Tide Turns Against Offshore Listings

15 Oct

The regulatory climate in Europe has tightened the screw on money-laundering and counter-terrorist financing, with the result that many institutional investors are warier of offshore-listed funds without a similar level of transparency…. How widespread is this offshore aversion, and will it prove an enduring trend?

 The EU’s 4th AML Directive now requires EU states to keep central registers listing info on the ultimate beneficial owner of corporate and other legal entities; as well as compelling trusts to make information available to relevant financial authorities and “obliged entities” e.g. banks conducting “customer due diligence” duties.

Publicly listed companies, i.e. non-trusts, will be forced to make such information available to any inquirer with a “legitimate interest”, be it investigative journalist or concerned citizen.

However, these requirements will not be imposed on the Cayman Islands, which foreign office minister Grant Shapps recently announced would subscribe to an alternative scheme that also includes the British Virgin Islands and Bermuda.

Under this alternative plan, “corporate service providers” themselves will be responsible for making available information on company ownership to law enforcement agencies within 24 hours of a request being made.

So if Interpol comes knocking, they must respond promptly. But does this really amount to a legislative change? What was the window of response time before?

Shifting sands of investor sentiment

Pension funds, and any fund structure which takes risk assessment seriously, are averse to investing in opaque structures where it is difficult to pinpoint the party which is ultimately liable in the event of compensating for losses, failure to meet targets; or, in a worst-case scenario, actual bankruptcy.

The Caymans and other ‘tax-neutral’ jurisdictions are attractive to many fund managers, particularly hedge funds, because registering the company here means they can bypass paying capital gains on their astronomic profits. But at the same time, these island governments have such a laissez-faire attitude to corporate regulation, they are also a haven for criminal gains disguised under ‘shell’ companies with no officially registered connection to their actual owner.

There have been several recent controversies about the Caymans’ use as a cash transfer node in what it is alleged is a network of illegitimate wire recipients.

On 17 July, Fidelity Bank’s sideline money transfer service, Western Union, closed its Cayman Islands branches, as well as those in Turks and Caicos and the Bahamas. Fidelity Bank (Cayman) CEO Brett Hill told the Cayman Compass, “It’s been an increasingly marginal business for us,” because fees had fallen along with the business becoming higher risk.

 In May, Western Union was forced to pay a 1.75 million euros (US$1.9 million) by Irish officials, for having insufficient policies and procedures in place against money laundering; part of the aftermath of the FIFA scandal. In fact, Jeffrey Webb, the former FIFA and CONCACAF (Confederation of North, Central America and Caribbean Football Associations) official now facing corruption charges in the United States, worked as Western Union’s local agent.

People prefer UCITS

The risk-averse investors’ favourite course, Undertakings for Collective Investment in Transferable Securities, are popular because of the greater insurance they offer to investors. UCITS have an independent supervisory entity, a ‘depositary’, which has no commercial interest in either the fund or external commercial links with the fund’s investment managers.

Prime brokers who act as counterparties to a fund on swaps, options or other derivative contracts, are not permitted to act as its depositaries. This further guarantees the integrity of its assets and capital deposits.

The depositary has two main roles: first, it acts as custodian over the fund’s assets; second, it performs legal oversight of a UCIT’s sales, repurchase and redemption of units or shares is carried out in accordance with applicable laws. This includes verifying the net asset value of units, calculated in line with national accountancy standards.

A recent (2014) amendment enhanced the ability of UCITS depositaries to meet their obligations in the event of the assets being “lost in custody”. Should this occur, the depositary will have to provide replacement assets to investors without requiring an investigation to establish liability. Unlike in a dodgy Caymans ‘fund’, where it is sometimes impossible to establish where the buck stops.

Of course, because the core EU UCIT framework is open to changes under different national interpretations, countries like Ireland have found ways of sweetening the deal. The Central Bank of Ireland (CBI) has removed the requirement for UCITS fund promoters to be approved by the bank. This opens the field for a variety of smaller, unregulated placement agents to conduct the marketing and sales process for new UCITS funds.

Simultaneously, the CBI has taken action to enforce standards in the repo and and securities lending markets, demanding all counterparties involved in securities lending, repo or reverse repo lending transactions have a minimum credit rating of A-2 or equivalent.

Demonstrated Preference

UCITS have remained in demand globally, despite rival pan-continental regulatory structures being instigated in Asia: the Asean Collective Investment Schemes, as of August 2014, which clears funds for distribution across Singapore, Malaysia and Thailand; the Apec Asia Region Funds Passport, which provides a similar unified framework across Australia, New Zealand, South Korea and Singapore.

Yet, as CEO of Hong Kong’s CitiTrust, Stewart Aldcroft, pointed out in an FT op-ed:

“Malaysia and Thailand have similar schemes to allow the approval of locally domiciled funds to operate as feeder or fund of funds, where they use third-party products such as UCITS. In both markets, these have proved to be more successful and popular than anything under the Asean passport scheme.”

Fund registration figures show that across the three principal markets of Hong Kong, Singapore and Taiwan, there are over 4,500 listed UCITS funds; though as many of these are listed more than once, the total of unique funds runs closer to 1,200.

And recently there have been significant new UCIT fund registrations with an Asian focus. Noteworthy is Neuberger Berman’s new Asian-focused fixed-income vehicle, which invests across debt grades, from government to high-yield. This new Asian Debt Hard Currency fund will be joined, Neuberger states, by the launch of a China bond fund and Asian debt local currency fund.

All of the emerging market products are sub-funds of the Irish domiciled UCITS fund feeder, Neuberger Berman Investment Funds; a clear indication of investor preference for Ireland’s regulatory environment.

Neuberger is particularly optimistic about opportunities for UCITS in the Chinese market. The asset managers were granted a Reminbi Qualified Foreign Institutional Investor (RQFIII) status in December 2014, allocating a quota of certain non-strategic mainland Chinese Renminbi-denominated equity and credit-based securities.

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