Onshore exodus?

The marketing restrictions currently in the proposed European Union Directive on Financial Regulations could put some of private equity's favourite offshore jurisdiction out of favour. Simon Thomas and David Billings of law firm Akin Gump Strauss Hauer & Feld discussed with Private Equity Manager some of the potential consequences of new regulation. Thomas is a partner in Akin Gump’s investment funds practice, and Billings is the head of the investment funds practice. They are based in the firm’s London office.

HOW COULD THE PROPOSED DIRECTIVE, IF PASSED, IMPACT PRIVATE EQUITY FUND STRUCTURES?
Simon Thomas: The proposed directive, which is quite controversial and is subject to a lot of political lobbying at the moment, effectively regulates every single investment manager in Europe, whether they are infrastructure, real estate, private equity, distressed debt, or a hedge fund. The quid pro quo of being regulated is that a regulated manager under the Directive will then be able to widely distribute the funds that they manage within Europe. What currently happens is if you want to sell a private equity fund, you need to use all the private placement exemptions, and every time you went to Germany, France, and Italy you’d need to get a separate legal opinion as to can you distribute, and who can you distribute to. Now they’re going to do away with those private placement exemptions and just have one set of rules governing the marketing of funds.

The downside for places like the Caymans is that the ability under the proposed Directive to market the fund widely at the moment really only applies to European based funds. There’s no guarantee that the concessions will be passed onto Cayman funds. Investment managers in Europe are now thinking they won’t be able to market their Cayman fund to professional investors in Europe, even if they are regulated, and therefore in order to get rid of that headache they will set up a Europe-based fund now, rather than try to make sure that our fund fits into whatever exemptions apply.

DOES THAT MEAN WE’RE GOING TO SEE FUNDS MIGRATING AWAY FROM PLACES LIKE THE CAYMANS?
David Billings: I think people are waiting to see to what extent the Cayman Islands, which has been a very common jurisdiction for private equity funds, particularly international and emerging market private equity funds, is going to continue to be viewed as an acceptable jurisdiction from both a tax and regulatory standpoint and an investor standpoint. We have seen some institutional investors question the Cayman Islands; they’ve expressed a preference for onshore jurisdictions. But what we haven’t seen is a migration away from the jurisdictions that have traditionally been used. There’s not a lot of fundraising that’s going on, but there is a lot of discussion, because there are a lot of people that are planning to raise funds and are watching these developments, and are talking to each other and trying to see where the trend is.

WILL US-DOMICILED FUNDS BE SIMILARLY DISADVANTAGED IN EUROPE?
Simon Thomas: The US finds itself in a tricky position. If the Directive comes in, one of the jurisdictions that may gain from a migration of industry from London to another fund centre would be the US. Fund managers won’t go and live in Switzerland; they’ll go and live in New York and Connecticut. So the US government has to balance its potential gains, as against the existing US fund managers’ ability to market funds in Europe under the proposed Directive. The other thing which the US government has to be slightly cautious of is that EU politicians may not take too kindly to the US lobbying it on financial regulation when many Europeans consider that US and UK financial regulation (or more specifically, the lack of regulation) caused the current crisis.

WOULD GPS HAVE A TOUGH TIME ADJUSTING TO LIFE ONSHORE?
David Billings: From a London perspective, England and Guernsey are popular because again their kind of legislation is very flexible, and you can pretty much do what you want subject to getting the agreement of their investors. So I don’t think there are any major barriers, it’s just that it’s less familiar, it’s a bit more bureaucratic. If [fund managers] aren’t forced to change, they won’t. But if they are forced to change, they can. Many countries like Luxembourg for example have been trying to attract more business, so they’ve created new vehicles specifically to attract private equity funds, and they’ve succeeded to some extent. They view this fairly positively. This would be a positive thing for their industries.

HOW WOULD  LISTED PRIVATE EQUITY VEHICLES FARE UNDER THE DIRECTIVE AS IT STANDS TODAY?
Simon Thomas: The new Directive is relatively unclear as to how the Directive will impact listed private equity funds. Theoretically they are subject to the same Directive. If I were to make a guess about this, I would say that any fund that is listed on a recognised stock exchange will be exempt from the Directive when the next draft comes out, because they are already subject to regulatory oversight.