A new narrative for funds transparency
IFCs are no strangers to the concept of transparency. From the signing of TIEAs and complying with the US’ FATCA, to being early signatories to the OECD’s Common Reporting Standard (CRS) and committing to establishing accessible registers of beneficial ownership and directors, IFCs have a good track record in responding to transparency issues and are in most cases ahead of many other jurisdictions.
Now, however, there is a new form of transparency emerging that looks set to shake up the cross-border investment funds landscape. It's a new narrative for transparency that is founded not on regulatory compliance, but on an ability to proactively demonstrate value, ethics, purpose, and impact.
It has resonance right across the international financial services arena, but it has particular relevance for the funds industry - in areas like ESG investment, being able to demonstrate measurable impact, and respond robustly to accusations of green-washing and value-signalling; for private equity and real assets sectors, which face increasing scrutiny around their ethical behaviours; and in being able to demonstrate authentically that, across the board, an organisation can justify and back up its actions.
As we look forward through 2020 and beyond, it's clear that this approach to transparency is not going to be an additional ‘nice to have’, it’s becoming the licence that gives service providers, legal advisers and IFCs themselves a remit to operate.
With the January 2020 deadline for EU Member States to transpose the 5th Anti Money Laundering Directive (AMLD5) – a directive with transparency at its heart - into national law having now passed, the ongoing march of transparency continues.
Only the reality is that the ‘march’ is more accurately described perhaps as more of a ‘stagger’. In the EU, the picture is a very chequered one, with some Member States nowhere near as advanced in implementing the Directive as others.
But for IFCs, with their strong track record on transparency and an ability to act quickly, there’s a real opportunity.
To seize that opportunity, it will be important for IFCs to stay alive to the overriding dynamics and respond to them positively, by asserting the value of what they do and providing solutions to transparency challenges - so that they can play a key part in engendering trust and understanding, not just in what they stand for as IFCs themselves, but in instilling confidence in markets more widely.
Positioning themselves as secure, tax neutral investment hubs that encourage cross-border investment and capital pooling is one thing, but drilling down to a more granular level to demonstrate what impact that is having and what the benefit is to society more widely, beyond the benefit to themselves, will be more powerful.
How, for instance, are IFCs helping to address the climate crisis, find solutions for social challenges and champion good governance?
Some centres are already addressing these questions through specialist regimes, expertise and infrastructure for green finance, ESG investing and philanthropy. The Guernsey Green Fund is enabling Guernsey to build a solid platform for a sustainable finance proposition whilst the Jersey Private Fund has seen exceptional growth since it was introduced in 2017 – more than 350 established to date – and is showing particular appeal for impact investment.
This is a good start, and building on those capabilities and exploring new avenues to help define their ‘purpose’ will be crucial, so that they not only talk about what they are doing, but build their sophistication and show demonstrably that what they are doing is valuable, helpful to other jurisdictions and essential to society and the environment.
Strengths open up opportunities
If IFCs and IFC firms cancan play to their strengths, then the opportunities are significant.
For the Channel Islands, for example, trends in the real estate, infrastructure and private equity space – areas where those IFCs have excelled traditionally - are hugely positive. Preqin figures show that 2019 was a strong year in these sectors, with global real estate fundraising reaching $151bn, the highest amount ever recorded, some of the largest infrastructure funds ever closing to push infrastructure dry powder to $212bn, twice the figure at the end of 2015, and private equity fundraising exceeding half a trillion dollars ($595bn) for the fourth year in a row.
Appetite to continue to allocate to these asset classes remains strong too - there is a high likelihood of a post-UK election uplift in UK FDI as uncertainties around Brexit reduce, whilst private capital is starting to outstrip traditional listed capital. This pent-up investment will need to be put to work in an environment that is likely to be highly scrutinised and managed against new transparency criteria, and IFCs that are already ahead of the game should be well placed to support that.
Pushing the envelope
But this is an evolving narrative and IFCs need to be proactive.
More could be done, for example, on the governance side, where there is an opportunity for those jurisdictions that have well-established substance laws in place to push that experience and competence to help firms and other jurisdictions deliver the ‘G’ in ESG.
IFCs are also experts in reporting – we've previously argued that when it comes to ESG, the real gap is in benchmarking and reporting to enable the industry to provide clarity around meeting impact targets. Investors and managers are screaming out for progress in this area – and it's another area where IFCs have expertise.
Now more than ever, there's an opportunity for IFCs to use their experience so that they lead the transparency agenda, setting the pace in a new, fresh and exciting way rather than being just the supporting cast.
If IFCs can get to grips with this new narrative – and they have the tools in their toolkit to do so - then they will be in a very strong position to enhance their reputation, as responsible, trustworthy centres that are integral to a new transparent funds ecosystem that is founded on the twin pillars of ethics and compliance.
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December 2019 / Driving Innovation and Delivering Value - An IFC Roadmap for the 2020s
2019 was a watershed year for IFCs.
The year began under the EU and OECD's tax transparency microscope, leading to the introduction of economic substance legislation and calls for public registers of beneficial ownership. IFCs had to contend with a series of challenges in 2019 – and those that met the challenges head-on have turned them into positive differentiators seeing a return to record business levels.
2020 will no doubt bring new challenges. Of course, the landscape is complex and multi-faceted, but there are some overarching themes for IFC firms to reflect upon as we begin a new decade.
Sunshine is the best disinfectant
Transparency has been a growing consideration over the last decade, with IFCs responding through adherence to Tax Information Exchange Agreements (TIEAs), the US's FATCA legislation and the OECD's Common Reporting Standard.
With the EU's 5th Anti Money Laundering Directive undergoing implementation by Member States, and with the UK's Overseas Territories and Crown Dependencies committing to create public corporate beneficial ownership registers in step with the EU, the onward march of transparency looks unstoppable.
There will be new transparency targets – trusts were featured in the recently defeated Labour party manifesto, and we can expect civil society to continue to apply pressure to expose the affairs of the wealthy albeit in counterpoint to developing data protection and security principles. Private wealth firms will need to be sensitive to the direction of travel, and make a case for compliant confidentiality.
Conversations around the role of IFCs in 2020 will continue to relate to the low tax environment they provide. In the eyes of larger nations, highly focused on finding ways to boost their tax receipts, low-tax is often misrepresented as predatory.
