Channel Island funds post-Brexit - Part II
18 March, 2021
In the second of a two-part blog, we’re discussing the future of the Channel Islands for fund domiciliation and looking at some of the economic, tax and regulatory developments on the horizon.
In Part I of our blog, published last month, we looked at the EU-UK Trade and Cooperation Agreement (“TCA”) which came into effect at midnight on 31 December 2020.
We highlighted the immediate impact on existing funds, noting that for fund distributors which are not the fund itself or its principal manager and therefore fall under the MiFID regime, the end of the transition period and the TCA not providing for ongoing passporting from the UK to the EEA meant their MiFID passporting rights were lost. The consequence of this being that UK distributors became more restricted in their ability to engage with potential investors going forward. We discussed though that a number of solutions were available and that PwC were working with managers to implement these.
In Part II, we’re thinking about what the current political and regulatory environment means for future fund launches and whether things have changed for the Channel Islands.
- The Channel Islands’ position is unchanged
- Increased competition on the horizon?
- Blacklisting threat
- The COVID-19 question
- “If it ain’t broke, don’t fix it”
The Channel Islands’ position is unchanged
As we look ahead at future fund launches, we are often asked about the ongoing attraction of the Channel Islands for fund domiciliation and administration.
First and foremost, the Channel Islands’ position from a financial services perspective is unchanged as a result of Brexit. We were a third country and we remain a third country. This has the advantage of offering funds a menu of options, depending on the intended marketing activities.
Funds not marketed into the EU
As a third country, AIFMD rules are not applicable to Channel Island funds when they are not marketed into the EU. For such funds, therefore, the Channel Islands continue to offer an attractive proposition with a proportionate regulatory approach for such structures. Tax neutrality remains assured through transparent vehicles or the headline 0% corporate tax rate.
National Private Placement Regimes (“NPPR”)
For funds which are intended to be marketed into the EU, this is possible through national private placement regimes, which have proven incredibly effective over recent years in raising targeted capital. Furthermore, compliance is required with only Article 42 of the AIFMD rather than ‘full fat’ AIFMD, meaning some of the costlier obligations such as the requirement for a depositary may not be applicable. This remains an attractive option where marketing into a smaller number of pre-defined jurisdictions.
Marketing passport potential
A marketing passport is currently only available to EU managers of EU funds. This is a more onerous regime from a regulatory perspective but comes with the benefit of being able to market funds throughout the EU without further authorisation requirements or Member State approvals.
In 2015, ESMA recommended that Jersey and Guernsey be included in the first wave of third countries to participate in the marketing passport, once available. Although there has not been much movement on a passport since, it is reassuring that the Channel Islands should be at the front of the queue if/when it is forthcoming.
With this in mind, there is an option for a Jersey manager, for example, to opt-in to a fully AIFMD-compliant regime such that they are ready for when the passporting regime is extended to third countries.
To summarise the above, whether a Channel Island fund is to be marketed into the EU or not, there are regimes to suit and these have proven successful in raising capital both in and outside of the EU.
Increased competition on the horizon?
An interesting development is that, with the UK joining the Channel Islands as a third country, there has been discussion about whether it might become a competitor for fund domiciliation. Indeed, the UK is now actively consulting with industry stakeholders on what changes it should make to its tax and regulatory regimes to become an attractive jurisdiction to establish funds and their underlying asset holding companies. Similarly, we’ve seen a new Irish Limited Partnership product launched, offering more competition in the alternative funds space.
The challenge the UK has is that they have an immensely complicated tax code (ask any tax professional about the bible-paper thin “yellow books”) and regulatory environment and there has been some concern that the policy development starting point seems to be about how to prevent abuse, rather than how to create an attractive product. The obvious risk here being that the final product could be too complex, clashing with business demands for simplicity.
