The key to unlocking Europe

Originally published in the February 2013 issue

The global funds industry is currently in a state of transformation. Regulatory and legislative changes are leading the fund sector into increased regulation ostensibly with the goal of enhanced investor protection. The Alternative Investment Fund Managers Directive (AIFMD) has polarised funds and fund management jurisdictions into the European on the one hand and the non-European on the other. Gibraltar’s position within the European Union means it will be one of only a handful of jurisdictions able to offer effective and efficient fund solutions to fund managers that either must comply with the Directive and access its marketing passport provisions or indeed to those who do not need to comply but wish to opt into the regime.

On the other hand, Gibraltar will continue to provide solutions for fund managers that remain outside the scope of AIFMD, but wish to domicile themselves or their fund products in a well regulated, tax-efficient EU jurisdiction. For many fund managers, Gibraltar could indeed be the key to unlocking Europe’s markets.

The Experienced Investor Fund (EIF) – Europe’s most flexible fund regime
Since 2005 with the advent of the Financial Services (Experienced Investor Funds) Regulations 2005, updated to the Financial Services (Experienced Investor Funds) Regulations 2012, Gibraltar’s funds industry has experienced positive and qualitative growth.

Investor restrictions
The investors who are eligible to invest in EIFs are investors who:

  1. Have €1million in assets besides the value of their residential home; or
  2. In their ordinary employment activity are investment professionals; or
  3. Invest an aggregate of €100,000 in one or more EIFs; or
  4. Are classed as professional investors under the Markets in Financial Instruments Directive (MiFID); or
  5. Are investors who invest €50,000 in an EIF andare advised to do so by an investment adviser that is regulated to European standards.

It is important to note that that these conditions are non-cumulative and therefore by simply meeting one of the above conditions, the investor will be recognised as an “experienced investor” under the EIF regulations. There is no minimum or maximum amount of investors, investment restrictions or diversification requirements imposed on EIFs. EIFs can trade as private companies but are not restricted to a maximum number of investors. EIFs do not have any legislative restrictions on accepting US investors provided that the fund and its manager adhere to the relevant US securities laws.

Since Gibraltar funds can trade as private companies, they are eligible under US law to do a “check the box” election and thus be treated, for US tax purposes, as a partnership. In some cases this obviates the need to set up a US feeder fund structure for US investors.

Promoter/investment manager/custody requirements
There are no promoter requirements in Gibraltar beyond the ordinary due diligence and KYC requirements. A fund can be self-managed (by its board of directors) on advice from an investment adviser or it can be managed by a third-party investment manager. The investment manager must comply with the legislation from the jurisdiction where it acts. If it is in any other jurisdiction, such as Switzerland or the Caribbean jurisdictions, it is sufficient from a Gibraltar perspective that it comply with the legislation in those jurisdictions. There is no requirement for a Gibraltar-based investment manager or adviser.

At present, there is no legislative requirement for a Gibraltar-based custodian or prime broker. This is likely to change as from 22 July 2013 when the AIFMD is enacted into local legislation, with respect to funds to which the Directive applies. Funds that are out of scope are exempt from the provisions of the Directive and will therefore be able to continue to use depositaries from any jurisdiction that is considered acceptable to the Gibraltar’s regulator, the Financial Services Commission (FSC).

Directors and offering documents
A key element of the EIF regulations is the requirement for two directors who are resident in Gibraltar and who are licensed by the FSC to act as EIF directors. There need not be a majority of authorised directors on the board of the EIF. Other directors may be resident in any other jurisdiction subject to fiscal considerations. The presence of the authorised directors allows for the flexible EIF regime as they, in essence, act as the FSC’s “eyes and ears” on the board of every EIF, thus ensuring the proper management and operation of each EIF.

Each EIF must produce an offering document that outlines the service providers, investments, risks, exit strategies, and such general information as is standard in this industry. The offering document is the document which lists the information that an investor would reasonably expect to have before making an informed investment decision.

