A new centre for alternative investment

Amid political upheaval and an evolving legal and regulatory environment for alternative investment funds and managers in the EU, Cyprus has become a cost-effective European hub for funds and managers


Over the past decade Cyprus has significantly enhanced its fund legislation to position itself as a flexible and cost-effective jurisdiction for funds and fund managers within the European Union. The country remains committed to enhancing its competitiveness through regular upgrades of both products and services.

It has also positioned itself as a regional fund centre and a cost-effective investment platform into the EU, drawing on its strength of being a common law jurisdiction with a comprehensive tax treaty network and leveraging its comparative advantages in certain sectors such as the shipping and maritime industry.

The Cyprus RAIF
The success of the registered alternative investment fund (RAIF) in Cyprus has been a big step in the right direction and the jurisdiction continues to work hard to further enhance the reputation of the sector both domestically and internationally. A Cyprus RAIF is available for subscription from an unlimited number of professional or well-informed investors and is required to be externally managed by an authorised alternative investment fund manager (AIFM) that has its office in an EU member state and is fully compliant with AIFMD.

Setting up an AIFM is not a prerequisite and third-party AIFMs (independent management companies, or ManCos) are available, which can potentially offer a turnkey solution instead of setting up a proprietary AIFM. In addition to the AIFM, the appointment of a depositary, a fund administrator (a delegate of the AIFM) and an auditor are mandatory requirements for the RAIF.

Cyprus RAIFs are also not subject to licensing or an authorisation processes by the regulator, the Cyprus Securities and Exchange Commission (CySEC). CySEC only needs to be notified of the RAIF with a mandatory suite of documents and it maintains a special register for RAIFs that includes approved Cyprus RAIFs. Through the Cyprus RAIF, setting up a fund on the island is now significantly expedited (in principle, within one month).

An investment gateway
As noted above, Cyprus is positioning itself as a regional fund centre and a cost-effective investment platform into the EU. Moreover, Cyprus offers fund managers and promoters scalable and compliant substance solutions to meet the increasingly demanding, complex and evolving legal and regulatory dynamics of the European fund industry as demonstrated by the European Commission’s review of AIFMD in November 2021 and subsequent legislative proposals.

Brexit means the UK is no longer the logical choice for a cross-border European fund management company. For UK asset and fund managers looking to benefit from European passporting and needing to maintain access to the wider European market and cross-border investors, a more substantial part of their business will have to be created and managed in the EU over time. For example, in October 2020 the Central Bank of Ireland published its findings of the review of its fund management company guidance (commonly referred to as ‘CP86’) that inter alia stated that all fund management companies should have a minimum of three full-time employees (or equivalent to full-time employee) each of whom is suitably qualified and of appropriate seniority to fulfil the role. This number is only relevant for the smallest and simplest of entities. Other firms are expected to have a number of full-time employees as determined by the nature, scale and complexity of their operations.

At the height of Brexit uncertainty a few years ago, a number of asset managers set up their own ManCos/AIFMs

With respect to delegation, the aforementioned European Commission’s review of AIFMD in November 2021 also highlighted the need to strengthen the supervisory oversight of an AIFM’s delegation arrangements. It required AIFMs to provide additional information to national regulators on their delegation arrangements during the authorisation process including the extent of delegation and sub-delegation arrangements as well as detail on their personnel, systems, controls and procedures implemented to effectively monitor, supervise and control their delegates. The entire delegation structure will have to be justified based on objective reasons.

Cyprus offers fund managers the ability to domicile funds and establish new management companies in Cyprus in order to ensure continued, unfettered European market access. Fund distribution in the EU is an important consideration. Under AIFMD, a marketing passport is not granted to the investment fund product itself, but rather to the manager of it, meaning only authorised EU AIFMs can currently access the marketing passport.

One of the fundamental aims of AIFMD is to allow an AIFM authorised in one member state of the EU to ‘passport’ its authorisation to any other member state. Article 33 of AIFMD allows an authorised EU AIFM that wishes to manage an EU AIF in a different member state to passport in its licence from its home member state to the host member state where the AIF is domiciled. They can then manage that fund provided they are authorised to manage that type of AIF. Practically this means that a Cyprus AIFM could manage an Irish or Luxembourg AIF or vice versa.

Growing demand in Cyprus
With the growth in the RAIF product in Cyprus has come demand for alternative investment fund managers to manage them. While setting up a proprietary AIFM does offer advantages including the retention of maximum control over a fund structure, it is not a prerequisite and third party AIFMs (so called independent management companies, or third party ManCos) are available, which can potentially offer an alternative solution to setting up a proprietary AIFM. This development has also coincided with self-managed investment funds or self-managed investment companies (SMICs) becoming less popular. SMICs were traditionally popular and cost-effective with the board of directors of the fund responsible for all functions, but in practice most of these functions (investment management, fund administration, among others) were outsourced through contractual arrangements. The viability of SMICs is, however, now questionable given the increase in substance requirements as well as time commitments from directors in recent years. Regulatory pressure has made this fund management model the least robust in terms of substance demonstration and is increasingly expensive.

At the height of Brexit uncertainty a few years ago, a number of asset managers set up their own ManCos/AIFMs, mainly because they were uncomfortable with the lack of choice in the third-party market. However, this dynamic has changed over the past couple of years.

Institutional investors are increasingly comfortable with the third party AIFM management model that offers comfort with respect to governance. The third party AIFM is responsible, among other things, for the day-to-day management and oversight of the fund including current areas of particular regulatory focus such as liquidity risk management. The AIFM’s responsibility for risk management includes a wide range of risk areas, from investment risk to market risk to operational risks linked to the day-to-day operations of the AIF. The AIFM takes on liability for its role of ensuring that the AIF is managed in accordance with the fund documents and applicable rules and regulations and has a regulatory capital requirement that is linked to the size of its assets under management. While some degree of control, ostensibly, is lost to the third party AIFM, ultimate control typically resides with the fund board.

The model is also cost-effective given increasing regulatory focus on fees, the so-called value assessment of funds. The FCA in the UK for example has introduced rules requiring UK fund managers to assess the value that their Funds deliver to investors and to publish a summary of these assessments annually.

The third party AIFM management model also fits in well with the broader industry themes such as increasing regulatory and taxation pressures for fund management functions to be conducted within the same location as the Funds and SPVs. There is also the increased focus of the OECD BEP’s project on fund management activities requiring substantive fund management activities to be conducted in the same location where profit is derived with the goal of combating tax avoidance. In addition, FATF’s global focus on AML requires increased local oversight of AML/KYC functions in the jurisdiction of the fund that this fund management model satisfies. The model is also currently well-placed to satisfy the criteria of the anti-tax avoidance directive III (ATAD 3) that remains in a draft form.

Of course the regulatory landscape is always changing, but for investors looking for a cost-effective platform into the EU, they needn’t look much further than Cyprus.