Focus Report on Regulation - Going through a seismic shift - Ogier

<strong>Focus</strong> <strong>Report</strong>:
Sponsored by
Regulation
Going Through
A Seismic Shift
Special <strong>Report</strong>
Frontiers Come Down in New World
Order – Pages II-III
Sponsored Feature Article
A Haven for an Industry Under Siege
– Pages IV-V

II <strong>Focus</strong> report: Regulation
September
24, 2012
Frontiers Come
Down in New
World Order
Recent years have witnessed the
emergence of several significant
pieces of regulation with potentially
seismic implications for the private
equity industry. Yet with certain
key provisions still being debated,
managers are struggling to prepare
themselves, writes Solomon Teague
At times it must feel like an earthquake, so
much does the regulatory ground beneath the
feet of private equity managers move. In the
five years since the credit markets first froze,
regulators have been shoring up regimes in a
process of almost continuous discussion and
change. And though the source of the crisis
was undoubtedly in banking, the alternative
investment fund industry has been at the heart
of regulatory change.
“The problem is regulation is such a moving
target,” said Iain Bannatyne, a Partner at
KPMG. “Things are changing all the time and
there is a lack of clarity still with much of what
is coming out. It is a major jolt for the industry,
having come out of a comparatively benign
period for regulation, to have to deal with the
avalanche of regulation we have now.”
Mike Newell, Partner at law firm Norton
Rose, added: “Only a hard-core minority disagree
with the principles of regulation outlined
at the G20 level, but the U.S. and E.U. have
moved to achieve those goals independently
and that has not been helpful.”
With private equity houses becoming increasingly
institutionalised and global, in terms
of investment and capital raising, it is almost
impossible for big funds to avoid regulation concocted
in either the U.S. or Europe, regardless
of where they are based, Mr. Newell said.
Disparate Approaches
The approaches of regulators in the U.S. and
Europe “are too disparate for them to achieve
any unity of purpose within any reasonable
time frame,” added Mr. Newell. “But the industry
will make it work more efficiently over
time. Industry bodies and advisers will come
up with ways to satisfy all regulations, and
will fill in any gaps themselves with best
practice.”
In Europe the new regulation of private
equity has taken the form of the Alternative
Regulation is such a moving target…
things are changing all the time and
there is a lack of clarity with much of
what is coming out
Iain Bannatyne, KPMG
Investment Fund Managers Directive. Despite
the first draft having been published in
2009, there are still clauses of the Directive
being amended and haggled over. The Directive
officially came into force on July 21, 2011
and member states have until July 22, 2013
to implement it into national law. A year later
managers need to be authorised under the Directive
by their home state regulator.
Stage Three of the process, when national
regulators interpret and implement the Directive
in their own territories, will be decisive,
giving industry answers to many of the remaining
questions. But there are doubts as to
whether the Stage Three target will be hit on
time, with rumours currently circulating that
the September deadline for the latest draft will
be missed.
Industry sources continue to protest that
the rules appear to have been drafted without
due regard for the mechanics of the private
equity – or hedge fund – industries. AIFMD
requires all alternative funds use a depository,
for example, despite this being more relevant
for hedge funds than private equity funds.
“The feeling is this requirement does not address
the real underlying risk and is disproportionate,”
said Mr. Bannatyne. “It is a huge
administrative challenge and an extra cost, and
it is not clear how the depositories themselves
will manage the risk.”
AIFMD requires private equity funds to