Authorisation and regulation
The authorisation process for EIFs is probably the EIF regime’s most attractive element. Gibraltar is possibly the only jurisdiction in the European Union that allows for a fund to be launched prior to formal authorisation on the basis of a legal opinion, provided that the fund’s documentation is submitted to the FSC within 10 business days of the fund’s launch. There is also an optional pre-approval channel of authorisation whereby the documents can be submitted to the FSC before launch and the FSC has 10 business days to respond.

The majority of Gibraltar’s EIFs, however, still opt for the pre-authorisation launch with the caveat that any unexpected or unusual structuresor elements are generally discussed with the FSC beforehand. Going forward, the fund must submit its audited accounts to the FSC within six months of its year end along with a form containing general compliance and statistical information. An EIF has an obligation to notify the FSC of any material changes within 20 business days. There is an obligation to notify the FSC of any breaches to regulations immediately.

The fund administrator plays a central role in the ongoing communication with the FSC. Indeed they are often the primary interface with the FSC. There is a requirement under the EIF regulations to use a Gibraltar-based fund administrator. This was recently relaxed under the new EIF regulations to allow non-Gibraltar-based fund administrators who are approved by the FSC and by the Minister with responsibility for Financial Services. It is anticipated that the larger internationally recognised fund administrators will be permitted to administer Gibraltar-based EIFs. It is important to note that this is not an authorisation procedure but a much shorter approval process by the local authorities. In such cases the foreign administrator would have to appoint a local agent for service of documents; it is not otherwise required to maintain any presence in Gibraltar.

It is important to note that when a fund is established outside of Gibraltar and re-domiciles to Gibraltar it may retain its foreign administrator. This will be of particular benefit to funds wishing to re-domicile to the European Union and yet have legitimate concerns about retaining continuity with their service providers. Investors in funds in jurisdictions that have similar although not identical experienced investor regimes will, with approval of the FSC either on a fund by fund or jurisdiction by jurisdiction basis, be deemed to be experienced investors under the EIF regulations.
Since EIFs are targeted to experienced investors, there are no statutory investment or borrowing restrictions save that the fund must state in its offering memorandum what its policy is with respect to these issues.

Taxation of funds
Gibraltar funds are generally structured to be tax-transparent. This can be achieved in two possible ways. The first is by obtaining a certificate from the Commissioner of Income Tax on the basis that the fund is a Collective Investment Scheme. Under this certificate the fund is not subject to corporate tax on invested income. There is no capital gains tax in Gibraltar. The other option is that the fund may elect to be taxed under Gibraltar’s 10% territorially based corporate tax regime. This latter option is often used for real estate or private equity funds that wish to avail themselves of the European Parent Subsidiary Directive and which need to demonstrate that they are taxable in order to gain the benefits of that directive. These funds are nevertheless unlikely to be liable to any Gibraltar corporate tax as Gibraltar’s territorial corporate tax regime only taxes profits which are derived from Gibraltar-sourced assets. Unless a fund invests in physical assets located in Gibraltar it is unlikely it will produce any taxable income in Gibraltar.

Taxation of Gibraltar managers
Investment managers on the other hand are taxable, if established as a limited company, at a rate of 10% of profits. When the principals of the investment manager or adviser are expatriates to Gibraltar and have elected to be taxed under a tax regime such as that known as Higher Executives Possessing Specialist Skills (HEPSS), their personal employment and dividend income tax is capped at under £30,000.

In order to be considered under the HEPSS scheme, applicants must possess skills (such as fund management) which are not readily available in Gibraltar, earn more than £100,000 from their employment, and they must own or rent a residence in Gibraltar that is suitable to their family’s needs and that is approved for such categories of residents.

Valuation rules
A fund must state its policy on valuation in its offering memorandum. Funds in Gibraltar must be audited to internationally accepted accounting standards such as UK or US GAAP or IFRS.

