset of a firm’s life cycle, E&Y can help plan for outcomes to avoid tax and other problems that could be encountered in the future with a transaction.
“The due diligence process usually turns out to be far more arduous than expected,” adds Young. The expertise E&Y offers can thus help hedge funds prepare for a variety of potential transactions.
Top tax issues
A hedge fund version of the 3 Rs covers the biggest tax issues managers are currently facing. They are: remuneration, regulation and re-domiciliation/relocation (funds/mangers).
On remuneration, hedge fund firms are getting larger with the number of partners and key employees increasing beyond the core group. The issue is how to retain and reward these employees, while balancing alignment issues with respect to investors and the asset management firm itself.
“We’re going to see changes in the way the industry handles remuneration,” says Young. He adds that this will go beyond simple personal remuneration and will likely have an effect on new product launches and how firms choose to expand in the future.
While the Capital Adequacy Directive may be less prescriptive for asset managers than other financial services companies, hedge fund managers will still be required to put in place remuneration policies and practices that are consistent with and promote effective risk management. Although hedge fund managers are not likely to have remuneration paid in shares to effect a deferral, they do need to develop a remuneration policy that encourages a responsible approach to risk.
The AIFMD also addresses hedge fund remuneration practices. The new rules will extend beyond risk takers and those with control functions to any employee whose total remuneration will take them into the same pay bracket.
“These measures are forcing mangers to look for alignment on compensation between the demands of the firm, investors and what regulators require,” says Hanifan. “It means spending time on formulating plans that meet an asset manager’s commercial needs but correspond with demands that are outside of the firm.”
Overlapping with remuneration is general regulation. FATCA (the Foreign Account Tax Compliance Act) comes into effect in some instances on 1 January 2013. Though it has ‘tax’ in the title, Hanifan says the provisions in the act concern mainly operational issues, and he stresses the need to explain to hedge fund clients the impact of the new rules. Given the simultaneous emergence of issues such as of FATCA, the AIFMD and the Dodd-Frank Reform Act, E&Y uses a multi-disciplinary approach to advise hedge funds, building a team of tax and non-tax specialists to examine the broader issues at play.
The industry is also looking at redomiciliation as the AIFMD offers managers the potential ‘carrot’ of the passport rules, smoothing access to the various national markets in the EU. It could be, for example, that the compliance costs of AIFMD are less than the cost of continually using the private placement regime. “There is a need to understand the tax consequences of bringing a fund onshore and making sure also that the post re-domiciled state of play for the fund is at minimum no worse than it was prior to the move,” says Hanifan.
Relocation is another area where E&Y has valuable experience, having advised several established mangers on their move to a new jurisdiction. Moving a business may well start as a straight commercial decision, but Hanifan notes it is a lot more than that. Here the planning must take account of the personal circumstances of different partners. Invariably the tax issues for different individuals will also vary considerably.
More than compliance
“The impact of the AIFM directive is about far more than compliance,” Young says. “It will drive structural change in the industry. Groups, including promoters and managers, should consider a strategic re-think of their fund ranges and a review of their operating models.”
Hedge funds face a number of strategic choices. How distribution channels to different investors function is an obvious issue that funds will need to address. Changes in these arrangements will have a knock on impact on direct and indirect taxation. Other operational factors, notably with respect to risk management and compliance, are also at issue.
The optimisation of an operational model can create new opportunities, leading to spin offs, mergers, acquisitions and, in some cases, liquidations. E&Y is well-placed to advise hedge funds on the consequences of different courses of action and optimising outcomes. With the AIFMD, for example, E&Y is working hard to help hedge fund clients get ready for some of the fundamental changes – and choices –that the new regime is likely to bring.
However, perhaps the biggest challenge facing hedge fund managers is just how vague the directive may turn out to be in implementation. Due to its supranational nature, the AIFMD requires implementation by local authorities. It means that some provisions will only be clarified when they are put into effect and being practically applied. E&Y is working with clients to keep them abreast of the AIFMD’s evolution and providing advice on risk areas. The firm’s range of expertise across the tax practice combined with a presence on the ground throughout Europe provides E&Y with the local knowledge to help hedge funds navigate the changing maze of EU legislation.
Experience provides solutions
With its global presence, E&Y was closely associated with hedge funds in the industry’s early years when boutique funds served the wealth management sector. This means E&Y is likely to have experience of any particular tax issue a hedge fund client may confront.
“Not only will we have probably seen it before, the likelihood is we’ll have the answers too,” says Julian Young, the EMEA Hedge Fund Leader at E&Y. On tap for clients, is an unparalleled depth of expertiseon the financial affairs of hedge funds and managers. “We spend a lot of time thinking about how regulation applies to this industry, and its consequences,” Young says.
In recent years, E&Y has been kept busy with incoming regulation. Governments, meanwhile, are fiscally stretched and have put pressure on their revenue collection agencies to focus more on hedge funds than ever before: “Clearly, there are pressures,” Young says. Combined with a challenging environment for raising assets and creating performance, hedge funds are also grappling with a variety of new regulations. E&Y has worked hard to position itself as a leading advisor on the issues the regulations pose, notably concerning tax, but in other areas, too.
Julian Young, Partner
Julian Young is a partner in Ernst & Young and leads the EMEIA hedge fund services practice. He has over 18 years experience in the asset management sector, both as an advisor and in industry. Julian has worked with traditional and alternative asset managers in Europe, North America and Asia, advising on assurance projects, regulatory change and transactions.
Jon Hanifan, Director
Jon Hanifan joined Ernst & Young, as part of the hedge fund tax team, in September 2007 from Barclays Tax and is a member of both the Association of Taxation Technicians and the Chartered Institute of Taxation. Jon specialises in the provision of tax advisory services to the firm’s hedge fund clients. He advises clients on the tax implications of structuring new businesses; restructuring; international expansion; and mergers and acquisitions.
Zeynep Meric-Smith, Senior Manager
Zeynep Meric-Smith is a member of the EMEIA Hedge Funds Steering Committee and the Account Manager for a number of EY’s most significant European hedge fund clients. She also leads Ernst & Young’s AIFMD Campaign across EMEIA. She joined EY in 2007 and was previously in senior industry roles within the hedge fund and investment banking sectors. Zeynep specialises in business strategy and change initiatives impacting her clients arising from market, investor or regulatory-led developments. She holds an MSc. from the ICMA Centre, Reading, and is a Chartered Alternative Investment Analyst.