There are a number of jurisdictions and structures available for consideration for a new hedge fund manager. Operational considerations and investor location may influence the choice of structure and jurisdiction, while other factors, such as political instability and legal system, may compel hedge fund managers to launch offshore.
1) Tax Neutrality (Double Taxation) & Transparency
Hedge fund managers may decide to accept capital from investors based around the world. In this case, one structure that might be tax efficient (due to tax transparency of certain structures) for one type of investor may not be suitable for other investors based elsewhere.
A tax neutral jurisdiction would normally be chosen by the fund manager, to ensure that double taxation will not occur. Double taxation is where the hedge fund itself is taxed in the jurisdiction it is domiciled in, and the investor is taxed again as tax resident of his own jurisdiction when the investor redeems his investment. Tax neutrality will allow the investor only to be taxed once, where the proceeds of the investment is returned and taxed at the individual level, as capital gains or income (depending on the tax legislation & policies where the investor is tax resident). Tax transparency is made possible through information-sharing policies like FATCA and CRS.
Infrastructure & Institutions
An offshore jurisdiction might be chosen due to the various infrastructural and institutions-related advantages that it brings.
A political system that is stable will yield a policy-driven and apolitical regulatory environment for businesses and financial institutions.
Many offshore financial centres are either British Overseas Territories (such as the British Virgin Islands, Cayman Islands and Gibraltar) or Crown dependencies (such as Guernsey, Jersey and the Isle of Man), inheriting the tradition, structure and stability of the English legal system.
There is a concentration of talent and professional expertise in such jurisdictions, with an established financial infrastructure & financial institutions and experienced third-party professional services providers.
Political, Economic & Social Instability
In an increasingly volatile world, where political and social instability is the norm, investors and fund managers may decide to choose an offshore jurisdiction that will provide a safe haven from civil strife.
Institutional investors tend to have a long time horizon, with some assets that may be illiquid or not easily disposed, and therefore cannot react to rapid regulatory changes caused by political instability.
Balanced Regulatory Approach to Financial Services
Established offshore financial centres such as the Cayman Islands and the British Virgin Islands have regulators that create transparent and compliant regulatory frameworks that oversee the financial services industry based in their jurisdiction, and collaborate with governments, national regulators and international authorities on an ongoing basis.
FX Hedging & Capital Controls
Political instability and macroeconomic shocks can lead to wild swings in the value of a country’s currency, causing an investor or a fund to sustain significant losses due to currency depreciation.
Additionally, governments and national authorities may be compelled to introduce capital controls, which can damage the performance of a fund, and prevent international investors based outside the jurisdiction from redeeming their subscription.
Basing a hedge fund in an offshore jurisdiction will minimise a hedge fund’s exposure to such scenarios.
Regulatory Expertise, Efficiency & Flexibility
Regulators in offshore jurisdictions are known for their efficiency and expertise, in relation to the financial services sector.
Applications to the national authorities and regulators are reviewed and approved quickly and unlike onshore jurisdictions, there are few or no restrictions for hedge funds on both investment strategy and asset classes.