This article is sponsored by RBC Investor and Treasury Services.
One of the key considerations when it comes to launching a new fund is which jurisdiction to opt for – and there is plenty of choice for managers, from Singapore, Canada and Australia, to Jersey, Guernsey and Ireland. Yet, as our survey shows, there remain three clear market leaders – Delaware, Cayman Islands and Luxembourg, all of which rank highly among respondents for regulatory and tax frameworks and the presence of local expertise.
We caught up with Dirk Holz, director and private capital lead at RBC Investor and Treasury Services, to discuss key trends in fund structuring and how service providers are changing the way private equity houses operate.
Delaware, Cayman Islands and Luxembourg are the top three domiciles for our survey respondents’ next funds. Why do these locations continue to be so attractive?
They are all well-known jurisdictions and Delaware and the Cayman Islands, in particular, have a very long track record for institutional private capital. Both GPs and LPs are comfortable with these three. For LPs, the predictability of these jurisdictions and their familiarity with the processes and reporting means they can easily plug them into their internal processes and operational flows. LPs also view them as reliable jurisdictions over the long term, particularly given they are tying up their capital in largely illiquid vehicles. Delaware, Cayman and Luxembourg all have the right infrastructure with service providers and other third parties that are experts in handling private capital business.
The survey suggests that Luxembourg is gaining market share. Are you seeing this and if so, to what extent has AIFMD been responsible for this?
AIFMD was a trigger for Luxembourg to become a major fund structuring location. Delaware and the Cayman Islands used to account for around 80 percent of fund domiciles for institutional investors but that dominance has been reduced by Luxembourg. Through the launch of the RAIF (reserved alternative investment fund) vehicle in 2016, Luxembourg created a toolbox which enables fund managers to launch fund structures under AIFMD, which helps speed up the time to market. Its launch of the SCSp (special limited partnership) has also boosted the market as this effectively uses features from the established and familiar US and UK limited partnerships.
LPs’ concerns around reputation risk have also boosted Luxembourg as one of the jurisdictions of choice as the spotlight has been cast over other offshore jurisdictions’ tax schemes. Luxembourg’s status as a regulated market gives LPs the comfort they need. And finally, the uncertainty over Brexit has pushed many UK-based managers to use Luxembourg to ensure they retain access to the European market for investors and investments.
To what extent are you seeing complex structuring involving more than one jurisdiction among GPs?
We’ve seen a significant shift towards this over the past few years. This is particularly the case for US GPs with global operations. Where previously, their default might have been to opt for Delaware or Cayman structures, now they are also looking at parallel AIFMD-compliant platforms (which often means Luxembourg). Asian GPs are also establishing funds in Luxembourg with Delaware feeders. The picture is becoming more complex, especially when tax-driven special purpose vehicles are additionally being established as holding entities to ensure tax efficiency for investments and investors.
Given this complexity, the time to market you mentioned earlier must be more important than ever. How has this changed recently?
Time to market has changed considerably – and this is very important for private capital generally. Five years ago, it could take up to a year to get organised. Now, it’s more like three months. Part of this is down to institutional investor expectations. As many of them have shifted allocations away from liquid investments towards private capital strategies, investors have brought with them their expectations of faster turnaround times. For their part, as they build asset management businesses, private capital firms are reluctant to wait 12 months from planning a fund to launch. It’s a much more efficient process today.
What about some of the other jurisdictions? Do you see any particular trends on the horizon?
I think Jersey and Guernsey are jurisdictions to watch over the coming years. They have a lot of skilled and knowledgeable people with specific expertise in the private capital space and there are strong governance controls. The two jurisdictions could play an interesting role depending on the agreed final terms of the UK leaving the European Union. Additionally Ireland has the potential to compete with its main rival (Luxembourg) in a similar way that they do in the UCITS (mutual fund) space.
What trends are you seeing in fund structuring in private equity?
The biggest trend is towards long-term vehicles, as, in some respects, the private equity houses are moving in on territory that was once occupied by the banks before Basel III. We’ve seen institutions such as Carlyle, KKR and CVC Capital Partners raise such funds on the basis that, in some instances, a three to five year hold is just too short.
We will see more of this as private equity houses develop longer term strategies to partner with businesses for ten or perhaps even 15 years to build long term, more sustainable value in the companies they back. That clearly has an implication for IRRs, but has gained some traction for LPs that have longer investment horizons and for whom this extended period of illiquidity can be a good match. And while some of these structures may be closed-ended, we will also see more open/semi-open ended vehicles– that clearly has implications for the way in which they are structured to allow investors liquidity.
Overall, the picture is one of rising complexity – of fund structuring, tighter regulation and increasing LP requirements. What effect is that having on GP operating models?
If we take the example of a US manager that previously used only the Delaware or Cayman Islands jurisdictions, it was perfectly feasible and efficient to run most functions in-house. This has clearly changed, in particular as many LPs – especially those more accustomed to liquid assets, where they have access to real-time valuations and exposures – are pushing for more granular and timely information from their GPs.
GPs are increasingly thinking about where their core competencies lie and what differentiates them. They are therefore focusing on their relationships with LPs, identifying and closing deals and managing their assets. And the US manager I gave as an example probably now has parallel fund structures in Delaware/ Cayman and in Luxembourg. The manager may retain its Delaware/Cayman fund services in-house, but will most likely outsource the services needed for the Luxembourg structure. In the long term we believe that GPs will outsource most of their middle and back office tasks to stay competitive.
Yet the overall outsourcing trend is far broader than that. LPs increasingly want standardised reporting across jurisdictions, so GPs are seeking out partners that can offer the same platform regardless of where the fund is domiciled. Added to this is the need to keep up with technological developments and the potential for disruption, which is leading them to partner with service providers who can deliver a whole package with scale and global reach.
What does that mean for service providers to private equity?
Scale is important for coverage of the main jurisdictions and to ensure you can keep up with all the latest regulatory developments and technology. You need to have a global model which is is why we have seen a number of mergers and acquisitions among third-party service providers. The seamless service however will take time to deliver as the integration from an M&A can be challenging.
Private equity clients are particularly demanding when it comes to time to market. You need to be able to work with agility. And, while there are a lot of similarities between private equity, private debt and private equity real estate structures, you need to have dedicated teams to each. We strongly believe that you need to speak the same language as your private equity clients and provide bespoke services. Private equity is particularly complex and clients need people who understand that each transaction they do is unique. Clients buy into a brand if it delivers on their promise of focused and specialised individuals that value the relationship – it is, after all, a people business.