Make the UK great - for funds - again

It’s been a grim start to autumn. As the sun disappears and testing is ramped up, somewhat inevitably, COVID-19 has reappeared, sending the Government into spasms of despair and the rest of us, to our rooms. Amid tightening social restrictions that could permanently destroy large portions of the UK economy even with state support, Brexit inches ever closer with still no trade deal and no clarity over passporting rights for UK investment firms once the transition period ends on 31 December 2020.   

Entrepreneurs are however positive by nature, and we think that there is one big potential for the United Kingdom once outside the EU. For one thing, a post-Brexit future could see the UK build on its status as one of the most vibrant asset management centres in the world.

A brand new fund structure and marketing regime could be a platform on which the UK revives some economic growth and creates an ecosystem of employment, not just in London, but around the UK.

For the alternative investment community, this could represent a huge step in making investments and deal-making more straightforward, efficient and user-friendly - a mission that resonates with our commitment to bring great user experience to the alternative investment space.

Outside of the EU, the UK is disqualified from most retail schemes that need EU-wide general passporting, but we think there is a big opportunity in the private funds space for the UK to capture. For decades, top fund jurisdictions, such as Luxembourg, Ireland and the Cayman Islands, have attracted international investors with compelling tax-neutral structures and specially designed legislation. The result is that they now have large communities of service providers, like  custodians and fund-structuring companies, to service their clients.

Over the years they have fine-tuned their regulatory frameworks to fit hedge funds (Ireland and Cayman) and private equity (Luxembourg) funds in a manner that the UK never did. Yet, despite the relatively strong position of these fund centres compared with the UK, there are strong signs that, should the UK pursue action to onshore the value chain for investment management, the appetite in the industry is there to use onshore structures.

It is well known that some of the traditional fund jurisdictions do not always offer the fastest and the most cost-efficient service. Their administrative requirements and old school approach can be cumbersome to some fund managers, dealmakers and investors.

For example  Lloyds of London, the UK-based global insurance & reinsurance market, sent a letter to its Member Firms barring them from investing in Irish and Luxembourg UCITS fund structures by 2022 due to “onerous” compliance requirements. 

These jurisdictions still have a lot going for them and will remain the favourite choice of institutional players for many reasons that we detailed before. But the relative affordability of UK service providers and the technology capability of its government agencies can make it a solid option for smaller and private schemes.

Turbulent financial market conditions and the upsurge in demand for alternatives provides the optimal time for the alternative investment market to shine – and if the UK had appealing onshore solutions for this sector, one that had fewer demands than the EU’s Alternative Investment Fund Managers Directive (AIFMD) – that growth could help catalyse the UK financial sector in a post-pandemic, post-Brexit era.

There are no quick wins here. The UK has a long road ahead to convince a £9 trillion industry to re-shore assets currently largely held in the traditional jurisdictions. But with pressure from the industry gaining momentum, there seems to be a move towards laying the groundwork for a unified UK regulatory approach that is aimed at encouraging onshoring.

The introduction of the Private Funds Limited Partnerships (PFLPs) amendment has been helpful, as is the fact that non-resident investors no longer have to register for Self Assessment with HMRC.

A few months ago, the UK Government launched a consultation to explore the attractiveness of the UK as a jurisdiction for the intermediate entities through which alternative funds hold fund assets, and to understand the current barriers to the establishment of such intermediate fund entities.

While the Government confirmed that it is not prepared to make changes that take significant amounts of existing UK taxable income and or gains out of the scope of taxation in a way that is inconsistent with the principles of the UK tax system, it committed to making legislative changes in response to the consultation, subject to evidence that those changes will bring clear benefits to the UK, by facilitating the flow of capital, income and gains between investors and the underlying investments.

So, in the interest of supporting the UK Government to create the optimal tax and regulatory framework for an onshore asset management industry and enable the growth of a competitive and sustainable private capital ecosystem over the long term, we think the below ideas could help:  

1. Remove the requirement for UK resident non-domiciled investors to pay remittance tax on the capital invested through UK partnerships if the underlying assets are not in the UK. Politically, this could be a hard sell because of the need to beef up public sector finances in the wake of the coronavirus pandemic, but pragmatically, the direct loss in terms of taxes collected is close to zero (Because 99.99% of cases where the situation happens, they would just use a non-UK partnership) while the potential gains from onshoring are big.
2. Introduce the ability for PFLPs to be compartmentalised and establish sub-funds. It’s a (fairly) simple, and very neat and elegant innovation that Luxembourg, Ireland and Delaware among others have been offering for a while. Such legal innovations are at the very root of phenomena like “Rolling Funds” for example - which the UK is completely missing on. 
3. Create a tax neutral open-ended vehicle for hedge funds, similar to the SICAV or to the new Singapore VCC, and a light-touch open-ended fund regulatory framework with minimum subscription terms and professional investor classification with a fast registration speed.
4. Formalise an unregulated SPV structure, like the SOPARFI in Luxembourg, and allow it to be more legitimate, rather than having it as a JV, specifically allowing for the unregulated single-deal SPV structure to be a possibility, provided that no investors are retail.
5. Enable the growth of digital banks that can accommodate the investment management industry. In the UK, there are few banks that are able to onboard investment vehicles, unlike Luxembourg or Germany, and compliance is arduous. It is difficult for most in the space to get a bank account. This skews the playing field to the large incumbents and is obstructive to grow the market. 
6. Allow for a light-touch marketing regime to professional and retail-exempt investors. In the US, sponsors can fundraise publicly under 506(c). In the UK, it is extremely painful to fundraise even privately. Retail-exempt investors inclusion in alternatives is often scorned by regulatory agencies because of the consumer protection concerns around it. But while there have been without a doubt a few scams - mostly around Real Estate, for example the now notorious mini-bonds scandal - this has also - at a much greater scale - helped finance a number of great companies and have provided investors access with a more interesting and more lucrative asset class. There are good reasons to believe that, would marketing & access be easier, these benefits would scale proportionally.
7. Allow for a light-touch investment management regime for startup managers. Currently the process of becoming an investment manager in the UK is far from being easy, forcing the majority of them to rent out their license from regulatory hosting providers. The industry would benefit from a light-touch regulatory regime for startup managers focused on anti-money laundering (AML) with heavy restrictions on the profile and number of investors and on assets under management (AuM) for example.
   

It will certainly be interesting to see how the UK engages with the investment industry on these matters.   

In the meantime, VAUBAN will be supporting the Alternatives industry with best-in-class digital legal entities, and take a huge amount of complexity out of the administrative process in the process. 

Until next time.

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