Updated Irish structure set to attract new wave of PE managers
Ireland’s investment funds industry shows no sign of slowing with total AUM reaching EUR2.4 trillion by end of 2017. That’s a 16 per cent growth year-on-year and represents a new high watermark for the jurisdiction, as alternative fund managers continue to set up UCITS and QIAIFs.
That growth was underpinned by an exceptional year of net sales into Irish funds.
“There was EUR298 billion of net sales in 2017, more than twice the 2016 number. Some EUR242 billion net sales went into UCITS and EUR56 billion into AIFs. The overall aggregate AUM of QIAIFs is now EUR476 billion, which represents a 14 per cent annual increase,” says Kieran Fox, Director of Business Development at Irish Funds, which promotes the attractiveness of the jurisdiction to global fund managers.
According to the Central Bank of Ireland, in terms of breakdown every sub-category of AIF attracted net sales last year and as Fox remarks, the QIAIF is very much the “flagship fund type for alternative strategies”.
Fox confirms that the large majority of new fund launches are ICAVs.
“Pre-existing funds, which were launched as corporate structures, will often wait until a convenient time i.e. when planned changes are being made to the fund that require shareholders’ approval. At that time, they may look to convert the structure to an ICAV.
“We always expected interest in the ICAV to be strong. There was a lot of demand for that type of structure. The ICAV came on stream in March 2015 and since that time assets have grown to EUR97 billion, of which EUR32.3 billion are in UCITS and EUR64.7 billion are in non-UCITS. In fact, ICAVs have had positive net flows every month since inception,” says Fox.
What is particularly encouraging for Ireland is that the number of PE/RE funds being set up is rising. This is no longer a jurisdiction that hedge fund managers turn to for a European regulated fund solution.
It helps that the Investment Limited Partnership is being enhanced through amendments to the Investment Limited Partnership Act, 1994. This will be referenced in more detail later in the report, but in effect this 2.0 version of the ILP should, once the amendments have been approved by the Irish Government, make Ireland even more competitive, from a PE/RE perspective.
“I think that is going to make a big difference to the attractiveness of Ireland as a jurisdiction,” comments Donnacha O’Connor, Partner at law firm Dillon Eustace.
“In the interim, there are some partnership structures being set up but in the main managers are choosing to use the ICAV. Alternative funds in a non-UCITS format are being established at a greater rate than UCITS and there is particular growth in the PE/RE area. We think that there is a lot of opportunity and that there will be a lot of growth in those areas over the next couple of years.”
“I haven’t established a single Irish Plc structure since the ICAV came out,” confirms Gayle Bowen, Partner, Pinsent Masons (Ireland). “The ICAV is the structure that everybody now tends to use. It has a legal personality, everybody understands it and it’s more flexible.
“If you are selling it into the US, it checks the box for US investors. Where someone will deviate from the ICAV is if an investor has a very specific tax requirement; then they might set up a common contractual fund (CCF) or a unit trust. But otherwise it’s the ICAV.”
In many respects the Irish Plc, which would have been the only corporate legal structure prior to the ICAV, has died a death. The ICAV is a corporate fund, it has limited liability and it doesn’t come with the added corporate law complications that a Plc has.
“The ICAV is definitely the default legal structure for regulated funds in Ireland at the moment. Over 450 have been established since the ICAV legislation was enacted in March 2015,” remarks O’Connor.
O’Connor confirms that he is seeing more European real estate focussed funds being set up in Ireland than funds focussed on the Irish property market, referencing a number of ICAVs that Dillon Eustace recently established that invested in commercial properties in Italy, UK brownfield sites, healthcare facilities and in “alternative” residential sub-sectors such as student accommodation and social housing.
“The ICAV can access some double tax treaties or can get the benefit of some domestic tax exemptions where the properties are located which can reduce tax leakage,” he says.
REITs are enjoying some good success in Ireland, with new announcements such as Core Industrial REIT plc, backed by York Capital, one of the first such REITs in Ireland aimed at capitalising on investment opportunities in the Irish industrial property sector.
Existing REITs, such as Green REIT, announced a 9 per cent increase in NAV for its full year results in June 2017.
