The Non-Regulation Of Hedge Funds In Off-Shores Jurisdictions

The Non-Regulation Of Hedge Funds In Off-Shores Jurisdictions: Cayman Islands, British Virgin Islands, Mauritius And Delaware Date: May 29, 2022 Presented by: Dr. Ana Maria Fagetan (University La Sapienza of Rome) Hedge funds regulation in Switzerland - The main Swiss legal and regulatory overview in terms of hedge funds is represented by the Collective Investment Schemes Act of June 23, 2006 enacted on January 1, 2007 and adopted by the Swiss Federal Council and the Swiss Financial Market Supervisory Authority (FINMA). FINMA issued several circulars relevant decisions, respectively on August 29, 2007 updated guides on public offering and private placement enacted on October 1, 2007, regarding the private employment of nonSwiss collective investment schemes. - Up to now, Switzerland has been a significant domicile for single hedge funds. Still, Switzerland does represent an important market for the placement of funds of offshore hedge fund products and an attractive jurisdiction for the management and distribution of foreign hedge funds. The Impact Of The AIFM Directive On The Switzerland Regulatory Regime  The AIFM Directive does not apply because Switzerland is not a member of the EU. Still, the Swiss Financial Market Supervisory Authority (FINMA) has made no statement whether some transparency aspects of the AIFM Directive should still be adopted and whether co-operation agreements between the targeted EU country, the Swiss authorities and the fund domicile's local authorities should be in place.  The AIFM Directive had a direct impact on the Swiss alternative market: Switzerland has become more appealing to the EU managers, mainly to those managers in the UK that seem to be most adversely affected by the new rules, besides the impeding tax reform adopted in the country. Since the implementation of the AIFM Directive, local consultants and lawyers have been overwhelmed with inquiries from UK asset managers questioning about setting up in Switzerland. The Swiss law has become more attractive as a result of its light regulation background.  Nevertheless, recommended changes to be incorporated within the laws of investment market in Switzerland raised several concerns because European regulation is already very strict and it seems that this country intends to implement even stricter regulations. The Regulation Of Hedge Funds In The United Kingdom And The Impact Of Brexit - Generally, hedge funds are domiciled in offshore jurisdictions (mainly because offshore hedge funds enable entities to avoid domestic regulatory, at the same time having a favorable tax treatment), as the UK-based hedge funds are relatively few. Nevertheless, after New York, London remains the second-largest international center for hedge fund managers. Practically, there was a tendency for the regulation of hedge funds in UK to target managers themselves, instead of targeting the hedge fun entities, in order to reach also the funds located outside UK's jurisdictional reach. Fund managers in UK, similar to other investment managers, must be developing activities which represent a regulated activity under the Financial Services Market Act (FSMA) and also under the Regulated Activities Order. Therefore, in order to be able to carry out such activities, hedge funds must hold the necessary Financial Conduct Authority (FCA) authorizations. - The current regulations allow some funds that invest in underlying hedge funds (funds of funds) to be domiciled in the UK and also to be listed on the London Stock Exchange under the form of investment trusts. As Dickson states: "investment trusts are not collective investment schemes (CIS) for the purposes of the Financial Services Market Act (FSMA) and do not require Financial Conduct Authority (FCA) authorization themselves. Nonetheless, the investment manager of an investment trust will still need to be authorized. The advantage of a UK-listed fund of funds is that it can provide an indirect route to investment in multiple underlying hedge funds while still requiring adherence to the continuing obligations and reporting requirements contained in the UK Listing Authority's Listing Rules." - In March 2019, although asset managers have already implemented their contingency plans, the Investment Association (IA) was highly disappointed by all the failures of the House of Commons in passing the withdrawal agreement together with the other uncertainties concerning Brexit. According to the IA, British savers have withdrawn nearly £15 billion from UK equity funds since the date of the referendum. - At the same time, in 2017, the Investment Association (IA) pointed out the paramount of avoiding a no-deal exit. At the same time, "statements made by ESMA in July 2017 raised doubts about the continuing viability post-Brexit of the 'delegation model' employed by many international fund management groups, in which a fund manager authorized in one country delegates fund management or advisory duties to an affiliate in another jurisdiction (which may be outside the EU)." In a recent keynote address, the Chair of ESMA, highlighted that the delegation model is under no way undermined or doubted by ESMA. This model stands as a basic, important characteristic of the investment funds market at the same time contributing to its success through the ability to organizing centers of excellence in various jurisdictions. - At the same time, ESMA clarified that "it does not envisage changing the legal requirements, but is rather seeking to aid their practical application and help authorities when supervising delegation arrangements so that national regulators would be able to interpret the requirements consistently." On the side of this, in February 2019, a memorandum of understanding (MOU) was signed by ESMA with the FCA, making sure that the delegation model will be employed further on by asset managers in the scenario in which the UK would have left the EU without a agreement. However, this is no longer the case. The Non-Regulation Of Hedge Funds In Offshores Jurisdiction Cayman Islands, British Virgin Islands, Mauritius And Delaware  Palan (1998) offers one of the most precise definitions of the term 'offshore' depicting it "as legal enclaves distinguished from their 'on-shore' brethren, not necessarily because of their location, but because they define a territory or a realm of activities in which states choose to withhold some or all of their regulations and taxation. In that sense, offshore signals a profound fissure in the life of the state system: it denotes nothing less than the bifurcation of the juridical space of sovereignty in into mutually dependent relative spaces". In a similar definition, this time more recent, an "offshore hedge fund is called offshore when its manager creates a legal entity in a country other than that of the management company in order to profit from its low-income tax and financial benefits."  Offshore hedge funds tend to be set up by sponsors expecting to manage a significant amount of capital from non-US investors and/or from US-based tax-exempt investors which want to avoid Unrelated Business Taxable Income (UBTI), most of the time domiciled in tax-li tax-light or even no-tax jurisdictions.  Unrelated Business Taxable Income (I.R.C. Section 511(a)(1)). The definition of the UBTI regards the gross income derived either directly, or indirectly, through a partnership with any organization; this is chargeable on the profit its unrelated trade activity or other business regularly carried on by it (I.R.C. Section 512), minus the deductions directly connected with carrying out such act activity. Both the gross income and the deductions are computed with certain modifications and are subject to certain exclusions.  In general, UBTI does not imply: interest, dividends, or gains from the sale o exchange of capital assets. As a consequence, a tax-exempt investor's distributive share from a hedge fund does not class as UBTI, which does not make it subject to federal income tax.