Who’s Who Legal brings together Yukako Kawata of Davis Polk & Wardwell, Andreas Rodin of P+P Pöllath + Partners and Iain McMurdo of Maples and Calder to discuss a range of key issues, including the market’s “new state of play”, the growing secondaries field, the current jurisdictions that are popular for domicile and how to ensure client satisfaction.
Davis Polk & Wardwell LLP
P+P Pöllath + Partners
Maples and Calder
Grand Cayman, Cayman Islands
WWL: There was general consensus in our interviews with leading practitioners that fund managers have now accepted the new “state of play” and begun to launch funds yet again. Have you seen a return to activity? How are managers looking to overcome the regulatory burdens? Have they affected the types of funds being launched or tactics being employed?
Yukako Kawata: Yes, I have definitely seen a return to activity, including fund managers launching or getting ready to launch their first-time funds. This is clearly a change from the fundraising environment that prevailed for a few years after the global financial crisis, which was particularly challenging for the first-time fundraises. I also believe that fund managers have become more accustomed to the regulatory requirements and made appropriate adjustments to their operations, so that the regulatory requirements are slightly less burdensome than they were initially. I have not seen material effects of the regulatory burdens on the types of funds being launched or the strategies being pursued, but the overall disclosure being provided in the fundraises is generally even more robust than previously.
Andreas Rodin: The trend generally confirmed by practitioners also applies to Germany, and fund managers have begun to launch funds again. Those investing in small and medium-sized enterprises register themselves under the new European regulation for venture capital fund managers; those focusing on club deal or pledge fund structures place more emphasis on avoiding “fund” status. Similarly, large institutional investors prefer structures designed (and priced) to accommodate their specific needs. As a consequence, managed account schemes have become more popular.
Iain McMurdo: Our clients in Europe and North America have been awaiting the implementation of the EU AIFMD and considering how this will affect their businesses both with respect to ongoing regulation and day-to-day asset management and fundraising within the EU.
In Europe we are by far the busiest we have been since the 2008 financial crisis with regard to new fund products, seeing a material uptick in new Cayman hedge fund launches through our various offices. Ireland as a fund domicile jurisdiction has increased in popularity, with large, established asset management firms most active in the market.
This increase in activity could be due to people coming to terms with the new regulatory world (AIFMD), as well as improvement in the macro-economic situation, with investors turning on the taps again.
We have seen EU net sales of private funds (AIFs) rise to over €3 trillion, UCITS to over €7 trillion and, in Ireland, about 18 per cent growth in QIAIFs, year to date.
Across the wider market, we are seeing a pick-up in EU fund launches. Managers have decided internally how to address the “new state of play” and many have settled house positions on how to address the regulatory issues, whether it’s AIFMD, Dodd-Frank, FATCA, etc. That seems to have eased the backlog internally and projects which were on hold are now moving forward as managers make informed decisions on fund domicile and vehicle choice.
The largest trend continues to be parallel fund launches. Many of the new fund launches are not by start-ups but established managers, likely reflecting two things: first, established managers have replenished their core strategies post-crisis and are now in product building mode again – looking for new ways to generate yield and to build capital, so we see large managers adding new strategies via new funds; second, new entrants to the market – even those with excellent credentials – are finding the cost and process of establishing a greenfield management business prohibitive, so they are joining established fund managers to leverage off their infrastructure (particularly IT and legal/compliance) rather than starting their own shop. Established managers are playing a seeding and support role. These challenges for start-ups are amplified on the Irish side, given the enhanced regulatory regime now in effect.
We see a continuing increase in the use of managed account fund platforms as an access point for managers that want to plug into a fund structure without the onerous compliance requirements and operational infrastructure that now come with operating a fund range.
Our North American clients have been particularly active with respect to private equity fund launches and hedge fund launches, although the number of hedge funds registered with the Cayman Islands Monetary Authority appears to be running level with 2013. Notwithstanding this, the number of new companies and partnerships formed in the Cayman Islands has risen since 2013, reflecting a strong resurgence in private equity markets and the increased number of special products being offered by institutional clients. In Asia, our clients have similarly seen a significant uptick in private equity fund formation and hedge fund formation.
