As Cyprus continues to enhance its fund legislation, it has positioned itself as a flexible and cost-effective jurisdiction for funds and fund managers within the European Union. The island nation offers unique advantages that provide operational flexibility while also achieving a fine balance between the freedom of operation for asset managers and investor protection.
Cyprus offers unique advantages that provide a fine balance between the freedom of operation for asset managers and investor protection
The island’s recently created Registered Alternative Investment Fund (RAIF) reflects its commitment to continue enhancing its competitiveness in this respect. The local market works towards this goal 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 spanning 60 countries.
At the time of World Finance going to print, the terms of the UK’s withdrawal from the EU are still being negotiated and are highly likely to change. However, asset managers (both inside and outside the EU) will still need to address the succeeding challenges. They will also need to identify the potential long-term opportunities that will arise in a European fund management environment that has already been significantly reshaped since the introduction of the Alternative Investment Fund Managers Directive (AIFMD).
The potential impact on investment funds domiciled in the remaining 27 member states of the EU (EU 27) varies from fund to fund, depending on the structure of the fund and its distribution strategy. It also depends on the fund’s level of engagement with UK service providers – particularly with regards to the manager and, in the AIFMD context, the alternative investment fund manager (AIFM), as well as the alternative investment fund (AIF) itself. Against this backdrop, Cyprus can offer long-term solutions for a variety of managers and funds planning for a post-Brexit Europe, including both managers in the UK and those located in countries outside the EU 27.
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, it seems likely that a more substantial part of their business will have to be created and managed in the EU 27 in the years to come. Cyprus offers UK managers (and, more broadly, managers outside the EU 27) the ability to domicile funds and establish new management companies in order to ensure continued, unfettered European market access.
Post-Brexit, a UK AIFM managing an EU 27 AIF will no longer be able to do so as an authorised EU AIFM. Depending on the final deal, it should be able to continue to manage an EU 27 AIF as a third-country manager, similar to the arrangements already in place for US investment managers. Authorised EU AIFMs are currently permitted to delegate portfolio management to non-EU investment managers, subject to certain conditions. When the UK officially leaves the EU – again, depending on the final deal – it may well be necessary to have the UK entity approved by national competent authorities (NCA) of individual EU member states as a non-EU investment manager.
In the case of undertakings for collective investment in transferable securities (UCITS), the fund must be domiciled in the EU while also being managed by an EU-based management company. In the absence of a renegotiation of the status of UCITS management companies, a UCITS with a UK management company would need to appoint a management company in a EU jurisdiction, become self-managed if possible (although that is a more onerous option these days), or re-domicile the existing UK management company to another EU jurisdiction.
Fund distribution is an important consideration, especially given the dynamics of AIFMD. Under AIFMD, a marketing passport is not granted to the fund product itself, but rather to the AIFM. As only authorised EU AIFMs can currently access the marketing passport, EU 27 AIFs managed by UK AIFMs will be significantly impacted.
With respect to the concept of delegation, on May 31, 2017, the European Securities and Markets Authority (ESMA) published an opinion piece that set out the general principles on supervisory approaches in relation to relocations of entities from the UK to EU 27. Within it, ESMA published its opinion based on the scenario that the UK will become a third country after its full withdrawal from the EU, while also setting out nine general principles for NCAs on the avoidance of supervisory arbitrage risks. One of the nine principles requires NCAs to ensure that substance requirements are met – specifically, this implies that certain key activities and functions should be present in the EU 27 that cannot be outsourced or delegated outside the EU.
These important activities include internal control functions, IT control infrastructure, risk assessment, compliance functions, key management functions and sector-specific functions. The ESMA statement also said that special attention should be granted to mitigate the use of letterbox entities in the EU 27. As such, NCAs should reject any relocation requests where the main intention is to benefit from a EU passport, with all substantial activities or functions being performed through third-country branches. Furthermore, ESMA advised that outsourcing and delegation to third countries is only possible under strict conditions, subject to outsourcing or delegation arrangements between the EU NCAs and a third-country authority.
The Cypriot option
A Cyprus RAIF is available for subscription from an unlimited number of professional or well-informed investors. It is required to be externally managed by an authorised 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. Given ESMA’s view on substance requirements for AIFMs, independent ManCos offer the ability to effectively meet substance requirements on the risk management side through more extensive human and technical resources in the event that the portfolio management function is delegated to a third-party investment manager.
In addition to the AIFM, the appointment of a depositary, a fund administrator and an auditor are mandatory requirements for the RAIF. Through the Cyprus RAIF, setting up a fund on the island is now significantly expedited (in principle, within one month). Cyprus RAIFs are also not subject to licensing or 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; it maintains a special register for RAIFs that includes approved Cyprus RAIFs.
More importantly, given that the Cyprus RAIF must be managed by an authorised AIFM, it also benefits from all passporting advantages for distribution by way of the marketing passport. As a result, marketing Cyprus RAIFs across Europe is significantly rationalised when compared with non-EU jurisdictions, as the AIFM may rely on cross-border passporting arrangements to access all 31 European Economic Area jurisdictions without relying on private placement regimes.
There is no minimum share capital requirement for a Cyprus RAIF, and there is also legal form flexibility in terms of structuring, including the option to be open-ended or closed-ended. For many investors, including but not limited to unregulated investor groups such as family offices, the Cyprus RAIF represents an attractive investment vehicle from a legal, regulatory and tax perspective. It also allows an expedited, cost-effective fund solution to be brought to market. In addition, the Cyprus RAIF provides investor protection through the requirement to appoint an authorised and regulated AIFM that is responsible for ensuring AIFMD compliance (in practical terms, the regulator oversees the RAIF through oversight of the AIFM). It further benefits from a licensed depositary that is required to act independently and in the best interests of investors by performing oversight, cash-flow monitoring and safekeeping of assets duties.
Against the backdrop of a pending Brexit deal, ESMA has focused on ensuring that minimum substance requirements are created for new fund management entities established in the EU 27. This is necessary in order to mitigate a creation of letterbox entities – a likely outcome without certain rules in place. As such, ESMA now requires a minimum of three full-time employees for an entity within any of the EU member states.
Specifically, these employees are required to work in the areas of portfolio management, risk management and the monitoring of delegates. ESMA has also clearly stated that relocating entities have to transfer the majority of their portfolio management and risk management functions into a new entity within the EU 27. As an emerging fund and fund management jurisdiction, Cyprus has the ability to offer fund managers and promoters cost-effective and compliant substance solutions to meet the increasingly demanding, complex and evolving legal and regulatory dynamics of the European fund industry. The country also serves as a practical long-term platform for fund managers and service providers to develop their fund business – all from one convenient hub.