As the EU looks to protect its financial hubs with the UK going it alone post-Brexit, there will be a renewed focus on the mechanics of cross border financial services. We have already seen this with the introduction of economic substance laws in 2019 – but it will not be the end of the matter, as a new narrative on corporate tax develops through the OECD's digital tax proposals.
IFCs need to be alive to these dynamics and respond to them positively, by asserting and demonstrating the value of what they do as secure, tax neutral hubs which encourage positive cross-border investment and capital pooling. We are already seeing some centres offering tailored regimes, expertise and infrastructure to support positive investment initiatives such as green finance, ESG investing and philanthropy.
For IFCs, 2020 will be about building on these core capabilities, whilst exploring new avenues which will help redefine their 'purpose' and demonstrate the positive value of their contribution to society and the environment, through fostering sustainable growth.
In 2020, for instance, we will see new developments as the OECD-driven corporate tax proposals move forward. IFCs have an opportunity here to come together and create a platform to demonstrate the benefits of tax neutrality and their role in adding value to cross-border investment flows.
A further area where leading IFCs offer huge potential is the exportation of regulatory competence and best practice. Few can claim to have as much expertise as the Crown Dependencies in dealing with international regulatory fora, such as the FATF or OECD. That experience is hugely valuable in a complex regulatory world. IFC firms can leverage this advantage by demonstrating how other jurisdictions can thrive whilst bolstering their own regulatory frameworks to meet international standards.
The Political Landscape will be challenging
Political dynamics will continue to be pivotal in shaping global markets. While the UK election outcome has provided a clearer direction in terms of Brexit, there is still a long way to go, and the UK's future trade arrangements are still unknown. Crossing the Atlantic, the US election campaign trail will undoubtedly create a degree of instability, at least for a time. All this against a backdrop of global unrest more widely, with strife in the Middle East, Hong Kong and other Asian centres, and US-China trade wars – all exacerbated by the likelihood of a widely anticipated global market slowdown.
But, more than ever, governments will be under tremendous pressure to deliver on the social contracts they have made with their citizens. More and better schools, hospitals, and progress on climate change will all be in sharp relief. Without free-flowing global investments, countries are likely to fall short, and a focus on supporting large FDI projects will be an excellent opportunity for IFC legal and structuring firms, with some $50trn of investments already planned across the coming decade.
In this context, the core stability of leading IFCs and their firms – their calm, steady, secure environment; the tried and tested rule of law; respect for property rights and democracy – will all be hugely attractive. Safe harbour IFCs, with an architecture of good governance, will prove increasingly attractive as the political world continues to fracture. IFCs that offer these qualities are in short supply, and those that can nurture the right environment will be the winners over the coming decade.
Innovation - working with change
There will be new considerations for IFCs in the digital innovation space in 2020, and plenty of opportunities. We have previously argued that IFC firms need to focus on long-term investment in digital technology if they are to expand their role in cross-border trade and investment against a back-drop of growing regulatory and operational complexity. A rapidly emerging data-driven financial services environment; that is both modular and bespoke, will require IFCs to be ambitious and agile in their adoption of ground-breaking technologies. With the right investment, they can work smarter, boost their productivity, and better support their clients.
IFCs like Guernsey, Jersey, and Cayman, which have pre-existing digital jurisdictional strategies, are well placed to make the most of the opportunities in this area – but one big question for 2020 might well revolve around the scope to explore new markets.
Should IFCs serving HNW and institutional markets so well, for so long, continue their exclusive focus on these core groups? Or, given the significant investment they are making in technology at a jurisdictional, industry, and firm-level, could they apply their skills and technology innovations into other, more retail markets?
Tapping into extensive retail opportunities, by providing access to international markets through digital delivery – gold markets through blockchain for example - maybe a break from the norm, but offers diversification and reputational benefits through extending the service focus to the many, and not just the few.
New Attractions for a New Decade - built on strong foundations
Global Perspectives is a commentary by a legal services firm on events that shape the cross border world, so the start of a new decade is a timely opportunity to devote a few lines in this last blog of a closing decade to the future of legal services in IFCs and other centres.
The 'Out with the Old' and 'In with the New' philosophy implied in the innovation section of this piece may lead you to believe that robots will rule the legal world, with legal precedents and laws relentlessly mined by an army of AI bots who don't need pay, sleep, food or rest!
Not a bit of it
According to comprehensive research by Acritas, purchasers of legal services above and below the age of 50 demonstrate quite distinct buying behaviours across the full spectrum of corporate, litigation, wealth, governance, and regulatory functions.
Above the age of 50 and the emphasis is on the quality of expertise and the individual strength and character of the lawyer. Buyers under 50 lean in to how proactive the legal firm is at providing advice that drives competitive advantage and better mitigates risk. Interestingly, a quality that both groups share is the value they place on international capability.
In today's cross-border world, 85% of firms with a revenue figure exceeding $1bn need international legal services. Perhaps more surprising is that 67% of these companies need legal advice on eight or more countries, and no less than 35% require information covering more than 25 countries!
The Path to Success
The transparency and equality agenda, purpose and value, political turmoil, and digital innovation look set to be the defining macro drivers of change for IFCs in 2020.
For IFC firms, including legal services firms, the path to success will be augmented by innovation, but the core competencies of managing cost and complexity when connecting international investors that have made IFCs so successful will continue to be highly prized.
Generating thought leadership that demonstrates insight and intellectual capacity will differentiate the leading firms from the rest, enabling them to identify business opportunities and risks before their clients do, and ensuring they are part of their client's strategic development, binding in the relationship through their trusted adviser status.
Identifying and tuning in to client needs in an uncertain and turbulent world will sort the winners from the losers and will be achieved by doing three things well; Listening, Understanding, and then Delivering.
We'll be looking more closely at some of these themes as 2020 progresses so please watch this space!
November 2019 / IFCs must contribute to the evolution of the corporate tax landscape
In the IFC world, we are used to the concept of unintended consequences with instances that start as one thing morphing subtly but considerably into something else – the AIFMD, BEPS, and Brexit, to name a few.
Significant changes to the global corporate tax landscape are underway – what started as a means of tackling digital giants, has moved to look at multinationals more widely and consequently, potentially has far-reaching ramifications.
If this steams ahead, there is the potential for a seismic shift that could have a significant impact on cross-border trade and investment.
