HOW TO START A HEDGE FUND IN THE EU 2012 ppt

As transparency and security become key requirements, structural solutions such as managed account platforms MAPs will start-be appealing to investors, and in addition, prime brokerage s

FEATURING Dechert // Dillon Eustace // KB Associates // One Ten Associates

// Point Nine // Quant // Zammit & Associates Advocates

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REPORT EDITOR Richard Weston T: +44 (0)20 7029 4025 r.weston@pageantmedia.com STAFF WRITER

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This HFMWeek special report explores the key issues facing European ups and what potential investors will be looking for Setting up a hedge fund infrastructure demands a good understanding of both the needs of the business and those of the investors, and there are many different considerations to address early on The COO and compliance department will naturally have an important role in making sure regulatory approval is obtained Fund managers will have to establish a viable business, showing the necessary controls and risk mitigation in their infrastructure at the same time As transparency and security become key requirements, structural solutions such as managed account platforms (MAPs) will

start-be appealing to investors, and in addition, prime brokerage services will start-be looking

to assist those start-ups unable to afford the costs required to attract the attention of the larger European prime brokers

Ireland continues to be an attractive domicile, in particular due to its Qualifying Investor Funds (QIFs), which already meet many of the requirements of the AIFMD Malta is coping with the increasing number of international businesses setting up operations there with the Highly Qualified Persons Rules, introduced by the Malta Government in 2011, which offer a favourable tax rate on employment income

Therefore, choosing the jurisdiction which best suits a fund manager’s needs remains as important as ever Obtaining eligibility for Ucits space will also be attractive to investors enticed by the prospect of open passporting rights within the eurozone Moreover, apart from meeting all the operational and due diligence requirements, the ability to offer potential investors a unique opportunity one way

or another is just as important

Richard Weston

REPORT EDITOR

W

H O W T O S T A R T A H E D G E F U N D I N T H E E U 2 0 1 2

4 H F M W E E K CO M

C O N T E N T S

H O W T O S TA R T A H E D G E F U N D I N T H E E U 2 0 1 2

LEGAL

GERMANY: TRANSPARENT INVESTMENTS

Achim Pütz of Dechert gives an overview of the benefits of a

managed account platform from the perspective of a German

institutional investor

PRIME BROKERAGE

HEDGE FUND IN A BOX, EVERYTHING YOU NEED IN

ONE PLACE…

Jerry Lees of Quant explains the important role of a Mini Prime

broker: to get you to market quickly, bypass set-up and regulatory

delays and raise funds

LEGAL

ATTRACTING THE ‘BEST OF BREED’ FOR MALTA’S

FINANCIAL SERVICES INDUSTRY

Andrew Zammit, chief legal officer of CSB Group, gives an outline of

the Highly Qualified Persons Rules, 2011

RECRUITMENT

START-UP HEDGE FUNDS

Mush Ali of One Ten Associates explains the different challenges

facing COOs of hedge fund start-ups

HOW TO MEET INVESTORS’ EXPECTATIONS?

Phillip Chapple of KB Associates discusses some of the demands

of starting a hedge fund infrastructure

LEGAL

QUALIFYING INVESTOR FUNDS – THE REGULATED ALTERNATIVE

Derbhil O’Riordan of Dillon Eustace explains Ireland’s benefits as

a regulated jurisdiction for alternative fund investors and fund managers

6 H F M W E E K CO M

H O W T O S T A R T A H E D G E F U N D I N T H E E U 2 0 1 2

During the financial crisis of 2008, many

hedge fund managers exercised their right

to restrict fund liquidity, using their quently underestimated legal powers to put

fre-in place gates, suspend redemptions and even segregate illiquid fund assets for years

in closed-end vehicles (so-called ‘side pockets’) Among other factors, this resulted in a substantial deterioration of liquidity for investors

Single security deposit accounts held in trust – which are known as segregated managed accounts – emerged from the crisis as a favoured structural solution, as they not only offer investors full transparency, but also an effec-tive protection against the above-mentioned liquidity con-straints In a segregated managed account, the portfolio’s liquidity derives from the liquidity set by the underlying financial instruments, rather than by conflicting activities

of other investors who may force the hedge fund manager

to liquidate securities positions and thus take measures to restrict liquidity

STRUCTURAL SOLUTIONSThe experiences gained from the financial crisis caused Bayerische Versorgungskammer (BVK), the largest Ger-man public pension scheme – with €50bn AUM – to carry out an internal analysis of their existing hedge fund invest-ments This analysis indicated that it is reasonable for a large investor such as BVK to invest in single hedge fund strategies via managed accounts (MACs)

Therefore, BVK decided to structure and launch its own BVK-controlled managed account platform (MAP)