Pat Gunne, chief executive of Green REIT, said asset values were up to EUR1.4 billion, which was a good achievement given that the REIT has only been in operation for four years. “That’s up 11 per cent year on year. One of the key components is rental income and dividend flows,” Gunne was quoted as saying by RTE.
REITs are Irish Limited Companies that are publicly listed. As such, they aren’t regulated. While they generally fall within the definition of an alternative investment fund, they do need to have an appointed AIFM.
Michele Foley is Head of Alternative Investment Services (Ireland), Northern Trust. She says that Ireland has been a particular focus for real estate launches from both new and existing clients. “We have noted a recent increase in the use of Real Estate Investment Trusts (REITs) with some funds re-designating their status to this tax-efficient vehicle. REIT structures offer investors a gross dividend (without deduction of tax) so long as the fund continues to comply with certain conditions.
“Structures aside, there is also a general trend to invest in strategies with an environmental and/or a social governance theme, such as alternative energy developments like wind farms or solar energy. This may be held as a direct investment, or in the case of solar energy, held as part of a physical building as an alternative investment stream,” says Foley.
As the global surge in real estate investing continues to build, Northern Trust is busy driving new products and capabilities to support a diverse mix of real estate asset manager clients. The bank has been supporting RE fund launches from managers across the globe, seeking a European hub for their European real estate structures.
“We view ourselves as a strategic operations partner to our clients; providing the operational expertise and infrastructure to enable our clients to focus their time and resources on their strategy and investors,” says Foley.
The continued global focus on alternative asset investment has propelled inflows from both existing and new clients, helping Northern Trust achieve a 50 per cent increase in global real estate assets under administration over the past 12 months.
On the private equity front, Ireland has been a focus for technology investing over the last 12 months, with PE managers choosing to use Ireland as a tech hub for their investment strategies.
“There are a lot of international PE managers active here and there are some fast growing domestic PE firms. They are investing in a variety of sectors but particularly in tech companies. We see them funding a lot of M&A activity here. They are also using Irish funds to house their PE and loan origination strategies,” adds O’Connor.
Since mid-July 2014, EU-based PE fund managers have fallen within the scope of the European Alternative Investment Fund Managers Directive (“AIFMD”). This has made it a bit more difficult for fundraising in Europe for non-EU structures, though it is possible to use depositary lite solutions to address the brass plating requirements of Germany and Denmark; notably even where there is a non-EU Manager and non-EU PE Fund.
“As a result, many private equity houses are increasingly looking to Qualifying Investor AIFs (QIAIFs), as a potential solution to capital-raising issues within the European Union. Once you have a QIAIF you don’t need to go down the route of meeting the requirements of individual countries like Germany and Denmark; it’s a readymade solution,” explains Barry O’Brien, Head of Fund Client Relations, Quintillion.
The Central Bank has made some positive changes recently to facilitate the establishment of PE funds within the context of the Irish funds regime. PE funds in Ireland are able to:
• have different asset allocations between share classes;
• have multiple and longer initial closings;
• provide for carried interest and waterfall mechanisms (which wasn’t in place before);
• have unlimited amounts of borrowing or leverage;
• have either open-ended or closed ended structures;
• provide for partly paid shares, capital commitments and drawdown provisions;
• invest through wholly owned subsidiaries;
• provide for flexible valuation provisions which permit the Irish Venture Capital Association.
“These changes, together with the introduction of the ICAV structure, have sparked a lot of interest among PE houses looking for solutions to increasing their capital base and distribution network in Europe. This is evidenced by the number of QIAIFs established by PE and RE houseswhich include some rather well-known firms such as LGT, KKR, Old Mutual, Kennedy Wilson and Blackstone,” outlines O’Brien.
Investment Limited Partnership 2.0
Current amendments to the Irish Investment Limited Partnership – Investment Limited Partnership (Amendment) Bill, 2017 (the “ILP Bill”) – are a key legislative development for Ireland. They are a necessary update in the eyes of many Irish fund practitioners, given that the original Limited Partnership Act in Ireland dates back to 1907.
On 18th July 2017, the Minister for Finance announced that the Government had approved the legal drafting of the amendment to the ILP legislation and the Heads of Bill (Heads) was published in early March 2018.
“The goal of the ILP Bill will be to update and modernise the current investment limited partnership legislation, further enhancing Ireland’s suite of legal structures available for fund formation, and in particular Ireland’s offering for global private equity, venture capital, infrastructure, loan origination and other asset-focused investment funds,” explains O’Brien.