IFCs at the coal face of cross border investment, possess the knowledge and experience to evaluate these changes and to play a vital role in understanding their impact. Experience tells us that significant change, delivered at this speed, risks unintended consequences, which may be harmful to the global economy.
The context of how we have got to the current environment is critical. Corporate tax rates have been falling over the past couple of decades as countries have competed for corporate business. Since 2018, statutory corporate tax rates have fallen in 76 jurisdictions around the world, stayed the same in 12, and increased in just six.
Meanwhile, fiscal positions across the OECD have worsened as national debt has risen consistently across OECD members – for example, today the UK's national debt is equivalent to 113% of GDP, compared to 62% ten years ago.
It's important to point out that these two trends are not correlated, with corporate tax receipts increasing despite lower rates in many countries.
At the same time, effective rates of tax – the rates multinationals are paying on average as a result of varying rates across their global operations and their tax domicile arrangements – have been in freefall. There have been well reported instances concerning some of the larger digital firms paying minimal or no tax at all in the UK, despite significant turnover.
Against this backdrop, the underlying narrative is not that surprising. The drive towards a new international corporate tax framework is rooted in the conviction that the current tax rules, established in the 1920s, are no longer fit for purpose in the post-industrial world. Most would agree that concerns around profits generated with little to no physical presence have been building for some time, and that reform is inevitable.
It's also symptomatic of the post-global financial crisis drive amongst larger countries – particularly in the EU - to clamp down on perceived tax avoidance to tackle their widening national debt issues and increase tax receipts. They see territories around the world who can maintain lower corporate tax rates, are questioning how they can do this, and surmising that having lower tax rates leads to profit-shifting.
Low tax territories may come into focus despite the majority of IFCs committing to transparency measures and cooperation initiatives. Confidence can be drawn from the fact that many have had their tax regimes endorsed in the not too distant past by the very same organisations who are now pushing the new agenda forward.
With France, the UK, and the US (with its GILTI legislation) having all gone it alone to tackle the global digital players, the OECD put forward proposals in October this year in an attempt to take control of the direction of travel at a multilateral level. The aim is to coordinate global tax developments to head off a harmful proliferation of unilateral tax measures.
Pillar I, the consultation on how and where profits are taxed, has concluded; and Pillar II on a global minimum rate of taxation, a top-up tax, and several other new rules is expected to complete by January 2020. All achieved on an impressive timescale, but one which carries considerable risk given the scale and complexity of the task.
Overall, the proposal would seek to re-allocate profits and corresponding taxing rights to countries and jurisdictions where multinationals have their markets. And to ensure that those multinationals conducting significant business in places where they do not have a physical presence, be taxed in such jurisdictions, through the creation of new rules.
Those rules, if approved, would introduce a minimum corporate rate of tax, with firms earning profits in any territory offering a rate below that threshold (yet to be determined) being obliged to pay an additional 'top-up' tax payment. The proposals suggest that in some circumstances, treaty benefits would be disapplied, with amounts remitted to low-tax centres subject to a withholding tax.
Importantly for IFCs and investors, the proposals are silent at this stage between trading and investment or fund vehicles and therefore have the potential to challenge the concept of tax neutrality and alter the face of cross-border investment.
The Silver Lining
However, a number of factors will mitigate the impact of these measures on IFCs.
First the favoured basis of assessment is consolidated financial statements. This idea has a lot going for it in that it is probably the least complicated to implement, and avoids the expense and complexity of assessing at individual jurisdiction or even at entity level. Whilst IFRS and GAAP are not universal, there is greater convergence than with national corporate tax systems. Provided timing issues and differences in accounting standards are addressed; this approach should gain support. If zero or low tax rates are blended at a group level, the overall rate the multinational is paying will be assessed at a more realistic level and will be less subject to distortion.
Furthermore, it would be logical to borrow from the BEPs action 13 Country by Country (CbC) reporting model, by setting the de minimis levels for assessment at the same level of €750m of group revenues. The real target here is the large multinational enterprise with significant global activities. There would be no sense in ensnaring smaller export companies or passive investment companies in a complex and expensive system designed to capture substantive footloose digital and IP profits, not to speak of the enormous compliance burden for SMEs.
Leveraging expertise in the IFC world
With the OECD looking to build a consensus-based solution, there is real traction for this initiative. For IFCs, though, there is a significant opportunity here to collaborate and provide experienced and meaningful input into crucial bodies like the Global Forum and Inclusive Framework, to set out a clear counter-narrative and argue the case for tax neutrality.
The principle of avoiding the multiple taxation of investment funds is near universal and supported by the OECD. A funds carve-out is a likely 'no regret' move that would see investment vehicles and funds distinguished from trading companies in the overall proposals. Ultimately, there is a need to uphold the principle of not taxing investors multiple times, a policy that forms the bedrock of tax neutrality.
Aiming for a fairer system to ensure global trading companies are operating in a clear corporate tax framework is a sensible aim, but this is a once in a generation opportunity to get this right, in an area where IFCs can play a meaningful and positive role.
The expertise and understanding IFCs have of the international investment environment, and of tax neutrality in particular, should be instrumental in helping to shape a workable new tax framework.
An equitable corporate tax system that helps stimulate much–needed, high-quality cross-border investment in businesses and infrastructure around the world, leading to the creation of jobs, growth, and prosperity for all, must be a uniting goal.
October 2019 / Alternatives Rising Part II: Playing the Long Game
Counterintuitively, the most significant challenge currently facing the alternative funds community in IFCs is that they have been so successful over recent years.
Recent figures posted by Guernsey and Jersey, have shown strong growth, thanks to their ability to meet the demands of investors and managers, provide a stable environment and offer vast amounts of specialist experience.
High demand for alternatives to enable investors to pursue strategies of asset protection, diversification and growth, has led to an influx of alternative funds work. With the US and Europe dominating, and Asia emergent, innovative IFCs like the Channel and Cayman Islands have put in place targeted overseas market strategies and supported a burgeoning funds sector, and they have reaped the rewards.
As 2020 comes into view, the alternatives world is finely balanced, with a mixed bag of trends across the spectrum. The long-term prospects for alternatives are good, but understanding what is going on under the bonnet is vital. IFCs cannot take anything for granted if they are to maintain their positions as leading alternative fund hubs.
Headwinds are building - geopolitical disruption, trade wars, the prospect of a market downturn, and the actions of central banks are all contributing to an uncertain outlook.