September 24, 2012
<strong>Focus</strong> report: Regulation III
Flying the flag: the U.S. in particular has gone
global with the scope of its regulations
the SEC’s investment rulebook, bringing private
equity funds into the same sphere as U.S.
retail funds, with an associated compliance
cost. Managers are now preparing to meet
the SEC’s new Form PF filing deadline, which
requires a level of detail that many advisers
believe is unprecedented, with roughly 1,600
data points, according to KPMG.
Arguably even more extraterritorial in its
scope than the AIFMD is FATCA, the U.S. tax
rule that demands all funds disclose details
about transactions with U.S. investors to the
Internal Revenue Service. Entities that decline
to provide such details will be subject to
a 30% withholding tax – essentially a penalty.
This will be levied on their interests in U.S.
companies, both on ongoing payments, such as
dividends, and on gross proceeds at the point
of sale.
Evolving regulation will also impact the
European insurance and pension industries
hold capital against their investments, even
though such funds do not take proprietary risk,
meaning funds will need to set aside at least a
quarter of their fixed overhead costs, said Jon
Wilson, Director of Project Consulting at The
IMS Group, a regulatory consultancy firm.
Even more contentious are rules governing
remuneration, particularly deferred payments.
There are questions as to how this can be applied
to private equity, where payment is already
deferred to the point at which portfolio
companies are sold and profit realised.
Exactly how regulators will judge how much
business needs to be done onshore or offshore
to qualify for different tax treatment also remains
ambiguous, as do the specifics around
a host of exemptions, on holding companies,
joint ventures, family office vehicles, insurance
contracts and securitisation special purposes
entities.
Until the details on AIFMD in particular are
finalised it will be impossible for managers to
take key decisions that will determine the future
shape of their business, such as whether
entities and management teams need to be
relocated, and whether to continue accepting
investors from certain jurisdictions, said
Newell.
Managers must also be aware of various
other initiatives, for example the Financial
Conglomerates Directive, known as FiCOD,
which has been around for years but has been
updated to bring private equity funds within
its purview. The industry has also been
caught within the scope of Dodd Frank and
the Foreign Account Tax Compliance Act, a
U.S. measure designed to compel non-U.S.
financial institutions to provide information
on any U.S. client which has $50,000 or more
invested, with potentially enormous compliance
implications.
Going Beyond Jurisdictions
Regulators are in no mood to confine their attentions
within their own borders, with the latest
wave of regulations notable for the impact
they will have beyond the reaches of their home
jurisdictions. AIFMD prevents non-E.U. based
asset managers from marketing their products
in the E.U. unless they comply with E.U.
rules and will be felt acutely by many managers
themselves not operating in Europe.
Dodd Frank is lighter touch outside the U.S.,
with most mid-market and leveraged buyout
funds outside the country classified as Exempt
<strong>Report</strong>ing Advisers, with only partial SEC supervision.
In practise such funds are required
to make fairly detailed disclosures, but without
too big an impact on the operational side of the
business.
Registered Investment Advisers, on the
other hand, comprising most U.S. funds and
the largest foreign funds, must comply with
Only a hard-core
minority disagree
with the principles
of regulation
outlined at the
G20 level, but the
U.S. and E.U.
have moved to
achieve those goals
independently
Mike Newell,
Norton Rose
– both with heavy historical commitments to
private equity. Solvency II, a European initiative
setting out the solvency requirements of
insurance companies, is also set to have a significant
impact on all private equity funds, said
Mr. Bannatyne.
“Discussions continue on the risk classification
which will be attributable to private equity
investments which will determine the capital
requirements set against such investments,
potentially discouraging allocations,” he said.
With all this regulation taken together, matters
are complicated by the fact that different
legal advisers are reaching different conclusions
about what private equity funds must do
to comply, said Mr. Wilson.
“I hope that even if AIFMD does cause
some pain at the implementation stage, in
terms of ongoing costs it will be manageable,
and will not interfere significantly with fund
operations,” said Mr. Bannatyne. “I think
there is much more uncertainty in the U.S. for
RIAs in terms of ongoing compliance costs and
how U.S. rules might impact how they manage
their business.”

IV <strong>Focus</strong> report: Sponsored Article
September
24, 2012
Europe’s markets have had
a torrid few years but while
many investors have run
for the exits, others have
recognised the moment
to be a major buying
opportunity. For foreign
private equity managers
looking to invest in Europe,
the Channel Islands provide
a tried and tested route,
write Jane Pearce, Group
Director of Ogier Fund
Services
and Tim
Morgan,
Partner of
Ogier in
Jersey
A Haven for
an Industry
Under Siege
Feature Article
Sponsored by
Despite the constant stream of negative news from
Europe, the unrelenting threat of downgrades from
the rating agencies, the attention of the IMF and
social unrest, Europe remains an attractive place for
international investors.
The single biggest reason for this is valuations:
markets are often known to overshoot on bad news,
and there has been plenty of bad news to overshoot in
Europe. After years of pummelling in the equity markets,
valuations in Europe now look cheap and private equity
managers with an eye for an opportunity are moving in
to pick up companies that could look real bargains once
sentiment turns.
Private equity has proved to be a safe haven for
international investors and continues to perform
strongly. This combined with the relative strength of
the U.S. dollar against currencies, provides U.S. dollar
investors with an opportunity to diversify their portfolios
to include U.K. and European assets.
Analysis of price-to-earnings ratios either side of the
Atlantic support this claim. European price-to-earnings
ratios are about 75% of U.S. ratios. Relative valuation
over the decade has oscillated between 60% 130%.
The Preqin All private Equity Index showed
that private equity as a whole had considerably
outperformed the S&P500 index since the 2007
fi nancial crisis. Preqin further reported that “the majority
of LPs expect returns in excess of 400 basis points over
the public markets”. With Europe selling at a discount
from the U.S., historical patterns suggest that sooner
or later, it will outperform its American counterpart,
diminishing the valuation gap.
Add in the funding crisis and regulatory tightening
of capital adequacy requirements for European banks
and it is likely that some existing leveraged structures
will be sold at a discount to intrinsic value. As European
banks continue to be under pressure to shrink their
balance sheets, well-funded purchasers with access
to equity or debt fi nance will be well placed to take
advantage of opportunities in the U.K. and Europe.
This all suggests that managers willing to take a
long-term view, who are able to ride out some short
term volatility, should be – and are – looking at Europe.
Having taken that decision, the question is how to
structure the fund to ensure the best blend of effi ciency
and protection.
Non-European managers looking at Europe will be
struck by the Alternative Investment Fund Manager
By basing a fund in the Channel
Islands a manager can continue to be
regulated with the light touch, pre-AIFMD
regulation beyond 2013, and perhaps
until 2018

