An article written by our Managing Partner, Dr Richard Bernard, for the Malta 2016 special report published by the prestigious HFMWeek and which focusses on the regulatory innovation that underpins Malta’s role as a European hedge fund domicile of choice.
The very fact that HFMWeek is publishing this jurisdiction-specific report is testament to Malta’s ‘coming of age’ as a European financial services centre. The growth of our asset management sector, driven by new fund set-ups and redomiciliations, has resulted in the establishment of some 600 investment funds with a combined net asset value of circa €10 billion. A staggering 98% of all foreign direct investment in 2014 stemmed from financial services. Moreover, Malta was affirmed the ‘most favoured domicile in Europe’ by the Hedge Funds Review in its Service Provider Rankings in 2013 and 2014 and has retained its status as one of the most advanced global economies, ranked amongst the top twenty financial services jurisdictions worldwide by World Economic Forum.
What makes Malta so attractive to fund managers and promoters?
Malta was affirmed the ‘most favoured domicile in Europe’ by the Hedge Funds Review in its Service Provider Rankings in 2013 and 2014
Malta’s solid reputation as a stable Eurozone economy and a highly competitive, cost-effective and tax-efficient jurisdiction harbouring all the lifestyle luxuries of a Mediterranean island with a multilingual and professional workforce, has certainly contributed to Malta’s exponential growth in the sector and will undoubtedly be comprehensively covered throughout this publication.
Couple these incentives with cutting-edge regulatory innovation and Malta’s role as a European hub for financial services starts to make a great deal of sense. Ever-evolving regulation, restrictive by design to ensure greater financial stability, is ostensibly changing the rules of the game in a way that generates new demand for innovative, yet prudent, investment products and vehicles.
Since the enactment of Malta’s investment services legislation back in 1994, the Malta Financial Services Authority (MFSA), qua the sector’s regulator, has consistently demonstrated a commitment to working together with the financial services industry for the implementation of major strategic objectives with a view to fostering innovation through regulation which has effectively been manifested in the creation of various niche fund markets which Malta is well-positioned to service.
Post-AIFMD Malta – an opportunity seized
Few would disagree that the entry into force of the AIFM Directive has led to seemingly seismic shifts in the global hedge fund landscape as both EU and non-EU fund managers have had to re-consider their strategic positioning in the light of new regulatory demands and market realities.
As readers of this publication will be aware, self-managed AIFs which have assets under management in excess of €100 million, or €500 million if the AIF is unleveraged, are required to operate within the heightened regulatory strictures of the various regulations transposing the AIFM Directive into Maltese law. Operators not exceeding the said prescribed thresholds qualify as ‘de minimis’ AIFMs.
Malta was one of the first EU member states to transpose the AIFM Directive into local legislation, which is noteworthy of itself, but it is the manner of its transposition of the Directive’s ‘de minimis’ provisions which truly demonstrates its regulatory style. Consistent with this forward-looking and pragmatic approach to regulation, and driven by an ongoing endeavour to innovate, the MFSA has maintained Malta’s popular Professional Investor Fund (PIF) framework alongside the new AIF regime and, in so doing, has created niche market for ‘sub-100m funds’ which the island has excelled in servicing.
Whilst full AIFMD compliance certainly benefits larger operators, start-ups and ‘smaller’ funds may indeed be overwhelmed by the corresponding regulatory load. The PIF regime offers three different fund typologies, each based on the participating investors’ wealth and experience, with the regulatory regime being relaxed proportionally to the minimum entry threshold required from each individual investor. A PIF is fundamentally an AIF which escapes the necessity of full AIFMD compliance when structured as a self-managed fund satisfying the de minimis thresholds.
Accordingly, whilst many EU jurisdictions have seemingly been left reeling by the AIFMD regulatory overhaul, Malta has coupled its transposition into the local legislative framework with the retention of the light-touch, more flexible PIF regime and, effectively, has guaranteed the survival of the ‘start-up’ fund, which had come to be synonymous with pre-AIFMD Malta.