Fold in AIFMD and CRS regulation, the rise of ESG investing, and the evolution of the family office, and it is clear disruptive forces are impacting on the future of the alternatives industry.
Anticipating and mitigating the disruption posed by these forces will be pivotal if IFCs are to continue to play such a central role in the cross-border alternative fund space.
Add to this, a record US$2.1trn of dry powder, stretching valuations, and targets increasingly hard to find, it is clear that there is a vast amount for cross-border funds communities to consider.
But this is only part of the story – the reality is we may be on the threshold of a new era in alternatives that could usher in long-term change.
The current generation will live longer than any other, driving societal change on a scale never before seen as pension funds grapple with enormous public sector pension liabilities, and strive to meet the needs of a global population that is getting older.
According to the OECD, average public sector pension cost-to-GDP is set to rise from 9.5% in 2015 to 12% by 2050. It is an enormous challenge that is unlikely to be resolved in years or even decades – the horizons stretch long into the future.
With fully engaged public sector stakeholders, closer scrutiny of the bottom line of pension funds is an inevitability, and costs could become the new long-term battleground. Promoters will look for efficiencies in all stages of the supply chain, putting even greater pressure on fees and margins. In short, the alternatives market will be demanding more for less.
Navigating choppy waters ahead
We are already seeing that valuations and competition for assets are the top two challenges reported by private equity investors, according to Preqin (June 2019).
Only this summer, the AICPA published a comprehensive guide to private equity and venture capital valuations, with a view to establishing an industry standard on the issue.
Regulatory reporting and transparency obligations continue to rise. Firms are dealing with data protection and cross border reporting challenges through CRS, and there are moves to give investors greater visibility on performance. This summer, industry bodies ANREV, INREV and NCREIF announced plans to publish an ‘internal rate of return’ index, to boost transparency for investors. Greater sophistication, a focus on data quality and more complex processes all come with higher costs.
With a possible market correction on the horizon there is a real need for service providers to play the long game and invest. Consideration needs to be given to structural change now – and the risk is that, because IFCs have enjoyed, and continue to enjoy, such good growth in their funds industries, the urgency to act is not recognised.
Adding people will not deliver increased productivity. The focus has to be on working smarter, achieving operational efficiencies and investing in digital platforms. AI, software robotics and processes to make all stages of the alternatives supply chain more cost-effective, from administrators and lawyers to custodians and auditors, must become the focus – and not just tinkering around the edges. It needs fundamental thought to ensure that service providers and the IFCs that house them are ready for the prospect of a market that looks very different in the future.
This challenge was highlighted in a recent survey by Funds Europe and Temenos, which found that some custodians and fund administrators are not keeping pace with the changing requirements of asset managers.
Just over half of the respondents reported legacy technology amongst service providers was a major problem, whilst over 90% said that investment in operational systems had become essential for asset managers to improve efficiencies and reduce costs, with data analytics a particular priority.
The message is clear, asset managers faced with a profitability squeeze and intense scrutiny, expect a commitment to investment from firms if they are to be part of their long-term supply chains.
Digital capability will add value
The good news for centres like the Channel Islands and Cayman is the criteria that have made them successful till now, will continue to prove attractive – stability, good governance, reputation, and substance, will all be viewed favourably. But it is their focus at a jurisdictional level on their digital capabilities through the creation of digital development agencies which should increasingly put them in a leadership position.
Jersey alone has 400 digital businesses and over 3,000 professionals working in digital roles. A network of digital entrepreneurs is developing a tech hub enabling business growth and the rapid adoption of technology solutions that are lowering costs, improving reporting and delivering substantial operational efficiencies.
The initial investment for service providers is considerable, but it is vital that eyes are on the long game, so that a solid, future-proof platform is put in place now. With millions invested in world-beating gigabit broadband, digital skills academies and 'Sandbox' capabilities, the Channel Islands and other IFCs that follow suit can look to the future confident in their continuing relevance and long-term success.
September 2019 / Alternatives Rising
The alternative fund sector is one of the biggest success stories for International Finance Centres (IFCs) – since the rise of cross-border funds some four decades ago, IFCs like the Crown Dependencies and the Cayman Islands have positioned themselves as centres of choice.
The focus has been on high levels of service, an institutional style approach and a suite of appropriate vehicles to facilitate smooth, efficient, big-ticket capital flows.
Today Guernsey and Jersey alone service fund assets valued at around £600bn – assets that are put to work through private equity to help support and grow businesses all over the world. Essential investment is going into supporting infrastructure, developments in retail and commercial property, and in fostering innovation in technology and life sciences.
Mid-way through 2019, though, the alternatives world is finely balanced, with a mixed bag of trends across the spectrum.
Recent Preqin figures paint a picture of a real estate fund sector that is slowing following a period of positive growth. While just over half (52%) of investors are planning to make a new commitment to the asset class over the next year, many investors are also expecting to commit less capital overall as they anticipate a potential slowdown.
Within private equity, meanwhile, fundraising slowed last year compared to record levels in 2017, (although 2018 was still the third-highest on record), and 61% of investors consider we are now at the peak of the equity market cycle.
In the long-term, the future for alternates is bright, with over $2trn in the dry powder locker. Institutional investors are allocating capital as they pursue diversification and higher returns. More than a third of real estate investors, 46% of private equity investors and 50% of infrastructure investors, are all planning to increase their allocation to the asset class in the long-term.
Of course, the alternative funds' community cannot take anything for granted. It must continue, notwithstanding the success seen in recent years, to evolve and to demonstrate that it is fully tuned-in to the trends driving the disruption of the global economy. In this respect allocating capital to the right assets, driving down costs and increasing operational efficiency will be the keys to mitigating these disruptive forces.
According to Capital Economics, forces such as geopolitics and the weaponising of trade have seen protectionist measures more than triple since 2010. The risk of unwelcome interventions is eating away at investor confidence, while Brexit if a no-deal scenario is played out, will cause further disruption in cross-border fund distribution.
That said the continuation of market access through national private placement regimes provides assured safe harbour status for Channel island funds.
With a significant proportion of institutional investment booked in US Dollars, even more of a challenge is the US/China trade war, which risks upending cross border trade considerably.
This is hurting capital flows, with a perceived movement away from global flows to a more intra-regional picture.