September 24, 2012
<strong>Focus</strong> report: Sponsored Article V
A place of safety: Jersey is
considered well placed to offer fully
passported funds under AIFMD
Channel Islands
jurisdictions
offer the best
opportunity
for using the
familiar, traditional
structures in
Europe over the
coming years…
they will provide the
least disruption to
managers wishing
to continue running
their funds as they
have previously
Directive, and the magnitude of cost and time
associated with compliance.
When it comes to fund domicile and administration,
the Channel Islands offer the best of both worlds to
funds looking to invest in Europe: the comfort of a well
regulated, familiar jurisdiction, without being technically
onshore. For the purposes of the onerous AIFMD the
Channel Islands are regarded as third country, non-E.U.
jurisdictions.
Funds operating out of the traditional European
centres of Dublin or Luxembourg will need to be fully
compliant with AIFMD by 2013, but those operating
outside “onshore” Europe have more flexibility. By
basing a fund in the Channel Islands a manager can
continue to be regulated with the light touch, pre-AIFMD
regulation beyond 2013, and perhaps until 2018.
There are various advantages in deferring full AIFMD
compliance, but perhaps the biggest is the risk that the
rules will continue to change within the first few years
following initial implementation, as specific issues
arise showing certain rules to be unworkable or to have
unintended consequences.
This will lead to additional costs for those that
comply early, but are then forced to modify their
systems again when the rules are refined.
A wait-and-see approach gives managers a better
chance that when they do comply the creases will
have been ironed out of the regulations, meaning no
further changes in the rules. For now, Jersey is widely
regarded as being well placed to be able to also offer
fully passported funds under the AIFMD from 2105,
while still allowing the flexibility of private placement
up until 2018.
Time-Tested Structures
There is no doubt that for investors coming to Europe
from the U.S. and elsewhere, the ability to continue
using familiar, time-tested fund structures and practises
has considerable appeal, especially with managers
already wrestling with the demands of the Foreign
Account Tax Compliance Act ( FATCA).
No doubt some investors will prefer to gravitate
to fully compliant, onshore structures, but according
to research conducted by Jersey Finance, 71% of
alternative asset advisers would not replace non-E.U.
managers and funds with onshore solutions.
With their strong relationships with the European
Securities and Markets Authority and other European
financial authorities, Channel Islands jurisdictions offer
the best opportunity for using the familiar, traditional
structures in Europe over the coming years. Basing a
fund in the Channel Islands, in other words, will provide
the least disruption to managers wishing to continue
running their funds as they have previously.
This will leave them free to turn their attention to the
many other challenges currently facing fund managers.
Obviously times of extreme market stress and
dislocation, as well as presenting buying opportunities,
present equally numerous risks.
It has been much debated what additional service
costs the AIFMD will bring; the operational structural
changes the managers may need to make; the
compliance and reporting changes; and the additional
cost of depositories.
As the costs of operating an asset management firm
increases, many firms will revise their business model.
New fee structures and products will emerge and they
may also choose to outsource certain middle and
back office functions such as portfolio accounting and
investor reporting.
Traditionally, investors have chosen a classic closed
ended structure to gain exposure to private equity.
However, many are increasingly taking advantage of
direct or co-investment and secondary opportunities
to add value to their portfolio’s and reduce the cost
of investing. While co-investing alongside a fund
increases capital risk, it includes the potential to
enhance returns and lower fees.
Fund managers are under siege from all sides.
Investor expectations are high while market confidence
is low. Funds must generate strong returns or die, and
for all its problems Europe is the place with the best
opportunities for picking up under valued assets.
Yet Europe is also seeing regulatory retrenchment,
making it harder to do business there than it has been
for years. The answer, for many, is a compromise
solution: the Channel Islands offer the advantages of
Europe, with reduced regulatory risks and, therefore,
costs.

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Find out how we can help you, contact:
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T: 01534 753806 E: jane.pearce@ogier.com
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