LEGAL STRUCTURAL OBJECTIVESWith regard to the legal set-up of the MAP, the following objectives in particular had to be taken into account:

y BVK, as the managing and representative body of twelve professional and local pension schemes (BVK Pension Funds) wanted to ensure that the BVK Pen-sion Funds are the sole eligible investors for the MAP and the portfolios of different investment managers (portfolio managers) to be integrated The assets man-aged by the portfolio managers should be held directly

by the respective sub-fund and controlled by the MAP and its service providers

y Any dependence on the MAP operator and other service providers to the MAP should be avoided In the interest of the BVK Pension Funds, it should be

possible to replace these service providers as easily as possible

y It was necessary to safeguard the eligibility of the rect investments of the BVK Pension Funds under the provisions of German investment law and insurance supervision law

indi-STRUCTURING OF BVK MANAGED ACCOUNT PLATFORM

On the basis of the above structural objectives, it was determined that the following legal structure – as a plat-form vehicle – would be used: a Luxembourg Specialised Investment Fund (SIF) pursuant to the Law on Special Investment Funds dated 13 February 2007 (SIF Act), in the form of a stock corporation (Société Anonyme – S.A.) with variable capital (Société d’Investissement à Capital variable – SICAV) (SIF SICAV S.A.)

The reasons for choosing a Luxembourg SIF include its flexibility regarding investment policy, the lean regula-tory regime accommodated to such vehicles (supervised

by the Commission de Surveillance du Secteur Financier – CSSF), as well as its possible classification as a foreign collective investment scheme, from a German regulatory perspective The legal form of a Luxembourg stock cor-poration was selected in order to set up an independent corporate fund (rather than a contractually structured spe-cial fund dependent on a management company), which grants voting rights to its investors and is independent of the integrated service providers

Moreover, for efficiency reasons, the SIF SICAV S.A was structured as an umbrella fund with several sub-funds The SIF SICAV S.A has a central administrator and a central custodian bank

The MAP’s ongoing activities are co-ordinated and pervised by a specialised service provider, the MAP opera-tor, which has been integrated into the MAP by way of a tailored service agreement The MAP operator is respon-sible, among other things, for the following:

y Legal and operational launch of the MAP and new MACs on the MAP (as well as their liquidation);

y Legal and operational integration of fund infrastructure into the MAP and the negotiation of service contracts;

y Initial and continuous operational due diligence of the hedge fund managers and the fund administrator, the custodian bank and the prime brokers, if applicable;

y Recommendation of investment guidelines for hedge fund managers and negotiation of investment man-agement agreements;

ACHIM PÜTZ OF DECHERT GIVES AN OVERVIEW OF THE BENEFITS OF A MANAGED ACCOUNT PLATFORM FROM THE PERSPECTIVE OF A GERMAN

financial services group and

has extensive experience

in advising both German

and international clients on

traditional and alternative

fund structuring, structured

debt products and all

aspects of investment

strategy regarding complex

alternative structures

L E G A L

y Operative launch of commercial relationships

and negotiation of broker agreements with

prime brokers;

y Risk management, controlling and

monitor-ing of compliance with investment guidelines,

as well as examination of counterparty risks;

and

y Provision of online reporting, allowing BVK

to review any and all positions of the MACs

at any time

BVK thus outsourced all middle office and back

office operations to specialised service providers,

without giving up the unrestricted control of the

MAP as shareholder, or the ability to replace the

service providers at any time, pursuant to the relevant

agreements

LEGAL QUESTIONS

Within the structuring process, a number of specific legal

questions arose, the key issues of which are discussed as

follows:

PERMISSIBILITY OF AN INVESTMENT IN MAP UNDER

INSURANCE SUPERVISION LAW

The BVK Pension Funds are subject to state regulation,

which is largely in parallel to the regulatory framework

governing the investments of German insurance

compa-nies Therefore, it was necessary to structure the SIF

SI-CAV S.A and each individual MAC in a way to meet these

regulatory requirements

UMBRELLA VERSUS STAND-ALONE

An initial question regarding structure involved whether

the launch of one or several umbrella SICAV or the use

of a stand-alone SICAV would be advantageous for each

managed account with regard to the legal and practical

consequences It was determined to select an umbrella

SICAV, primarily for reasons of practicability and

pos-sible cost savings Since an umbrella SICAV is a single legal

entity (despite a basically unlimited number of possible

sub-funds), it can be managed under corporate law in a

more efficient way than a number of individual SICAVs,

each with an executive board, general shareholders’

meet-ings, disclosure requirements, and so forth In the case of

an umbrella SICAV, efforts to amend organisational

docu-ments would not need to be undertaken for individual

investment vehicles The legal relationships with central

service providers can also be implemented and later amended in a more efficient way and with less documentation requirements

This increased efficiency should result in siderable cost savings with increasing volume Furthermore, the launch of new sub-funds is easier than the launch of a new SIF SICAV S.A invest-ment vehicle for each individual managed account

con-A potential disadvantage to using an umbrella SICAV might be increased liability risks due to the umbrella structure Any residual risks existing

in this regard were analysed for the United States and the UK, which are eligible as potential (prime) broker locations Such risks were assessed as negli-gible, provided that appropriate contractual ring fencing protections are included in the relevant agreements INTEGRATION OF A CENTRAL INVESTMENT MANAGERAnother important issue to be resolved was the question

of whether the respective portfolio managers should be directly instructed by the MAP as to the management of the relevant sub-fund, or whether it would be beneficial