While North America, Western Europe and the UK are considered to offer the best opportunities for investors, developing markets are also providing opportunities. In terms of developed markets, 88% of private equity investors see North America as offering the most favourable opportunities followed by Europe (42%), and the Nordics (22%). China and India continue to lead as investment destinations in the developing markets, but a close analysis is vital in identifying investment patterns that are increasingly more regional than global.
Then there's regulation. The AIFMD was, for years, the major challenge faced by the alternatives community in Europe, but regulatory reporting, the Common Reporting Standard, beneficial ownership models and cybersecurity protocols are now substantive considerations for an industry where rising regulatory costs are such an issue. It's one reason why there has been so much consolidation in the alternative fund service provider market, as firms have sought economies of scale to manage these trends.
Then there's the move of private capital into the institutional space. Family offices are now estimated to allocate more than 50% of portfolios to alternatives (Family Wealth Report) and, given that they are sitting atop a mountain of readily investable dry powder, they have the potential to shape alternatives in the coming years significantly.
An emerging trend is the rise of ESG investing. A report by Newsweek Vantage last year found 78% of fund managers think their organisation should be making investments that aim to create positive value for society if they reduce long-term financial risks.
Given their expertise in governance and back-office administration, IFCs have a fantastic opportunity to provide the essential support to ensure fund managers can meet investor expectations in the ESG space.
The alternative fund communities in IFCs have batted themselves into a commanding position over the years, but navigating the coming decade will require all their skill and experience. Despite the near term headwinds, the structural demand for alternatives continues to grow. The primary driver is substantial pension funds in need of returns, with more than 10,000 baby boomers retiring every day, and average life expectancy 10 – 25 years better than the preceding generation.
Anticipating the disruption posed by economic and political volatility, regulatory change, investor demands and evolving fund models, will be vital if IFCs are to play such a central role in the cross-border alternative fund space.
Those IFCs that adjust their sails and navigate the short-term headwinds whilst delivering on the long-term promise can be confident they will succeed.
August 2019 / IFCs can bridge the ESG investment reporting gap
As Environmental, Social, and Governance (ESG) investment continues to evolve in the alternative asset world, International Finance Centres (IFCs) have a fantastic opportunity to provide some essential support to ensure fund managers can meet investor expectations.
However, firms will need to be quick to immerse themselves in this area, gain the expertise they need, and learn to speak the language if they are to prove their value.
Wealth is the new social battleground, prompting wealthy individuals to evidence better stewardship of their assets, by looking increasingly at strategies that can demonstrate social conscience.
Moreover, social conscience is just as relevant to the institutional investment world.
A Newsweek Vantage report published in 2018 found that more than three-quarters (78%) of fund managers agreed that their organisation should make investments that create positive value for society.
In another survey, members of the CFA Institute felt strongly that institutional investors should take ESG factors into account when making investment decisions.
This strong ESG movement in the world of alternative assets is particularly prevalent amongst the large players, the quasi-public pension funds. There's a good reason for this.
Pension funds exist to generate returns for millions of working people. Increasingly their members are the same protagonists demanding action on climate change, greater social equality, and better corporate behaviours.
Pension fund boards are acutely aware of this and are introducing measures to keep in step with the attitudes of their stakeholders.
In that vein, Mourant has helped blue-chip fund managers launch a number of ESG focused investment funds that have been supported by some sizeable pension firms.
The ESG investments are varied. Some of these funds have helped tackle issues such as urban regeneration, water-related infrastructure projects and, in one case, acquiring UK properties to be leased by high performing social sector organisations to deliver front line services to vulnerable individuals.
The common theme is that these funds have the usual financial return targets but these are coupled with delivering a positive social impact.
Governance structures now include the same 'millennial' generation that is increasingly focused on sustainability, purpose, and social value. Studies show that 84% of millennials cite investing with a focus on ESG impact as a central goal.
Given public pension fund investments constitute 44% of total worldwide private capital funding, private equity houses are understandably keen to reflect the changing attitudes of their prime investor base.
However, it's not a simple solution. The world of ESG continues to evolve; ESG itself has been around for decades, but the language, as well as the attitudes surrounding it, continue to change.
Larry Fink's annual letter to CEOs in 2017 was reflective of a growing movement amongst the world's largest investors when it comes to ESG investing.
With private capital moving increasingly into alternatives, courtesy of family offices, we can expect the evolution to continue. However, the convergence of individual and institutional investor aims, and varying geographical and cultural attitudes, have created challenges.
ESG terminology can be complicated; terms such as 'Impact investing,' 'socially responsible investing,' and 'green investing' are often used interchangeably, but have quite different meanings.
A notable change has been the evolution of negative screening, the 'do no harm' approach, which has morphed into a more positive 'do good' approach to investment selection.
So where do IFCs fit?
Institutional investors are demanding greater clarity around ESG performance and credentials. The experience and expertise of alternative fund service providers in IFCs, built up over the years in terms of reporting and governance, could be critical in meeting a perceived gap in service delivery.
Changes in attitude, for example, have certainly helped install a basic set of parameters, but the focus is now on standardisation, data management, reporting, and integrating approaches to ESG investment.
Notably, the BNP Paribas ESG Global Survey 2019 found that the most significant barrier to ESG investing is data (66% of institutional investors), while the cost of technology, analytical skills and the risk of greenwashing are all top challenges too. The same report found that ESG reporting capabilities were one of the critical factors attached to ESG manager selection – up from 11% in 2017 to 29% in 2019.
Administrators in the likes of Guernsey and Jersey have built up exceptional capabilities in cross-border reporting for private equity, real estate, infrastructure, and other alternative assets, but they must now adapt the experience they have and apply it in an ESG context.
Reporting, evidencing performance, and demonstrating impact will be vital in the ESG field, and there's no doubt that there's an opportunity here for administrators. While metrics and information are getting better and better, the overall picture is still quite fragmented, with different standards and reporting initiatives employed in different markets. A study by Guernsey Finance recently found, for instance, that greater transparency and certification around ESG focused alternative funds were essential to investors and managers.
Of course, there are serious questions administrators need to ask themselves to achieve that. Are they sufficiently equipped to be able to apply and develop the UN's Principles of Responsible Investment (PRIs) or Sustainable Development Goals (SDGs) to their reporting? Do administrators have the analytical skills to provide meaningful assessments around impact and performance? Do they need to develop new metrics and benchmarks of evaluation to be able to stand out as experts in the ESG field?
