Wed, 02/11/2011 - 11:38
By Simon Gray – With the private equity industry yet to recover fully from the market convulsions of 2008 and 2009 and economic concerns still weighing heavily on investment decisions, the outlook is uncertain for service providers to the sector, who have seen new business flows slacken since the onset of the crisis. However, there is cautious confidence throughout Guernsey firms that the island’s embedded experience in a field that favours specialist expertise will serve it well in a difficult environment.
“Our experience has been very positive,” says Andrew Boyce of law firm Carey Olsen. “Guernsey has done well in terms of maintaining its business. Although the financial crisis led to a fall in fund launches and consolidation of existing structures, the big players continued to be active, and we are fortunate to have a number of them within our stable of clients.
“In addition to tinkering with existing funds, well-established firms have continued to launch new vehicles. What has changed is from five years ago is that we no longer see the influx of first time managers entering the market, like real estate agents wanting to create property funds or artists with ambitions to establish art funds. A general theme of the flight to quality is investor support for private equity houses that have a demonstrable successful track record.”
Boyce says the range of funds is particularly varied at present, ranging from secondaries to infrastructure and debt funds as well as traditional buyout vehicles, but there has not as yet been a noticeable reduction in fundraising sizes, certainly among established players. “Fund sizes are pretty much what they were before the crisis, it's just that there are not as many fundraisings,” he says. “Flight to quality is not only a jurisdiction issue but also in respect of the managers. Investors are still interested in funds from private equity houses with strong track records.”
Mourant Ozannes head of funds Gavin Farrell says launch activity has been taking off because existing funds are at last approaching full investment, allowing firms to concentrate on their successors. “Existing investors are ready to become cornerstone investors for new funds because they are happy with the performance of the manager,” he says. “We have a couple of new managers looking to launch their first fund, but it’s quite difficult to raise capital in the current environment if you lack a track record.”
Barney Lee (pictured) reports that Appleby has seen more work on the transactional side than in fund formation since it arrived in Guernsey in early 2010. He says: “We are seeing that there is not so much new fund formation, that the disposal of assets is difficult, particularly in the past six months given the uncertainty in the capital markets, and that as a result private equity managers are finding it more difficult to raise funds and to return capital to investors.
“However, the right manager will always be able to attract money, as we are seeing with some of the mega funds from firms such as BC Partners, KKR and Coller Capital. These are managers that enjoy good relationships with their investors. Although they may not be able to get rid of assets at the moment, their investors still have trust that they are good assets and that they will be able to exit at some point.”
Lee notes that the difficulties in fundraising are not down to a shortage of capital, which investors have aplenty, but in confidence about allocating that money. However, he notes that while some investors may have run up against allocation limits for private equity because of declining asset values elsewhere in their portfolio, others are expanding their private equity commitments specifically because of its ability to deliver stable long-term returns.
He adds: “We have also seen that exits are still available for the right asset at the right time. For instance, even though the markets are difficult, you would still be able to get the right resources assets away, perhaps through a Hong Kong listing.”
Ernst & Young’s Mike Bane says: “It’s not really news that the mega private equity houses are managing to get new funds away. The mid-market is finding it fund-raising harder, but niche players specialising in in-demand areas such as mining and resources seem to be making some progress.”
“The other interesting trend is toward credit. It's one of those interesting crossover areas – at what point does it stop being private equity and become a hedge fund strategy? We are talking to lot of people raising debt funds, which reflects what's happening with corporate credit and the ability of banks to fund this kind of business when it all comes up for renewal over the next eighteen months or so.
“There are clearly significant credit opportunities for managers with the right credentials to raise money, but typically with corporate structures rather than as traditional limited partnerships. It's good news for Guernsey, because many of these funds have some sort of listing, including a few on London’s main market. The island’s reputation as a jurisdiction for setting up closed-ended funds, with all the associated governance requirements, is second to none.”
A recent survey sponsored by State Street found that 61 per cent of chief executives in the private equity sector would consider Guernsey as a jurisdiction. According to various members of the industry, that is about to borne out by the impending announcement by a leading private equity house – as yet not formally announced, but understood to be Cinven – that it is moving its business wholly offshore and migrating its existing structures into Guernsey limited partnerships.
The island is not resting on its laurels as far as its legislative framework is concerned. The industry is currently engaged in consultation about possible changes to its limited partnership rules. Says Guernsey Finance chief executive Peter Niven: “Because we are a small jurisdiction, we can change legislation relatively easily. Firms appreciate that they are canvassed on measures that will facilitate their business rather than just being presented with a fait accompli.”
According to Farrell, the proposed amendments to the limited partnership law should make it more attractive for private equity structures. “A new draft amended law should hopefully come out shortly to provide a legislative framework that is more flexible for the private equity world and that remove some of the original restrictions that have become obsolete or irrelevant in today’s world,” he says.
