It’s complicated

Europe’s private fund managers have been facing numerous back-office challenges. Juggling increasingly complex real estate transactions while staying compliant with laws like the Alternative Investment Fund Managers Directive and Solvency II has increased the need for practical guidance best practices.

Brexit has thrown up a litany of questions from an investment point of view, but also – perhaps more importantly – from a back-office perspective. Unresolved staffing issues and passporting dilemmas relating to UK-based managers’ ability to market funds in the EU are just two. But the three private real estate fund managers, fund administrator and lawyer gathered to discuss the challenges of running a private real estate fund also face another unexpected scenario.

Meeting a few days after Donald Trump’s shock election win, the conversation initially gravitates towards the president-elect and the potential impact of his policies on the private funds industry and the wider economy. Most participants agree there are pros and cons to his victory.

“There are known knowns, known unknowns and unknown unknowns – more so than in any other decade. Conflicting indicators created uncertainty. So for example, on the one hand the Dow Jones Industrial Average hit a record high, on the other, the Nasdaq was down on the threat of an immigration crackdown,” says Stuart Jenkin, director of fund management at Frogmore Property Group.

Turning to his potential policies, there is consensus that US-based funds and projects could benefit from proposals to lower corporate tax. This will have a knock-on effect on other jurisdictions likely to see reduced investment. “Potential lower corporation tax in the US under Trump in order to incentivize US companies to onshore cash piles abroad could work well for him, especially given his domestic infrastructure investment plans,” says Maqbool Mohamed, CFO at Castlelake.

This sentiment is shared by Rupert Robinson, COO at Mill Group, who questions the impact of potential reforms on inflows to the UK from both the US and Asia.

“It will be interesting to see how it affects capital flows; will more or less Asian capital come into the UK, will US investments in the UK slow? If taxation in the US is eased, more domestic capital is likely to be repatriated but could have the effect of further US capital inflows. But I see there could be an opportunity for an increase in more global fund flows,” Robinson says.

But there is also a suggestion that Trump’s anti-Europe rhetoric could strain relations between the US and Europe, which will have an impact on free trade. “Trump appears to be very pro-UK, which is encouraging, but he seems anti-Europe. There’s already some tension between the US and Europe, and Trump could make it worse, which doesn’t help free trade. It puts tax treaties under threat, which could restrict global flows of capital,” says Jenkin.

“The UK has a great relationship with Asia. They’re not particularly focused on Brexit; they just see long-term investment opportunities and the cheaper value of sterling,” he adds.

As well as proposing a number of tax reforms during his election campaign, the president-elect vowed to “reform the entire regulatory code to ensure that we keep jobs and wealth in America.” He was particularly vocal on his disapproval of Dodd-Frank, a component of which is the Volcker Rule, restricting US banks from making certain kinds of speculative investments that do not benefit their customers. This has a knock-on impact on private investment funds, as it reduces the amount of investment available from these institutions.

“He seems to be interested in loosening regulation. What happens in the US often filters through to the UK, so there’s a chance the UK could become more competitive if it follows the lead,” says Alex Amos, partner of the investment management group at Macfarlanes.

The UK’s vote in June to leave the EU will, of course, also dictate the direction of regulation in the country. The participants agree that while the referendum has created a great deal of uncertainty, the UK isn’t the only country dealing with an unclear future. A number of elections across the continent will take place in the coming months, raising doubts both about who the UK will be negotiating its exit with and the future state of the European Union itself.

“The EU will evolve and could look quite different in the future. There are more elections coming up and other country exits could follow; the prospect of a north-south, two-part state might become reality,” says Simon Burgess, managing director at Ocorian.

Whether Germany wishes to continue as the principle funder of the European Union, and France as its main cheerleader, is in doubt. Germany’s liberal chancellor Angela Merkel’s approval ratings have fallen, while those of France’s far-right Marine Le Pen have grown as sentiment toward the country’s current president François Hollande plummets to an all-time low. Far-right candidates with strong anti-immigrant policies are also gaining traction in other European countries.

“When we come to the EU exit discussions, after Article 50 has been served, who will we negotiate with? There quite possibly will be a new deck of EU players. The unexpected is to be expected; there is a huge movement against the political establishment,” Jenkin says.

And highlighting the need for politicians to listen to what they are being told, Burgess adds: “The rise in populism is creating a new order, fueled by social media. This development is too big to ignore and politicians will listen and respond in a new way. Instant communications we all have now means people can instantly have a say on policies, voices can be heard that otherwise wouldn’t be.”

Comparing the perceived outcome of Brexit with the reality to-date, the participants agree much of the negative outcome has, as yet at least, failed to materialize. One such prediction is that many companies will relocate to other European cities, taking large teams with them and leaving acres of office space empty.

“Relocation of financial services from the City of London is on the cards, but will it involve large-scale movement of forms and jobs? In terms of numbers of people who will move, there isn’t that much capacity elsewhere in other international financial centers. In addition, you can’t think of the office or financial services market as being static; there are always waves of comings and goings of financial occupiers. As some banks may leave, it’s possible that other international banks will expand or locate to London. It is rumored that many Asian financial institutions want to be in London, so they could replace any that leave,” Jenkin says.

Part of the problem is there is no real alternative, at least at the moment, because of a general lack of real estate in other European cities.

“There’s a lot of space in Frankfurt, as there was a pipeline of building five or so years ago. But I believe there is very little in France’s La Defence. Some people might go, but it’s likely to remain fairly unchanged for now. Plus, you’ve got to consider the cultural shock for employees moving to another country,” Robinson says.