The original Irish ILP was designed to be attractive to US managers at the time. The idea was that by being tax transparent, it would be favoured by US taxable investors to whom managers were selling their offshore funds.
“In reality, in the mid-1990s, a regulated Irish limited partnership structure was probably a bit too niche. At the time, as a domicile, Ireland was best known for UCITS and hedge funds. Ireland also had other fund legal structures that were achieving more or less the same results under US tax rules and that were also being used by UCITS and hedge funds. So, the ILP wasn’t featuring that much.
“The ILP legislation didn’t get updated for some years as a result and now it is being generally refreshed,” remarks O’Connor.
There’s no doubt that when the National Private Placement Rules are phased out in Europe, which should have been this year but will need to be extended because of Brexit, private equity managers with non-EU based funds who wish to access European capital will find the amended Irish Investment Limited Partnership a useful legal structure to consider.
One only has to look at the success of Luxembourg, whose Special Limited Partnership was introduced only a few years ago. If Ireland can compete on a more equal footing by having the new ILP structure in place, we expect that PE/RE managers could favour the English speaking jurisdiction and the speed to market of the Irish regulated product.
“At the moment, while not an ideal route, PE and RE Managers can still access capital in Germany, the UK, the Nordics and the Netherlands via the national private placement regimes. We therefore need the amended Irish ILP in place before those NPPR channels are shut down. That’s when I expect to see a lot of traction in these sectors,” suggests Bowen.
Alongside the growth in PE/RE funds, Ireland is also enjoying strong interest among managers – especially US-based managers – wishing to set up AIFMD-compliant loan origination funds; or L-QIAIFs. These are very flexible and very quick to set up, thanks to a 24-hour fast track authorisation process.
As the L-QIAIF is fully regulated by the CBI, a fund manager can benefit from the AIFMD passport to market their fund across the EU to professional investors.
“If you are a US manager, you can try going through a Cayman fund structure but you won’t be able to sell that freely across Europe, and you won’t be able to sell it to pension funds and insurance companies because they usually require a regulated version of any such product,” explains Bowen.
“When it was first introduced, managers could only engage in loan origination activities. That meant that they couldn’t also invest in equities or other debt instruments with a view to participating in the potential upside. The only way around this was to set a second sub-fund. The problem with this is that they ended up with quite a costly product, as costs, particularly annual minimums are applied on a sub-fund basis.
“Now, managers can hold loan participation debt and other credit strategies not only as collateral but also to avail of the potential upside. These changes will, in my view, greatly increase the uptake in L-QIAIFs by managers.”
Brexit and the rise of the Irish ManCo
UK managers must now come up with contingency plans to ensure they can continue to operate their funds and passport them into Europe under the auspices of AIFMD. Come 2019, UK managers will become de facto third country managers, even if they are operating as an FCA-authorised UK AIFM.
“The top-tier institutional managers picked up on the distribution issue straight away following the referendum,” says Patrick Robinson, Director, Bridge Consulting, which offers a range of regulatory compliance and governance services and operates its own Irish ManCo, Bridge Fund Management Limited (‘BFML’).
“A number of firms were receiving a lot of questions from their institutional investors on what these plans might be. As a result, one or two took the decision quickly to set up a ‘contingency’ ManCo in an EU jurisdiction like Ireland with a view to wait and see how Brexit works out and whether they would need to use the ManCo or shut it down. By the end of Q1 2017, the next tier of asset managers started considering their plans.
“Some are looking to set up their own license in the EU and extend their regulatory footprint, particularly where they have greater numbers in their own sales team and selling funds to wider range of investors in a larger number of jurisdictions. Managers who are selling into a lower number of EU jurisdictions to a lower number of institutional investors, will look to see whether they can leverage a third party ManCo license and whether that is a feasible model for them.
“We haven’t yet seen many managers actually pull the trigger. With a UK exit date of March 2019 and no guaranteed transition process in place, we may see a greater number of applications going in to the CBI towards the end of the summer.”
In terms of the delegation of portfolio management, Robinson points out that ESMA appears to have softened its stance and he doesn’t expect any real issues with the continuation of discretionary portfolio management on a delegated basis.