Finally, we are seeing across all regions a number of “second generation” managers being established: groups spinning out of big names to establish their own shop.
In terms of overcoming regulatory burdens, depending on the strategies and marketing initiatives, many managers are carefully considering the cost analysis of marketing in Europe and the regulatory burden this may impose on the funds and/or manager. In addition, there are the reporting implications for AIFMs under the AIFMD; many managers are considering alternative structures or strategies to alleviate these. These may include appointing an independent AIFM to take on some of these responsibilities for the manager/investment adviser. There are also additional roles required, such as depositaries providing depo-lite services for those marketing in Denmark and Germany under their national private placement rules, and the service providers offering these services are still feeling their way in terms of pricing.
Maples has responded to client requests in both cases to provide AIFM and depo-lite services to funds through affiliate companies within the Maples group. We can see further outsourcing of other services around regulatory reporting becoming more prevalent. This would include FATCA reporting, Form PF reporting and other regulatory filings as these develop across various regions.
WWL: Activity in the secondaries market is on the rise and US and European banks and insurance companies are said to be among the biggest sellers of private equity commitments as they seek to comply with new regulatory and capital requirements. How has the uptick in this market affected your practice? Do you expect activity levels to remain constant?
Yukako Kawata: We have definitely seen an uptick in the secondaries market, both in terms of secondary funds being raised as well as secondary transactions being completed by various parties. A number of clients are involved in secondary transactions, both on the buy and sell sides, and we expect activity levels to continue for the foreseeable future and probably increase, primarily due to regulatory reasons.
Andreas Rodin: In Germany banks and insurance companies are about to reconsider their private equity fund investment strategy and have begun to restructure their portfolio. P+P has been increasingly involved in secondary transactions and we expect levels to remain constant for the foreseeable future.
Iain McMurdo: It is hard to say. As Cayman counsel, we don’t see too many negotiated secondary deals as these are typically governed by US or UK law documents and our role would be advisory with respect to particular matters of Cayman Islands law. It is clear that the managers focused on raising secondary funds to buy these interests have been successful, and an appetite from investors to invest in these types of funds will continue. That’s where we see more activity and would expect to be involved in a few fund raises of secondary funds in the near future.
WWL: Which jurisdictions are popular for domicile? Are you seeing an increasing number turning to Singapore?
Yukako Kawata: The jurisdictions I see as popular for domicile are the usual suspects: Delaware for funds organised in the United States; Cayman Islands for funds organised in the tax haven jurisdictions; and Ireland and Luxembourg for funds organised in the EU. I also see funds organised in Canada from time to time. I have had discussions with a few sponsors about organising a fund in Singapore, but this is still a less common alternative compared to the other jurisdictions.
Andreas Rodin: As a consequence of the new European regulatory framework, the importance of Luxembourg as domicile for funds has significantly increased and because of Germany’s unprecedented position regarding VAT on management fees, many German private equity firms have begun to build up a managed presence in Luxembourg, thereby reducing their local activities to acting in an advisory capacity.
Iain McMurdo: The rate of Cayman Islands hedge fund formation driven by managers based in Hong Kong and the US is steady compared with 2013. The Cayman Islands remains as the leading hedge funds domicile jurisdiction, with over 11,000 registered funds. We continue to be busy working on funds-of-one structures for institutional asset managers who are being required to provide these structures for its SWF and pension plan investors. We have also seen an increase in private equity fund formation and downstream-related structuring in Cayman over the past year, which has been driven by our North America and Asia-based clients.
Ireland as a domicile jurisdiction has increased in popularity, with big names active in the market. We are also seeing an increase in the use of complementary vehicles (eg, acquiring Irish assets through Cayman funds).
We have not seen an increase in the number of funds turning to Singapore as a domicile. The Singapore fund product has a few technical shortcomings that make it less attractive to use. Anecdotally, I would say that we would likely see more Singapore funds if the legislation were amended, but while that is much discussed there are no signs that it is imminent.