Malta has … guaranteed the survival of the ‘start-up’ fund
Moreover, the appropriate mechanisms are in place to facilitate the change from de minimis status to full AIFMD compliance once the operators feel that the associated expense and resource can be justified by the fund’s growth.
One of the more innovative vehicles added to Malta’s repertoire of fund structures is the Recognised Incorporated Cell Company (“RICC”) which specifically targets platform providers, in that it facilitates the creation of a RICC or ‘core’ with the sole purpose of providing standardised administrative services to any number of incorporated cells (ICs), each established within its platform structure and each duly licensed as a fund. Such administrative services largely consist of routine contractual matters and start-up support.
Assets and liabilities of each IC are distinct and ‘ring fenced’ from those of other ICs within the platform and the RICC itself
A key advantage of a RICC platform is the ‘standardisation’ of fund documents, such that functionary agreements and regulatory consents in respect of standardised fund documentation will be in place upon the setting up of the RICC platform structure and, accordingly, a new cell or fund can be added at a fraction of the time that would be required were the fund to be established from scratch as a ‘stand-alone’ entity.
Notably, from a legal and asset planning perspective, an IC is endowed with separate legal personality. The key legal principle in this respect is that assets and liabilities of each IC are distinct and ‘ring fenced’ from those of other ICs within the platform and the RICC itself.
Whilst the RICC platform structure has also proven to be beneficial for larger funds, it is particularly relevant to start-up and ‘smaller’ funds to the extent that it offers an ‘incubation’ style set up. Indeed, in view of the increased cost and resource brought about by the AIFM Directive and other EU-wide regulatory reform, the RICC model is looking increasingly attractive as it allows several funds to co-exist under a single, service-providing platform.
Private Equity & Loan Funds
The past couple of years have seen Malta muster considerable interest as a domicile of choice for private equity and venture capital fund managers.
Recent changes to Malta’s already flexible limited partnership framework, which changes were geared primarily towards ensuring that the applicable Companies Act provisions would facilitate the structuring of private equity funds as limited partnerships, have inter alia clarified the extent to which limited partners can participate in the management of the partnership without losing their ‘limited liability’, a particularly relevant consideration in the context of investment committees. Moreover, Maltese limited partnerships are afforded separate legal personality.
Combine this with Malta’s unrivalled cost and tax incentives and an extensive network of double taxation treaties and Malta’s foray into the global private equity space becomes somewhat clearer.
Malta’s solid housing of private equity investment activity is further bolstered by the recently introduced loan funds regime comprising a set of rules applicable specifically to such funds, which effectively provide for an ad hoc regulatory framework addressing the specific risks and requirements of loan funds and under which Maltese funds can provide finance to unlisted companies and SMEs and acquire portfolios of loans.
In terms of the rules, loan funds may be established as PIFs or AIFs targeting ‘professional investors’ and are to be structured as unleveraged closed-ended schemes which will invest through loans solely and exclusively to unlisted companies and SMEs. Fund managers are expected to establish and implement various policies and procedures including a credit risk strategy proportionate to the scope and sophistication of the loan fund’s activities and an appropriate liquidity management system.
In July, 2015 the MFSA clarified that loans to households or individuals that have been originated by credit institutions may indeed be acquired by a loan fund under the applicable conditions established by the Loan Fund Rules.
The current EU regulatory environment has led banks to limit SME financing activities which has resulted in an opportunity to be seized by alternative fund managers and institutional investors.
Despite the turbulence, and subsequent regulatory overhaul, that has rocked global markets over the course of the past years, Malta’s fund industry has managed to secure consistent growth.
Going forward, the outlook appears bright insofar as the jurisdiction continues to leverage its unique selling points by fostering innovation through regulation, promoting unparalleled efficiency and incentivising compliance.
Of course, the ever-increasing regulatory load inherent in this industry means that proper preparation and careful selection of professional advisors will be paramount for operators to correctly implement a structure which suits their requirements.