By Phil Davis – Guernsey’s reputation for private equity expertise has developed over the course of more than a decade, a period during which the island has benefited both from the rapid growth of the industry and far-sighted decisions of its government and regulator that have encouraged the sector’s development.
But could the jurisdiction’s growth be restricted in the future by the rising cost and difficulty of doing business offshore and by the possibility of tax rises? After all, personal and corporate tax advantages played an important role in attracting funds and service providers to Guernsey in the first place.
Some of the names that have come to the island have raised its profile to the extent that it is better known in private equity circles than its larger neighbour, Jersey, and private equity has become a significant contributor to the Guernsey economy.
Peter Niven, chief executive of promotional body Guernsey Finance, says: “We have concentrated on private equity as an investment type and we have succeeded in growing a niche business.” The jurisdiction has attracted high-profile industry players, including Guy Hands and Terra Firma, and Jon Moulton’s new firm Better Capital.
“They were attracted by the island’s reputation as a centre of excellence, with its experienced accountants, lawyers and administrators,” Niven says. “There is a critical mass of people engaged in the industry.”
Terra Firma has brought a number of investment professionals to its Guernsey office, and other firms have followed suit to rub shoulders with Hands and Moulton and hope that some of the magic rubs off. Says Niven: “Funds are actually running investments out of Guernsey, which is a new departure and a great opportunity for us. We are creating a small, high added value group of people.”
An emphasis on corporate governance has bolstered the island’s reputation in the aftermath of the global financial crisis and there has been little or no flight of business from Guernsey despite the at times shrill anti-offshore rhetoric. David Bailey, managing partner of Augentius Fund Administration, says: “There is no doubt that regulation and processes here are among the highest of all the offshore jurisdictions.”
The quality of board members has been central to this. “There is a heightened sense that boards need to demonstrate how business decisions are reached,” says Ben Morgan (pictured), a partner at law firm Carey Olsen in Guernsey. “The world has changed. The burden is increasingly on directors to make sure that businesses are appropriately run and can demonstrate it. This is one of Guernsey’s strengths.”
Mark Helyar, a partner at law firm Bedell in Guernsey, says the role of non-executive directors is key within the corporate governance code that is being introduced. “The draft code sets out a list of risks – including liquidity, leverage, external markets and anti-money laundering – that directors need to consider. It is a sort of aide-mémoire.”
The critical mass of service providers on the island not only helps to ensure good governance but fosters innovation, the lifeblood of niche jurisdictions. Guernsey, for instance, was the pioneer of protected cell structures in 1998. Says Morgan: “Many of the other jurisdictions scoffed at the idea at the time, but many of them have copied it since.”
Experience and know-how are also essential in responding to changes in the market, such as in the post-crisis period. Augentius managing director Glyn Thomas notes: “The quality of reporting is being driven by investors, who expect to see more levels of detail in terms of data, presentation of performance and the depth of narrative. We are producing larger documents with greater frequency and faster turnaround times.”
Internationalisation of the investor base also brings challenges that only experienced hands can deal with, such as the different types of reports sought by investors operating under either US GAAP or IFRS accounting regimes. “We are thought leaders and guide clients rather than waiting for audits to throw these issues up,” says Thomas.
And whereas fund administrators used to be solely focused on the back office, a wider range of activities is expected of them now. Thomas says: “We have much more involvement in acting on new fund launches than a few years ago when administrators were essentially just processing shops.”
Nevertheless, Guernsey – in common with Jersey – is facing pressure on at least two fronts: the costs of running a fund are rising as non-executive directors demand compensation to match the increased risks they run, and the prospect of higher tax rates for some businesses.
Bailey points out that only 25 to 30 per cent of the private equity market uses offshore funds, so Guernsey is largely competing with onshore structures. “The costs of being offshore are rising because in the last two years the risk of being a director has increased,” he says, referring to increasing regulation and oversight of the non-executive role. “Some administrators do not want to provide directorship services these days.”
The dangers were amply demonstrated this year by the GBP35,000 fine imposed by the Guernsey Financial Services Commission on three directors for a breach of anti-money laundering rules. “Directors are unable to obtain company indemnities in Guernsey for fines arising from regulatory and AML issues,” Helyar says.
With the regulator having revamped its rules to prevent non-executives from sitting on too many boards, there is no obvious way to contain these costs, and they come on top of the extra expense of the lawyers and administrators involved in launching and running an offshore fund. “The net result is that offshore funds can be expensive to run and people do consider whether the benefits outweigh the costs,” Bailey says.
Some in the industry deny that costs have risen significantly. Barry McClay, operations director at specialist private equity administration firm Ipes, says: “We negotiate with non-executive directors on behalf of clients, and we have not seen an increase.” However, he concedes that costs are likely to rise at some stage in Guernsey as in other offshore jurisdictions.
In addition, the possibility of tax rises is also a worry for the industry, following whispers from within the European Union that the UK crown dependencies’ corporate tax regimes, which all offer a basic zero rate of corporate income tax with companies in certain sectors paying a 10 per cent rate, offend against the spirit if not the letter of the EU Code of Conduct on Corporate Taxation.
In an effort to avoid confrontation with EU, Guernsey has set up an internal review of its tax structure. If, as some observers believe likely, the standard corporate tax rate is raised from zero to 10 per cent, there should not be a direct impact on Guernsey funds, which will enjoy an exemption, but service providers are likely to be affected.
But not everyone believes it inevitable that the review will lead to tax increases. Morgan says the outcome depends to some extent on what happens to the other crown dependencies. “It is not clear what commitment to change means,” he says. “Guernsey will see what pressure Jersey and the Isle of Man come under from the EU before it decides what to do. Whatever comes of the review, it is pretty certain that Guernsey will not place itself at a competitive disadvantage.”
But costs are only part of the equation, and the island’s promoters seek to emphasise the value it provides in return. “There is critical mass here,” Niven says. “Funds and investors will always need people who understand what they are doing. Plus, this is a nice place to do business, and is accessible to UK and internationally. It’s win-win.”
Some industry members contend that there is little risk of business leaking from the island even if costs and taxes rise. “Guernsey has a wealth of experience and intellectual capital in its finance community,” Morgan says. “This comes at a cost. Higher director costs won’t adversely impact large fund clients because the level of those fees is immaterial in the broader scheme of things.”
On the other hand, smaller funds – and Guernsey has a high proportion of these – may come to decide that the island is not the place for them. “But you have to ask yourself whether you want to pay slightly more for fund administrators who really know what they are doing,” Morgan says, noting that many competing international financial centres have limited private equity infrastructure. “Do you want the fund to be run out of a jurisdiction that is in the early stages of development and knows little about the requirements for private equity?”
Of course, Guernsey was exactly at this point 15 years ago, but funds these days realise that cheaper servicing may expose them to potential reputational and regulatory risks. “Our niche is high-end, high value, and some smaller managers will be attracted by this too,” Morgan adds.
For now, there are signs aplenty that activity is buoyant for many Guernsey-based service providers. “Fundraising activity certainly slowed down over the last two years,” Morgan says. “Clients who were successful and did not have their fingers burned too badly have continued to launch follow-on funds, but clients who were adversely affected by past deals have been held back.”
Now, though, new managers and spin-outs from established firms are looking to set up on the island. “Some individuals have left existing fund management groups to establish new outfits,” he adds. “They come to Guernsey because during their previous lives they were launching funds in Guernsey too. It’s funny how a downturn can present opportunities – it’s not all negative.”
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