WWL: Ensuring client satisfaction is a constant concern for lawyers with clients increasingly looking for value. How has your firm met clients’ demands? Do you offer complementary services and if not, is it something the firm would consider in the future?
Yukako Kawata: It is of utmost importance to us at Davis Polk to provide the highest level of service to our clients. We seek to do that in the private funds practice by making sure that we address our clients’ needs in every area, whether that is advice with respect to the formation of a fund, or the regulatory issues that managers need to address while managing the fund, or assisting a fund in its investment activities on the buy side or sell side. In this regard, we believe that our expertise over the full range of areas that affect private funds and private fund managers enable us to cover our clients in a comprehensive manner, and we work very hard to make sure our clients are happy with our services.
Andreas Rodin: P+P attempts to accommodate the needs of our clients by introducing ourselves at the earliest possible point in time to new subject-matters affecting an impacting our clients. This enables the firm to constantly develop new practice areas already while the subject-matters are themselves developing. In a rapidly changing environment it is too late to start thinking about complementary services only when changes already took place. When comparing the scope and nature of services offered 10 years ago with what we do today, one realises that the terms “core activities” and “complementary services” are probably not the most efficient way for a “product-orientated” law firm to meet the demands of its clients.
Iain McMurdo: The Maples group values the strong relationships we have developed with our clients. We believe that the best results are achieved by creating teams within a group structure enabling our lawyers and MaplesFS professionals to work closely together to provide a comprehensive range of legal, fiduciary and administration services.
Worldwide, the Maples group has over 260 lawyers and 330 fund administration and fiduciary staff in key financial centres. Clients benefit from time zone convenience of local support via our network of offices around the world. This deep bench of expertise and understanding of the markets across not just legal but administrative and compliance related services puts us in a very good position to offer clients advice on what we are seeing in the markets with respect to trends and solutions to regulatory changes across the world. We can confidently say to our clients that if we don’t know the answers to their questions we know a number of other firms in the appropriate jurisdictions that do know and can make these introductions whenever possible.
In addition, we often work with clients and their onshore advisers assisting them with structuring issues before being formally engaged and we see that as real value added for our clients. Finally, we provide feedback to our clients on current trends in respect of fund terms based on our own market intelligence that we collect from the funds we represent. For example, we could see the trend in fees and relate these to our clients without breaching client attorney confidences.
WWL: Is the hedge fund market becoming more commoditised? What impact has this had on law firms? Do private equity clients represent higher potential earnings for a law firm? Do you expect to see more firms competing for private equity fund work?
Yukako Kawata: I think that the “plain vanilla” hedge fund formation work has been commoditised for some time, but some players in the industry have developed, and will continue to develop, more innovative structures or hybrid-type products that raise novel issues and are quite bespoke. On the other hand, fundraising by private equity clients tend to involve more negotiation over terms and, once the funds are raised, generate deal work in M&A and capital markets as the funds make and sell investments. Competition among law firms for private equity fund work has been intense for some time, and I would expect this trend to continue. As a result, it is all the more critical for the law firms to be known for their range of expertise and market knowledge in this area.
Andreas Rodin: Because there is no hedge fund market in Germany, it is difficult to compare the earnings potential in this segment with the one in the private equity segment. In general, we expect Germany to see more firms competing for private equity fund work.
Iain McMurdo: I think it would be too simplistic to say that the hedge fund market is becoming more commoditised. There seems to be more players in the market and that drives fee pressure but the work is, if anything, becoming more complex with the increased regulation. The challenge for lawyers is providing a good service at a competitive rate and still maintaining reasonable margins on fee recovery. We have seen a real increase in bespoke fund work since 2008 and the funds-of-one structures are quite heavily negotiated and often are more complex and demanding than the plain vanilla master feeder structures.
In terms of PE work, it’s clear that the onshore law firms covet the PE clients for their ability to generate significant fees for the M&A groups. This is less the case for the Cayman law firms as the role is significantly smaller in any downstream work, but the PE clients and their funds can generate significant fee income for the Cayman law firms as a result of the downstream transactions and related finance transactions. The market as it applies to the Cayman Islands is relatively mature and we don’t expect any significant change to the preferred counsel used for these types of funds.