As he points out, this is already happening in Ireland with respect to managers in the US and Asia. “UK managers are, however, currently having to consider: How does my distribution work and is it reliant on a UK license being passported elsewhere in Europe?
“As a result of Brexit, there is likely to be a move towards the use of proprietary or third party AIFMs,” adds Mark Crossan, Senior Consultant, Bridge Consulting.
Fox confirms there has been an increase in the number of third party management companies and platforms setting up in Ireland over the last 12 months, in part, no doubt, to Brexit.
“Some have stated that part of the reason for setting up is they anticipate providing solutions to UK-based AIFMs who will be regarded as third country managers from March 2019 onwards.
“Through conversations we have with asset managers, many are thinking about what to put in place as a contingency plan for Brexit. Do I need to have additional structures or authorisations to cover current or planned activity in the EU? Unfortunately, nobody yet knows what the future relationship is going to be between the UK and the EU and uncertainty is never a good situation in which to be making business decisions,” comments Fox.
For those launching funds in Ireland to enjoy passporting rights, most choose to set up standalone funds rather than set up sub-funds on platforms. This is because they want it to “look and smell” like their product, says Bowen. If a manager were to go onto someone else’s platform, they could keep their name on the fund but they won’t get to control the board of directors.
Bowen explains that post AIFMD a lot of US managers established management companies in the UK but now face the realisation that they may not be able to use these for distribution in Europe except by using the various national private placement regimes (to the extent that they still exist) once the terms of Brexit have been finalised and are looking to Ireland as a solution.
“Most of our discussions with US and UK based managers are around distribution – how can they continue to market into the EU?
“Ireland is well placed to benefit from this. It is an English speaking common law country. It is worth noting that the clients I am speaking with are not looking to move everything over from the UK to Ireland. While they are happy to have substance on the ground in Ireland, they are not looking to relocate the day-to-day portfolio management, which will continue to be delegated back to the UK, which is where that expertise lies,” says Bowen.
Under CP86, oversight and responsibility of the fund manager has to happen out of Ireland in the eyes of the CBI. The day-to-day portfolio management activities can be performed elsewhere, as Robinson alludes to above, but the Irish AIFM will have to show that they are properly supervising any delegated activity.
O’Brien says he does not see a huge imposition on UK based managers in the short to medium term and rather “a continuation of the status quo”.
The prevailing model is Irish regulated products being marketed in the EU with the correct management company structures in place if delegation continues to be possible.
“We see current clients choosing either Ireland, Luxembourg or Malta as viable options; maybe first to use a hosted AIFM solution before deciding whether to set up their own AIFM,” says O’Brien. “In Ireland, there are firms that are ‘Super ManCos’ and have wide European footprints. We see a lot of managers looking to this hosted regulatory solution in both Ireland and Luxembourg. Everyone is hoping that the status quo will remain. I don’t think it would be in the investors’ interests if there is no political agreement on delegation back to FCA regulated fund managers. We know it’s already available to US managers and believe it should be made available to UK fund managers.”
Currently, there are a large number of self-managed investment companies (‘SMICs’) in Ireland that need assistance with respect to substance in the form of governance and compliance. This needs to be in place by June this year in order to comply with the CP86 obligation deadline.
Although there’s no rush for SMICs to appoint an AIFM or establish a proprietary AIFM, managers who are setting up new funds must choose either option, in order to continue to operate freely under AIFMD.
Robinson says that third party ManCos in Ireland are developing quickly in terms of service standards, in terms of technology, compared to the pre-AIFMD era, when traditionally third party ManCo services were sold on a lighter basis given that most investment managers used the self-managed fund model.
“Now, with CP86, managers are looking for a third party ManCo service which can take on the day-to-day operations of a fund and take away the regulatory burden so that those investment managers can get back to focusing just on managing the portfolio and raising capital.
“We have the infrastructure commensurate with what a third party ManCo needs to deliver in today’s regulatory environment.
“In addition, over the next couple of years we will look at how we can best to use our ManCo services as a form of outsourcing to support managers who decide to set up their own ManCo in Ireland. We will be able to help people arrive at the most effective operating model using a mix of our people and their people; what that model looks like, however, will depend on the nature and scale of what they are doing,” concludes Robinson.