Some remain sceptical about the progress of ESG into the mainstream, but compelling and dramatic evidence of its impact continues to emerge.
European PE house Permira's investment in Dr. Martens saw a sparkling 2019 performance, with 30% revenue growth and 70% improvement in EBITDA. The boost to revenues was primarily attributed to the surge in demand for the groups innovative 'vegan boots,' demonstrating that an ESG driven approach to what consumers want can produce spectacular results.
Mourant assisted Generation Investment Management, the firm co-founded by environmentalist and former Vice President Al Gore, on the close of Guernsey domiciled US$1 billion Generation IM Sustainable Solutions Fund III. The firm's third fund focuses on growth-stage businesses with well-established technology and commercial traction in three areas: planetary health, people health, and financial inclusion.
IFCs who 'tune in' to societal change in this way, nurture skills in the right areas, and take proactive steps in bringing new products and services to market, such as Guernsey's 'green fund' wrapper, can undoubtedly capture the 'ESG' opportunity.
A proactive approach to evolving specialist ESG governance and reporting services presents a real opportunity to play a pivotal role in ESG's ongoing development, and to support fund managers in meeting the ESG appetite of institutional investors.
July 2019 / Stewardship is key as global wealthy embrace self-awareness
A call for the introduction of a wealth tax from some of the US’ wealthiest individuals including George Soros, Facebook's co-founder Chris Hughes and Molly Munger was perhaps, on the face of it, one of the more surprising developments on the US presidential trail last month.
But it shouldn’t really be that surprising – this open letter, which suggested that a wealth tax could ‘help address the climate crisis, improve the economy, improve health outcomes, fairly create opportunity, and strengthen our democratic freedoms’, is really symptomatic of changing attitudes amongst the wealthy towards their place in a world of shifting societal norms.
It’s an attitude that is informed, quite rationally, by decades of experience. Recent history tells us that, in the aftermath of economic downturns, governments have always sought to cast blame on the wealthy and the agents of the wealthy – the wealth advisers, the investment banks, the private client lawyers and the tax advisers – in order to maintain some sort of appeal amongst the masses.
The global financial crisis which started in 2008 is a case in point – something that has its roots in widespread unsustainable property debt resulted in the public bailout of banks, fuelling resentment against banking institutions, wealth advisers, the speculative hedge funds and the wealthy themselves.
We’re still seeing the repercussions of that today – cuts in public services in the UK as a result of the financial crisis and an era of austerity, for instance, have driven further resentment, a backlash against globalisation, a move towards protectionism and a political agenda that has become increasingly polarised – a split world symbolised by ‘Trump’s wall’: Remain and Leave, globalisation and protectionism …the rich and the poor.
Wealth has become the new battleground, and the wealthy are acutely aware of that, and responding – not in defiance, but in an attempt at understanding. Stewardship has become the watchword as wealthy individuals and their families look increasingly at strategies that can demonstrate social conscience, responsibility to the community at large, and transparency.
It’s a trend we have seen emerging for some years – philanthropy, Environmental, Social and Governance (ESG), ethical and impact investing have become increasingly central to the strategies adopted by wealthy individuals and families – the Global Family Office Report suggests that 39% of family offices are projecting when the next generation takes control of their families’ wealth, they will increase their allocation to sustainable investing.
Really only in recent years, has this discourse cemented itself in the corporate world. Larry Fink, CEO of Blackrock, the world’s largest investor, sparked the corporate world into life when he published his annual letter to CEOs in 2017, underlining the importance of a shared focus on long-term sustainability and ESG investing.
More recently, a survey of CFA Institute members revealed a growing tendency towards ESG, with 85% of respondents claiming institutional investors should take ESG factors into account when making investment decisions.
As family offices become more and more institutional in their approach, as the next generation of wealthy individuals take control of family wealth, and as a new breed of entrepreneur emerges, the ‘old’ principles that guided the baby boomers are being challenged.
Millennials seem to be voting with their feet and buying into sustainability, purpose and social value – studies show that millennials are nearly twice as likely to have made a purchase because of a brand's environmental or social impact whilst 84% of millennials cite investing with a focus on ESG impact as a central goal.
For the International Financial Centres (IFCs) that have typically supported the strategies of wealthy individuals, there are some fundamental issues to consider in light of these trends that go right to the heart of a modern approach to wealth management.
Stewardship clearly has to be at the core if they are to continue to reflect the attitudes of the wealthy. Traditional models of wealth and succession planning are not enough. Trustees need to be alive to the subtleties of societal trends; have the right structures and advisers in place to support the needs of the wealthy; and bring their offering together in a much more holistic way that recognises the sensitive and complex dynamic between the wealthy and society more widely.
The ramifications of investment and philanthropic activity needs to be carefully thought through, for instance, if it is to have the desired positive impact and win back the trust of the people - as the wealthy French donors to Notre Dame discovered earlier this year.
In addition, IFCs that have so long trumpeted the merits of globalisation and wealth creation need to think carefully about how they can adapt to defend and articulate a new style of ‘responsible capitalism’ that reinforces their legitimacy in the modern age of stewardship, working for the long-term benefit of the general public – whether that’s through developing niche ‘green fund’ products or by specialising in helping millions in the broader population with their savings for retirement.
Just as the wealthy have shown a greater self-awareness in this new era of stewardship, so too IFCs must continue to rise to the challenge.
May 2019 / Capturing Synergies in an Evolving Family Office Landscape
Today, the requirements of families can be complex, often global and increasingly digital with families often behaving as if they are institutions in their own right. They invariably have multiple cross-border business interests, different generations are taking a much more active interest in family affairs, and financial and lifestyle objectives are increasingly diverse and intertwined.
These are the ‘internal drivers’ that are proactively shaping family office behaviours.
At the same time, the investment, tax and commercial environment families are operating in has become more and more complex. Geopolitics is creating uncertainty and volatility, whilst international regulation and tax are impacting investment and structuring decisions.
These are the ‘external drivers’ that family offices are having to react to.
These internal and external forces are, of course, hugely pertinent to the infrastructures that support families and family offices too. For the advisers and service providers (and the IFCs that house them) that are smart and alive to the implications of this evolution, there are real opportunities to capitalise on the institutionalisation of the family office and capture the resulting synergies between ‘traditional’ wealth management and institutional investment.
