Reviewing the private equity model in the new financial world: How specialist financial centres compare

In the new financial world that’s followed the credit crisis, financial services companies including private equity are making sure that they’re fit for the more regulated, transparent environment. New regulations and tax scrutiny have triggered these reviews. But intense political pressure has added the threat of reputational risk.

As pre-credit crisis funds reach maturity, private equity firms are launching new funds and reassessing the construction of their investment vehicles– including the advantages of centres historically called ‘offshore’.

But when making these assessments, we believe that it’s no longer useful to describe centres as ‘onshore’ and ‘offshore’. Increasingly uniform regulation and tax transparency have made this distinction too crude. It’s more appropriate to think of specialist international financial centres, which have evolved to serve niche financial sectors, and to compare them according to their respective merits. The only sense in which some remain ‘offshore’ is that they’re islands.

The obvious questions are: Do the historic benefits of the largest specialist private equity centres remain? Or have today’s regulatory, fiscal and reputational changes shifted the balance in favour of other jurisdictions?

Our analysis shows that the most progressive specialist private equity centres, on balance, still give Limited Partners (LPs) and General Partners (GPs)a distinct advantage -- taking regulatory, tax, reputational and practical considerations into account. But this depends on selecting a forward-looking centre that’s working closely with all relevant governmental and inter-governmental organisations, across the European, US and BRIC regions, to offer transparency and to adapt to the evolving regulatory and tax environment.

When judging the merits of one jurisdiction over another, private equity firms rightly put their investors’ needs first. In the tough fund-raising climate, investors call the shots and this is unlikely to change. For investors, the best specialist financial centres offer tax neutrality and regulatory flexibility, which will allow them to market into Europe without suffering a disadvantage when seeking investors in the US or BRIC markets. The most forward-looking specialist centres have moved quickly to adapt to the changing international regulatory and fiscal environment–seeking to balance the concerns of inter-governmental associations with the needs of the private equity industry and its investors.

In our analysis for clients–which we have sought to keep objective–we have concluded that for almost all private equity firms the most evolved specialist centres such as Guernsey and Jersey remain the best option.

Having moved quickly to adapt to regulatory and tax changes since the 2008 crisis, the Channel Islands rank as specialist centres that differentiate themselves through offering private equity the flexibility to operate in the emerging multi-polar global market. In this global market, private equity managers need the flexibility to adapt to the rise of the fast-growing economies of South America, Africa, Asia and the Middle East, both to make investments and to market to theirfast-growing sovereign wealth funds. 1

1 Rise and connectivity of the emerging markets (SAAME), 2012. PwC Project Blue.

How the Channel Islands match up

The Channel Islands are the most established specialist centres for private equity. While they established this position before the financial crisis, they remain highly competitive. Many of the strengths that previously attracted GPs to the islands remain relevant, and the islands’ governments are successfully working to adapt to the new world of international finance.

Both Guernsey and Jersey have been among the most proactive specialist financial centres in preparing for AIFMD. They’ve been in active dialogue with European policymakers and regulators, in order to put the regulatory frameworks in place that will give GPs based on the islands the flexibility of a dual approach.

From a tax perspective, the islands retain the tax neutrality of a LP structure, but have also been signing growing numbers of TIEAs with other governments. With respect to FATCA, they’re also looking into following the intergovernmental approach pioneered by the UK and other European countries, which will simplify compliance. What’s more, the OECD made both islands early members of its ‘white list’.

When it comes to the increasing important topic of corporate governance, both islands have communities of well-qualified directors. In both cases, the principles of good corporate governance are enshrined in law.

Equally importantly, the islands have strong service infrastructures. The major accountancy and law firms have local presences, as do the international private equity administration companies. There’s also a large number of international banks and a big pool of educated financial services employees.

All of this is available at competitive costs. Both office rents and salaries are competitive on the islands. For these reasons, private equity CFOs continue to favour the Channel Islands. In a recent survey, CFOs ranked Guernsey and Jersey first and second among European private equity domiciles.2

2 Helping the industry reach new highs. Survey of Chief Financial Officers. 2011. Private Equity News/State Street.

While the broad shape of the new financial world is becoming clearer, a lot of important detail remains unclear. Important details of regulations still have to be agreed and the tax positions of different governments are still evolving. Against this background, choosing a domicile for a private equity GP or LP takes foresight.

Each private equity firm will have a different set of circumstances when making its decision. But we would argue that the new world has made two factors supremely important:

  1. Quality – Regulation and taxation mean that more of the GP and LP’s functions need to be carried out in the specialist centres where they’re based – this takes a strong infrastructure of service companies and qualified directors
  2. Stability – Continual changes and pressures mean that specialist international financial centres need to have respected governments that have open dialogues with international regulators and tax authorities, and that backing governments must have strong public finances to guarantee fiscal certainty.
 

Contact us

Roland Mills

Partner, Asset Management, PwC Channel Islands

Tel: +44 7781 117376

Mike Byrne

Asset Management leader, PwC Channel Islands

Tel: +44 1534 838278

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