This alone highlights differences that go to the heart of our respective jurisdictional DNAs; the collaboration in the Channel Islands between industry, regulator and government is second to none. The success of the Jersey Private Fund product is cold hard evidence of this. The UK proposal has huge potential to become a successful jurisdiction for fund domiciliation if the right balance can be struck and, importantly, maintained over the coming years to demonstrate its commitment to businesses looking to establish structures which may see multiple political and economic cycles.
Blacklisting threat
On the other side of the English Channel, the European Parliament recently passed a resolution on the EU’s list of non-cooperative jurisdictions for tax purposes, proposing it be expanded and that the existence of a 0% tax rate become a criterion of itself. Much has been made of this and whether it might result in the Channel Islands being blacklisted, particularly now we have lost the UK’s influence in Brussels.
In this regard, it is firstly worth noting that the Parliament does not have powers to unilaterally legislate; the EU Council sets the criteria for the list and ultimately determines the countries for inclusion.
The Channel Islands have consistently adhered to and even driven international standards on AML, regulation and tax. It would be reputationally and economically unwise for the islands to find themselves on such a list and so, in the event such a criterion is adopted, it would be possible to take appropriate action to ensure the islands remain off it.
Although this may initially sound concerning, from a funds perspective in particular, it appears a low risk development given there is a general acceptance of the transparent and low risk nature of funds. The EU’s acceptance that their exclusion from the scope of Jersey’s recently introduced Economic Substance law was appropriate, is one example of this. A similar outlook is held by the OECD and their own minimum tax rate project, under the title ‘Pillar 2’, also looks likely to provide certain exemptions for funds. We will be exploring the impact of Pillar 2 in due course.
The COVID-19 question
COVID-19 has had a huge impact on all of us and in so many different ways. While we’re hoping the worst is behind us and that life will return to some semblance of normality soon, the economic impact will be felt long into the future. We saw this with the recent UK Budget, where it was estimated that COVID-19 would have a permanent 3% negative impact on the UK economy.
The impact of COVID-19 on every jurisdiction’s finances has been significant and consideration is increasingly being given to how the costs will be paid for, largely through a combination of economic stimulus measures and tax rises.
We’re yet to see the final bill, but the Channel Islands’ economies look likely to come through the pandemic less impacted than other jurisdictions. Due to their unique geographical situation the islands have been able to manage the pandemic more effectively than most, resulting in fewer periods of physical and economic lockdown. Furthermore, financial services has globally been one of the less impacted sectors and, given it’s overweight contribution to the islands’ economies, this should again contribute to an overall less severe economic impact relative to other jurisdictions.
As we look at the future attractiveness of the Channel Islands, therefore, although the economic impact is and will be felt, it is likely to be proportionately less than other jurisdictions. This should ensure the islands remain internationally competitive from a personal and corporate tax perspective and can continue to offer the long-term stability fund managers seek.
With fund life cycles frequently spanning the best part of a decade, the political and fiscal stability the islands afford fund managers looking for the best jurisdiction in which to domicile their fund should not be underestimated.
Similarly, the islands have been popular jurisdictions for fund manager relocations in recent years and we have seen a further increase in the number of individuals looking to relocate to the Channel Islands as the pandemic has unfolded as families reevaluate their priorities. Through the excellent work Locate Jersey and others do in this space emphasising not just the tax and regulatory regime but, more importantly, the quality of life on offer, we expect the already noticeable uptick in fund manager relocation interest to be sustained, contributing to the economic recovery of the islands and bringing further substance to the islands’ funds sectors.
“If it ain’t broke, don’t fix it”
Much of the above was the subject of debate at a recent industry event and the message coming back loud and clear was “if it ain’t broke, don’t fix it”. The Channel Islands’ funds propositions remain strong and, although Brexit has created some immediate challenges and there is undoubtedly change on the horizon, there’s no reason the islands shouldn’t be able to navigate those to remain amongst the pre-eminent jurisdictions for funds and, increasingly, fund manager domiciliation.
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