One of the most powerful forces shaping the family office space is the globalisation of family activity with wealth moving more rapidly around the world as families become increasingly active in their investment strategies.
As the Knight Frank Wealth Report 2019 highlights, for instance, 36 per cent of UHNWIs now hold a second passport, up from 34 per cent last year, with 26 per cent planning to emigrate permanently, up from 21 per cent, reflecting a growing propensity to take an interest in multiple locations.
At the same time, family offices are moving increasingly into alternative investments as they look to diversify their risk portfolios. The latest Family Wealth Report’s Family Office Focus found that family offices now have an aggregated 53 per cent exposure to alternatives with 39 per cent of advisers globally saying that their UHNW clients had increased their private equity holdings in the past year. In addition, the Global Family Office Report 2018 found that half of family offices intend to invest more in direct investments, namely private equity, this year.
And philanthropic activities (up 29 per cent in 2018 globally amongst HNWIs according to Knight Frank); co-investment with other families; and international business ventures are increasingly common features of the modern family –significantly, over a third (39 per cent) of family offices project that when the next generation takes control of their families’ wealth, they will increase their allocation to sustainable investing (Global Family Office Report).
Regulation and Uncertainty
All this, though, is happening against an increasingly complex regulatory backdrop, with fragmented regional approaches to regulation and rafts of reporting requirements, including the Common Reporting Standard (CRS) and FATCA, impacting family offices with cross-border interests.
The indications are that family offices are still grappling with these issues. In particular, there is a real tension between the desire to comply with requirements on the one hand, and the desire to resist intrusion into their privacy as a family on the other. According to Hubbis, three-quarters of families in the Middle East will only adapt to the new world of transparency ‘slowly and painfully’.
Geopolitical uncertainty is a big factor too – 68 per cent of wealth advisers globally think that the political and economic environment will make it harder for their clients to protect and create wealth this year in their home country. That rises to 72 per cent in the Middle East (Knight Frank Wealth Report 2019).
And from an operational perspective, family offices are spending a fifth of working hours on manual processes on average as they struggle with generic software for accounting and investment analysis (Family Wealth Report).
There’s no doubt that the ambitions of family offices are more sophisticated today - but to achieve these ambitions and respond to external pressures there is still a clear reliance on third party expertise and a need for institutional-grade support.
Whilst ‘traditional’ wealth management expertise remains key for IFCs supporting family offices, the diverse expertise they have developed in areas beyond private wealth could provide opportunities to capture synergies in complementary areas too – specifically alternative investments, regulatory compliance, and digital support.
Guernsey and Jersey, for example, have developed formidable experience in alternative fund structuring. When combined, both jurisdictions today service funds valued at more than £0.6trn, enabling investors around the world to put their capital to work in private equity, infrastructure, venture capital and real estate funds, whilst both have also placed a real emphasis on growing their green and wider environmental, social and corporate governance (ESG) credentials - all precisely the areas family offices are looking at.
And this experience is heavily weighted towards institutional investors i.e. pension funds, sovereign wealth funds etc. That level of experience will resonate well with family offices.
Meanwhile, IFCs like the Crown Dependencies and Overseas Territories (CDOTs) have vast experience when it comes to navigating global regulatory obligations and managing cross-border reporting through CRS and FATCA. New substance rules in the CDOTs, in tandem with recognition from authorities such as the OECD, EU, IMF and World Bank, have also created strong, robust platforms that will appeal to family offices looking for locations that can demonstrate good governance and provide an attractive ecosystem for growth.
IFCs that are clearly committed to growing cutting-edge digital sectors will also reinforce that they understand that a successful family office must also consider the technological needs and the cultural values of the next generation – being able to deliver more efficient, automated, on-demand and remote services and advising on cutting-edge areas like AI and blockchain will become more and more important.
The evolution of the family office towards demanding institutional levels of service and infrastructure means that there is now more than ever a need for high quality expertise that can deliver global, multi-disciplinary and digital support. Those IFCs that take a holistic approach, recognise the synergies between traditional family wealth management and cutting edge global investment, and successfully bring them together, will have a bright future.
April 2019 / Brexit - Trick or Treat?
March 2019 / Brexit: Deal or No Deal
The streets of London were packed this weekend with hundreds of thousands of Remain marchers, determined to make their voices heard.
Mrs May has returned from Brussels without the 30th June extension she had hoped for, and instead must make do with 22nd May if her deal is passed in the House of Commons, and 12th April if not.
Fearing another defeat, the PM's Deputy David Lidington was reported to be engaged in a last ditch attempt over the weekend to build a cross party consensus between a no deal and the withdrawal agreement concluded with the EU.
Press reports have speculated on whether or not Mrs May can carry on, having lost the confidence of key Ministers and the European Council. Her searing midweek intervention, laying blame squarely at the feet of British MPs, appears to have misfired. MPs are after all the only people who could vote her deal through.
Can the House of Commons come up with a solution?
Parliament continues to be divided over the terms of the Brexit deal with the backdrop of a majority of MPs originally voting Remain. Rejecting no deal was relatively straightforward. Saying yes to something, and agreeing the detail is another matter entirely.
Deposing Mrs May will be no easy task with the 1922 committee unable to facilitate a leadership challenge until December 2019, and the fixed term Parliament Act providing a strong shield against Corbyn led calls for an election.
Despite losing out to Oliver Letwin’s indicative vote initiative Mrs May will only step down during the Brexit process if she chooses to. Meantime binary votes on different orders of preference will be a complex and difficult process.
Irrespective of who is PM or whether or not Parliament takes the driving seat, any revisions to the withdrawal agreement need to be acceptable to EU Leaders, who have indicated limited appetite for change.
What happens next?
29th March is no longer in play and the period to the 12th April could see a no deal confirmed simply by default through the passage of time. Alternatively, a new House of Commons consensus may emerge, but with no certainty that the EU will agree it.
What is in the withdrawal agreement?
When faced with the extraordinary quantum of information generated over the 1,000 plus days since article 50 was triggered, it's easy to lose sight of the terms of the withdrawal agreement. Ploughing through its 599 pages, not to mention the additional 26 pages in the political declaration, is a daunting task.
Withdrawal Agreement – what are the key points of interest?
When considering the agreement it's important to remember these are withdrawal terms and not the future trade deal. You can find a detailed but accessible summary here.
There are Brexit implications for the devolved administrations, and the Crown Dependencies and Overseas Territories (CDOTs). As the Withdrawal Agreement 'key points' graphic above indicates, they haven’t been forgotten.