“We are looking at segregated portfolios within a limited partnership structure, similar to the protected cell company structure. We are also revisiting the restrictions placed on limited partners under the law and aspects such as the name of the limited partnership. There is no intention of dumbing down the legal certainty of the limited partnership, but these new measures should offer greater flexibility or remove obsolete provisions designed for a very small structure involving a handful of limited partners who all knew each other.”
On the other side of Guernsey’s private equity industry, Ogier’s William Simpson sees the fund administration sector benefiting from a process of ongoing consolidation that is seeing smaller players absorbed by larger ones but also the arrival on the island of global players such as JP Morgan and State Street. At the same time, however, Guernsey is home to specialised administrators that are increasingly establishing offices in other jurisdictions.
“As the private equity business developed, it drew administrators into contact with two different types of people,” he says. “One was the very entrepreneurial investee companies, from whom they learned how people set up businesses. But it also introduced them to a different category, people who raise private equity capital and invest it. It's no surprise that after a while, some of the more entrepreneurial administrators at the bigger firms started to say, ‘We can do that.’ It’s in the nature of private equity that it encourages the emergence of smaller, boutique specialist firms.”
Simpson argues that the consolidation process, which has seen many of the big global players establish large alternative fund administration operations around Dublin and further across Ireland, suits Guernsey and other jurisdictions that do not have the scale and workforce to support businesses employing hundreds of people.
“When global firms concentrate back-office work in and around Dublin, this is good for Guernsey because what we really want locally is the high-value work that keeps people busy thinking very hard and being creative, while more mechanical functions are done off the island.” Segregating the different elements of administration work in this way, he suggests, makes the island more attractive to firms that might otherwise see its size as an obstacle to expansion.
Outsourcing has become more important to service providers in recent years, but Simpson notes that the rules imposed by the Guernsey Financial Services Commission require that responsibility, knowledge and supervision remains in Guernsey, wherever the work is outsourced to.
Farrell says: “There is definitely an argument for traditional offshore centres such as ours to outsource to cheaper jurisdictions where professional services are cheaper. This business case has been followed by a number of fund administrators, but you still need to retain the intellectual capital here, because people come to Guernsey specifically in order to benefit from the island’s expertise.
“There is no perfect model. Some firms don’t outsource because they want to retain full control and be able to say that no matter what happens, everything is offshore by virtue of being in Guernsey. That is a comfort to certain clients. Other clients may be more interested in the savings created by outsourcing basic secretarial or accounting services to offices in places like Bangalore. There is no single answer – it is very much led by the client’s priorities. But it’s true that at the moment everyone is being squeezed on cost.”
Administrators are also starting to find their own clients becoming competitors as private equity firms increasingly see the virtues of bringing some back-office functions in-house. Says Farrell: “A number of large players like Terra Firma and Apax have established their own operations in Guernsey. They all have people on the ground rather than outsourcing or using third-party service providers because they found it both cheaper and providing a greater degree of control.”
Bane believes that basic economics are likely to see this trend continuing in the future. “The historic position has been that we need to push all of this work to administrators because they are the experts,” he says. “However, the question is then whether you can incentivise a team of experts who are already highly skilled in this business to provide a high level of service by being part of a business that is not a service organisation.
“You might still want a traditional service provider for some functions, such as perhaps custody or payments, that you don't want in-house. However, the redrawing of boundaries to incentivise the best people better is something we will see more of, because the sort of rewards that the private equity industry can provide are significantly greater and more attractive than those offered by administration businesses.
“There will always be a degree of tension between the two, but I suspect that at the moment there is potential for more breakouts from established administrators to join mid-sized to large private equity houses that want their own back and middle office on the island and are looking to administrators for different things. Some of the requirements coming out of the AIFM Directive may consolidate that trend. I do see more break-outs from administrators, but in a different way from the past. I'm not sure there is obviously a new Ipes on the horizon.”
Bane also believes that existing administrators also need to think more about succession and incentives. “For those businesses that are becoming more mature, the question is how the people who've created those businesses monetise it. That's the next step for those businesses – and for those that have already taken it, the next question is, what about the next generation? What’s in it for them?”
One positive result of the new outsourcing models, he notes, is that pressure on human resources in Guernsey is significantly less than was the case a few years ago, when pressure of new business resulted in the ratcheting up of employment turnover and costs, albeit to a lesser extent than in other jurisdictions. “Over the past five years businesses have found ways to outsource various functions, which has created fresh capacity in the industry and probably greater choice for employers,” he says.
Outsourcing is also important for Guernsey’s efforts to balance economic development with restraints on population growth. Says Simpson: “Across the financial sector as a whole, I would expect firms to become more top-heavy as growth is accommodated by the outsourcing of lower added value functions. While Guernsey will maintain its population target, people will continue to come in, and as they do so the concentration of professional people in the population is likely to grow.”
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