The AIFMD is causing sweeping changes throughout Europe’s fund sector to the way fund managers are regulated and how they distribute the funds they manage. The concept behind AIFMD is to create a harmonised regulatory regime across Europe for fund managers (termed “Alternative Investment Fund Managers” and/or “AIFMs”) that manage a group of non-retail fund products (termed “Alternative Investment Funds” and/or “AIFs”). AIFMD will operate alongside and create a separate European regulatory regime from UCITS IV and MiFID. Effectively, all European funds will fall under either the AIFMD or UCITS IV. All EU member states must implement AIFMD into their national laws by 22 July 2013 and existing fund managers which fall within the scope of AIFMD have until 22 July 2014 to bring their operations in line with the Directive.

As from 22 July 2013, European AIFMs managing EU AIFs, such as Gibraltar AIFs, will be able to obtain authorisation under AIFMD and therefore benefit from the EU marketing passport provided for by AIFMD. Such AIFMs will be able to market to professional investors (as defined in MiFID) freely within the EU. There is the possibility that managers from third jurisdictions such as those in the US, the Caribbean and the Channel Islands will be able to obtain authorisation and therefore access to the EU marketing passport under AIFMD subject to certain conditions but only as from mid-2015 at the earliest.

In their implementation of the Directive the member states will have to decide how they wish to exercise the derogations provided for in AIFMD. They will also need to decide whether they wish to “gold plate” the Directive by adding provisions to their national fund regimes that are not required by the Directive. Critical distinctions in implementation may exist in such topics as regulation of the national fund regimes for funds and managers that are below the de minimis thresholds of the Directive (i.e., €100 million for open-ended funds and €500 million for closed-ended funds), including application of the depositary regime in the Directive to funds that are out of scope of the Directive, permission of AIFMs to conduct MiFID activities such as portfolio management in addition to their core activities of fund management under the Directive, and applicability of any private placement regimes.

The Gibraltar approach to the above issues, following an in-depth consultation involving a collaboration of the government, the FSC, and the Gibraltar Funds and Investments Association (GFIA), the representative body of Gibraltar’s funds and investment industries, is likely to be to retain as much flexibility as is offered by the Directive as possible. Indeed Gibraltar will keep its EIF regime for those funds and managers that are out of scope of the Directive while allowing those that wish to, in order to avail themselves of the marketing passport, to opt in to the AIFMD regime. Clearly, once they do opt in, they would have to abide by all the terms of the AIFMD regime as if they had been “in scope”. It is also anticipated that EIFs will form the basis for the regulatory regime to be used as the “in scope” AIF. Because they have to comply with the terms of the Directive they will essentially be “Super EIFs”. This is very significant because as we will see, this is likely to dramatically reduce the licensing time of “in scope” AIFs, thus retaining Gibraltar’s place as the European jurisdiction with the quickest potential for time to market for new funds.

Whereas European AIFMs wishing to establish in-scope AIFs will have to undergo the process of authorising those AIFs (which can take anywhere between a few weeks and several months depending on the fund and the jurisdictions), AIFMs wishing to set up Gibraltar funds will be able to do so by establishing Super EIFs.

The process for this would be simply to establish and commence trading the EIF on the basis of the pre-authorisation launch and then, concurrently with the submission of the EIF documentation to the FSC (either immediately or within 10 business days of launch), submit the AIF documentation including the passporting notices to the FSC. The FSC will then have up to 20 business days to consider the documentation and to process the passporting notices. GFIA and the FSC have discussed a streamlined process for the preparation of passporting documentation.

For funds that wish to market before this process has been completed, it may even be possible to conduct their initial marketing via the private placement regimes where such marketing is conducted by the fund’s directors rather than by the AIFM. This, Gibraltar’s solution, is a product of cooperation of the industry along with the FSC and government and is illustrative of the positive working relationship that these three elements enjoy.

In an age where promoters are seeking regulatory arbitrage, Gibraltar, because of its size and the close working relationship of the parties involved, can offer solutions that provide flexibility without compromising the protection of investors.

Gibraltar EIFs are probably the most user-friendly fund vehicles within the European Union. They certainly have the quickest time to market within the EU as it is possible to launch an EIF before getting approval from the FSC. The FSC on the other hand has a plethora of powers in order to regulate such funds and to protect the interests of the investors. This, along with the generally closely-knit investment community in Gibraltar, allows for a quick, efficient and safe funds jurisdiction within the European Union.