While the public markets remain volatile amid the current macro-economic environment, alternative assets continue to grow, with Preqin expecting AUM growth to accelerate to 11.7% and reach £23trn in 2026, says Justin Partington, group head of Fund and Asset Managers, IQ-EQ.
However, while this means a further period of continued growth for the funds industry, this growth will be uneven across different fund domiciles. Therefore, choosing where to domicile is one of the most important decisions that fund managers make throughout the life cycle of a fund.
Especially during this tightening macro-economic environment, it is crucial for fund managers to select the right fund domicile in which to structure their fund. We've explored five of these decision-influencing factors in this article.
1. The impact of Brexit
When Brexit was voted for by the UK in 2016, it was hard to predict the impact it would have on the fund industry. Six years on, we can confidently say that Ireland and Luxembourg have been the chief beneficiaries of Brexit in Europe from a fund perspective, introducing enhanced substance requirements over the past few years to take advantage of fund managers setting up shop outside of the UK.
Luxembourg is the world's largest cross-border fund domicile and, following the Brexit vote, it actively encouraged fund managers to move their fund structure to the Grand Duchy via enhancements to their fund regime. The introduction of the Reserved Alternative Investment Fund (RAIF) in 2016 has been one such structure that has played a crucial role in drawing fund managers to Luxembourg. RAIFs are an attractive structure as they must appoint an authorised external Alternative Investment Fund Manager (AIFM), which if domiciled in the EU, means that RAIFs can market their shares, units or partnerships via a specific passport to EU investors.
Similarly, Ireland is not only the most popular EU destination for UK managers but is the fastest growing European domicile for funds, accounting for 18.5% of all European fund assets. To support this growth, Ireland's government created the Investment Limited Partnership (ILP) in 2020, which can be structured to suit all major investment strategies and a full suite of liquidity options, making it suitable for private equity, real estate, infrastructure, debt, hybrid funds and more.
While Brexit provided an interesting opportunity for the UK to develop a different fund regime, six years on from the Brexit vote, regulatory divergence is only now beginning to happen. In the Autumn Statement, the government announced that they will be looking into financial regulation next year.
2. Tax structures
An OECD initiative, Base Erosion and Profit Sharing (BEPS) has been among the most important developments for the structure of the alternative fund industry, with every international fund jurisdiction signing on for implementation.
However, BEPS was originally aimed at large multi-national corporates that domicile their holding companies in a jurisdiction with lower tax rates than the jurisdiction of operation, which has presented numerous challenges for the fund industry. While regulated investment funds and fund managers may be able to rely on the regulated financial services exemption in the future, the scope of this exclusion is yet to be defined. Under the some BEPS-related initiatives, funds could be taxed twice - once at the fund level and then again at the investor level.
When choosing a jurisdiction, it's important for fund managers to keep in mind how a jurisdiction has interpreted the BEPS rules, with some regions taking a more draconian approach than others.
3. Rise of new asset classes
If the fund will be holding a variety of newer assets, such as digital assets or green investments, it's important to select a domicile with the infrastructure to support and structure these assets.
For example, Guernsey is well set up to support natural capital funds having introduced in September the Natural Capital Fund Framework, which is designed to help managers invest in ways that make a positive contribution to the natural world. On the other hand, Luxembourg has taken considerable time to get comfortable with digital assets and this has led to uncertainty for funds looking to invest in this asset class.
ESG and impact investment funds are a rising asset class and ensuring that the jurisdiction and the fund's end goal is aligned is key.
If an impact fund will be creating 1,000 new jobs through its impact investment strategy, it needs to do what it says on the tin and be structured in a jurisdiction where these benefits will be clear.
4. Choosing the right fund structure for investors
For institutional investors, fund structures provide a specific draw to certain jurisdictions. The Variable Capital Company (VCC) is especially popular in Mauritius and Singapore as it can be set up as a standalone investment fund or structured as an umbrella fund.
In Jersey, the Jersey Private Fund (JPF) regime has made it an incredibly popular jurisdiction. We've already touched on the popular Luxembourg RAIF and the Irish ILP, which have seen their attractiveness grow post-Brexit.
Further, with the rise of retail investors and the democratisation of the private markets, fund managers really need to consider different fund structures. If a fund manager is looking at marketing to both retail and institutional investors, it is important to select a jurisdiction that is comfortable with hybrid fund structures or has structures and regulations in place for both closed- and open-ended funds.
5. Investor choice is always key
Finally, investors have always been, and will continue to be, important to domicile selection. In the future, regulations may make it more difficult for certain investors to allocate to funds domiciled in some locations.
The rise of M&A in the fund management industry is causing domicile consolidation. Larger fund managers are buying smaller, specialised fund managers that have expertise in a certain sector, such as clean energy or real estate. As soon as the acquisition or merger completes, the purchasing fund manager inherits all the asset classes and structures - so while they might be used to dealings in Cayman, Delaware or Luxembourg, they now have to operate in say, Guernsey, the UK, Jersey or Ireland.
However, what we've tended to see is that fund M&A actually leads to a concentration of high-quality fund domiciliation with the fund managers migrating people and structures to their preferred domicile of choice over the long term.
As the funds industry continues to change and develop, the factors and priorities influencing domicile selection will also change, but what won't change is how important a decision it is to get right.
By Justin Partington, Group Head of Fund and Asset Managers, IQ-EQ