Citizens' rights to stay are clearly important as is a stable transition, and it's been confirmed that the common travel area within Britain will continue. In the case of the Crown Dependencies, industries such as fisheries and farming need new solutions.
However, it is UK manufacturing and supply chains that have the most to fear from a no deal crash-out. With the CDOTs largely focused on financial services and not being major manufacturing centres, this should not be a significant concern for them.
The CDOTs governments have been proactively engaged throughout the Brexit process and comprehensive information is available on their Brexit strategies on their official websites.
Examples can be see in the following links published by the Governments of Jersey and Guernsey.
Third country services are unaffected by Brexit
Economies in the CDOTs are heavily skewed to financial services with access to the EU through individual bilateral agreements negotiated sector by sector on an equivalence basis. They are classified as third countries for market access purposes. This means that their legislation, regulation, and investor protection rules must all be assessed as substantially equivalent by the EU before market access is granted.
Equivalence status means that approved third country regimes receive protections through the EU single market rules:-
“In a second step, the Maastricht Treaty, which entered into force in 1994, introduced the free movement of capital as a Treaty freedom. Today, Article 63 TFEU prohibits all restrictions on the movement of capital and payments between Member States, as well as between Member States and third countries.”
Source: EU Parliament
Alternative funds are one of the primary CDOTs' financial services activities in EU markets.
And the CDOTs have the infrastructure in place to enable investment flows to continue seamlessly through tried-and-tested private placement routes into the EU. Whilst there may be a second order impact from any economic slowdown, the CDOTs financial and related professional services market access to Europe is unaffected by Brexit. They continue to provide an attractive safe harbour for promoters through uncertain times.
Estimates of the economic impact of deal or no deal scenarios vary greatly. Whilst many options will be proposed in the indicative votes, there are realistically only four main scenarios: deal, no deal, no Brexit or a longer delay.
In our view, each of these would have a different economic outcome in a range of plus 1.50% to minus 0.5% of GDP in 2019, depending on how hard or soft the Brexit experience. The worst case scenario of no deal would, we believe, trigger a short sharp recession. However, with the British economy currently the strongest in the G7, media predictions of an economic catastrophe are unlikely to materialise.
The CDOTs are part of the British family and a good neighbour to Europe; they are important investment partners to both sides of the Brexit equation. They continue to support and engage constructively as Britain and the EU search for a fair and equitable outcome.
As facilitators of hundreds of billions of internationally mobile capital, the CDOTs will continue to work together with their British and EU partners to build a better future, by providing the essential long term investment needed to develop jobs, growth and prosperity.
As this week unfolds, the shifting sands of the Brexit deal or no deal situation will intensify. Please look out for a further update on our blog during next week.
February 2019 / A middle ground for globalisation
Rewind a year to Davos 2018, and the antagonistic dynamic between protectionism on the one hand and globalisation on the other was a clear theme.
Back then, German Chancellor Angela Merkel pronounced that ‘protectionism is not the answer’ to a prosperous future for global markets, whilst Indian Prime Minister Narendra Modi concurred, suggesting that resisting globalisation is one of the three biggest threats to global economic success.
A year doesn’t seem to have made much of a difference – in fact, fast forward to Davos this year, and if anything the temperature has been notched up yet again. Although the theme of Davos this year was “Globalisation 4.0: Shaping a Global Architecture in the Age of the Fourth Industrial Revolution”, in reality, globalisation was still in the dock.
Rather than fronting an unequivocal endorsement of globalisation as a force shaping a desirable future, Davos this year succeeded in sparking debates around the impact globalisation may or may not have on inequality, climate change, migration and tax. Those attending were cast as elite private jet-setters, detached from the ‘man on the street’, and as the champions of big businesses. President Trump, Prime Minister May and President Macron weren’t even there, leaving Japan and Germany to fight globalisation’s corner.
Challenging the assumptions around globalisation is understandable, because it impacts us all – what we buy, how we buy it, how we interact with each other, where we work, and there’s no doubt that having proper discussions around globalisation is an absolutely vital part of modern economics, politics and society. It involves complex questions that do not just revolve around trade, but impact on culture and society too.
Overall, the impact of globalisation is fairly poorly understood. Globalisation is often accused of benefitting the wealthy at the expense of the poor and yes, its impact on the wealthy is greater than on the poorest in society.
However, it is still the case that globalisation has helped pull millions of people out of poverty; it has provided jobs and employment; and it has provided opportunity for those who might not otherwise have had any. A World Bank study, for instance, has suggested that the number of people in developing countries living in extreme poverty has fallen from more than 50% in 1981 to 21% in 2010, despite a 60% increase in the population in the developing world.
It’s also vital that we have proper discussions about what the alternative means for each and every one of us. Protectionism and global fragmentation is a very real trend too – Capital Economics and the World Trade Organisation note that global trade-restrictive measures have more than tripled since 2010, whist HSBC’s latest global Trade Navigator survey found that 63% of firms think governments are becoming more protective of their home economies. But what does this all mean for our future livelihoods, career prospects and the cost of goods and services?
Again, these are complex questions – but it is all relevant to international finance centres. In fact, I would contend that IFCs have a key role to play in all this.
The world today is very much one of dichotomies – remain and leave; populism and globalisation; rich and poor; small business and multinationals – with proponents of each constantly shouting at each other through Twitter and other fora.
For the forward-thinking IFC, it strikes me that there’s a really crucial role here that goes beyond being passive conduits of international capital. As neutral centres, there’s also an opportunity - an obligation even - for IFCs to play more of a proactive, mediatory role, that can champion a new form of globalisation, promote inclusivity, and provide some balance, impartiality, rationality amongst the noise.
I’d even go as far as to say that, if IFCs don’t realise this opportunity, be bold, assert their value, and start asking themselves questions about what this new role means and how they can provide some middle ground that can encourage global collaboration, debate, and cooperation, they may well find themselves steamrollered by the big hitters in both corners.
And with IFCs providing trillions of dollars of inward investment to support the lives of millions of people around the world, helping to finance the construction of schools, roads and hospitals in countries in all corners of the globe, and doing so in a way that ensures public and private sector capital is put to work in the most efficient way possible, I think for IFCs to not be part of this future would be to the detriment of everyone.
Geoff Cook, Consultant