Pointing to the logistics involved in making such a move, Mohamed says those companies already established are unlikely to take on such a big repositioning, but there is a possibility that those looking to open a new outlet will reconsider doing so in the UK.

“I can’t see big institutions suddenly relocating all operations abroad. It’s a hassle to move offices, especially into a new country. However, if I am a large international corporate looking to open a new office or manufacturing plant, then why would I take a chance and invest in the UK? So I do believe that there will be an impact in terms of new investment,” he says.

Economically, much of the doom-mongering about a severe downturn post-vote to leave, has not materialized, either. The market has remained fairly liquid since the Brexit vote, the participants agree, with little signs yet of distress. There is a chance it will appear in the weeks running up to Christmas, with a clearer picture emerging in January. In the US, meanwhile, the impact of the Trump election is not expected to be felt until March.

“A number of retail funds have been closed for redemptions. This prompted a view that there could be many forced sellers at discounted prices. Unlike in the 2008-09 downturn, the current expected wave of distressed vendors on a ‘leave option’ for the UK has just not materialized yet,” Jenkin says.

The political picture on both sides of the Atlantic is also indicative that the lack of substantial infrastructure – be it transportation, housing or utilities – needs addressing as a priority, the table agree. The difference between the US and the UK approach to doing so, however, lies in treasury plans to tackle deficits; the US expects to reduce its debt while making investments in infrastructure.

“There is so much political unrest. Brexit and the election of Trump both pointed to the need to improve infrastructure, and money is needed to do that. The top 30 global cities have a shortage of homes. This suggests there are big opportunities for direct investments, joint ventures, and infrastructure fund of funds,” Robinson says.

In the UK, against a backdrop of low interest rates and reduced bank lending, it’s clear the opportunity to invest in alternative assets continues to be attractive, while the lack of sufficient infrastructure points to a need to break new ground. But whether the industry can go on attracting investments is dependent in part on the country offering a favorable tax regime, something it is not doing particularly well at present, the participants agree.

“Many investors, such as US pension funds, are tax exempt and are looking for gross returns back to their pensioners, plus they are looking for the best returns they can achieve internationally. The UK government is introducing more taxes. That is lowering the returns to international investors, so does this make the UK less attractive if their tax burden will be higher? In the future, if this direction continues they have alternatives in having to invest in the UK real estate market,” says Jenkin.

A key tax issue affecting the market at the moment is Base Erosion and Profits Sharing, or BEPS – referring to tax avoidance strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations. Under an inclusive framework put forward by the Organisation for Economic Co-operation and Development, over 100 countries and jurisdictions are collaborating to implement a series of measures to tackle BEPS.

“The industry is lobbying [against BEPS], especially in light of the Brexit vote. We need more tax efficient vehicles; regulation is stifling business and encouraging jurisdictions such as Luxembourg to improve their offerings. The government doesn’t seem to be listening, though,” Amos says.

He adds that fund managers have to make sure an investor in a fund isn’t in a worse position than if they had invested directly in the underlying asset. “It’s possible under BEPS they will be. International investors have got to relay the message about more favorable tax treatment, not domestic fund managers,” he says.

But while tax benefits are of increasing importance to investors, fund managers are becoming less concerned about these matters when choosing where to domicile a fund.
“A lot of decisions relating to where to domicile an investment vehicle are also dependent on other factors, such as asset expertise. Many aviation funds are based in Dublin, for example, because it’s an aviation hotspot,” Mohamed says.

Offshore jurisdictions are also ramping up their efforts to attract mandates in other ways, meaning the benefits of domiciling in a certain place outweigh even the tax benefits of doing so. “Clients are moving away from tax issues being a driver of a decision to appoint an administrator – whether onshore or offshore. Mainstream, well-regulated jurisdictions have positioned themselves as international finance centers. Managers and investors are therefore choosing fund administrators because of their sophisticated capability, not because they are in a particular location,” Burgess says.

Domiciling a fund offshore is a big decision, but once that is done, a fund manager faces another: whether to outsource its administrative tasks. This is costly in terms of time and money, but there has been a rise in the number of firms taking the decision to do so.

“We are seeing private equity and real estate fund operating models develop how hedge funds developed over the last 10 years with greater presumption that back office services will be outsourced. The trend of private equity and real estate managers outsourcing these functions is continuing, ensuring the managers concentrate on what they do best – managing the assets and interacting with investors,” Burgess says.

Developing technology, and regulatory requirements, are also leading some firms to harness software solutions. “There has been a rise in cloud-based solutions, with people taking a pick and mix approach to using the inland revenue’s guidelines [on reporting]. With some systems you just have to load information in and you can generate quarterly, monthly, even daily reports. It will transition to real estate,” Robinson says.

Alex Amos is a partner at MacFarlanes, a London-headquartered law firm. He advises asset managers and investors on their investment management arrangements, team incentive schemes and the structuring and establishment of, and investment in, alternative funds.

Simon Burgess is managing director at Ocorian, an independent global financial services business providing outsourced administration, fiduciary and accounting services. The firm offers services across asset classes and jurisdictions.

Stuart Jenkin is director of fund management at Frogmore, a direct investor in UK real estate and manager of private real estate funds. He has been involved in the formation of three value added funds, and other products, and raised close to £1 billion in equity over the past 10 years.

Maqbool Mohamed is chief financial officer, Europe, at Castlelake, a global alternative investment firm focused on deep value, asset rich opportunities in dislocated industries. He heads the finance and operations team in London, supporting deal structuring, execution, and transaction management.

Rupert Robinson is chief operating officer at Mill Group, an independent specialist investment manager focused on long-term income generation. He has over 20 years’ experience within the alternative investment asset class.