to interpose the MAP operator and/or a group company

as a central investment manager to authorise the portfolio manager within the framework of a sub-delegation.During the discussions with the various platform opera-tors it appeared, for a number of reasons, that the addition-

al assignment of the function of an investment manager to

a platform operator might not be practicable

Furthermore, a benefit of not having a central ment manager is that there is no risk that all sub-funds of the MAP would be affected if a central investment man-ager fails

invest-Accordingly, the MAP was structured without posing a central investment manager – since this was de-termined to be more beneficial in principle – provided that adequate security mechanisms are implemented in the contractual provisions with the MAP operator and the portfolio managers

inter-The set-up of a proprietary MAP for investments in hedge funds (and other asset classes) may considerably increase the transparency and security of such assets without causing higher costs for investors in the medium term These investment solutions will likely continue to make their way into the market for the benefit of insur-ance holders, pension fund contributors and/or other end-investors Q

THE SET-UP OF A PROPRIETARY MAP FOR INVESTMENTS IN HEDGE FUNDS MAY CONSIDERABLY INCREASE THE TRANSPARENCY

”

8 H F M W E E K CO M

H O W T O S T A R T A H E D G E F U N D I N T H E E U 2 0 1 2

The times they are a-changing”, to quote Bob

Dylan, and never more so than in the financial sector After 2007’s crises (Lehman, Mad-hoff, Bear Stearns, MF Global and the col-lapse of numerous hedge funds) we are faced with a very different and complex market, one more difficult than any of us have faced before But,

as ever, troubled times throw up opportunities as well as issues For many who are now leaving bulge bracket firms

or who are in the process of setting up a new fund or prop trading business, this is distinctly a time of opportunity – but not one without risk Even established mid-sized hedge funds are being kicked out by their prime brokers

as unprofitable, as they tighten their belts and command huge minimums But once again,

there is a solution

There is a real chicken and egg dilemma to be faced Because of recent events, investors from all levels of the investment commu-nity have an understandable mis-trust of unproven and untested products There is no point in a new fund coming to investors with a plethora of historical back testing The investor won’t believe you, and probably rightly so – I have never seen an unprofitable back test Equally, a track record

at a certain bank or fund is no proof that you can do the same job within the constraints of the new entity and in the new market conditions, which are very different now So, how do you prove your track record (while having only a limited initial investment) with-out being brought down by costs and shunned by every prime broker on the block because you are too small and puny to matter? If you have tried, you will recognise the phrase, “come back when you have $200m under man-agement, but don’t bother us before”

OVERCOMING HURDLES How do you overcome these hurdles? You need to set up

a feasible, regulated entity with limited capital, which is not overwhelmed by set-up and running costs It needs to

get a reasonable deal for execution costs and potentially some leverage, so that the trading strategy can be proven Meanwhile, it will take you more than 18 months to get regulatory approval and will cost north of £200,000 to set up the fund You will need to get an operating busi-ness in place and get regulatory approval before build-ing your track record At the same time, there are salaries

to be paid, compliance to be dealt with and offices to be sourced and paid for It doesn’t take much to realise that this is likely to be a serious roadblock!

Besides these potential troubles, funds with less than

£75m in assets have difficulty finding prime brokers As a small player, if they do find a prime broker, they are often faced with high minimums, impossible financing rates,

limited leverage, high brokerage fees and second rate service levels

In addition, the trouble with setting up a new hedge fund or prop trading business is that the people who are most likely to create effective trading strategies – which produce the return and create value – are often the least experienced in terms of running

a day-to-day business There is a conflict here: unless the business

is set up on sound operational lines and with a solid understand-ing of the operational constraints, timescales and costs, there is little chance of the fund’s raising and trading side succeeding The rea-son for this is that costs combined with timescale can completely overwhelm the strategic business goal of pro-ducing a viable track record

WE CAN OVERCOME – A HEDGE FUND HOTEL BUT MORE…Linear Investments and Quant Execution Management Services (Linear/Quant) have been set up specifically

to address the issues faced by the smaller hedge fund or prop trading desk The aim is to provide a menu of op-tions to address all of the client’s needs For some, the fact that at Linear/Quant we can provide the full FSA umbrella in weeks (with regulatory capital in place) and provide access to a fund cell (prime brokerage plus capi-

YOU NEED TO SET UP A FEASIBLE, REGULATED ENTITY WITH LIMITED CAPITAL, WHICH IS NOT OVERWHELMED BY SET-UP AND RUNNING COSTS

”

“

JERRY LEES OF QUANT EXPLAINS THE IMPORTANT ROLE OF A MINI PRIME BROKER: TO GET YOU TO MARKET QUICKLY, BYPASS SET-UP AND

REGULATORY DELAYS AND RAISE FUNDS

HEDGE FUND IN A BOX,

EVERYTHING YOU NEED IN

executive board, Jerry started

and grew the Electronic

DMA, Synthetic Prime

Brokerage business initially

in Asia and then globally

P R I M E B R O K E R A G E

tal introduction) at a stroke is a major

opportu-nity But we go further in providing outsourced

desk execution, DMA access across global

mar-kets and instruments and a fully technologically

equipped trading desk platform in the heart of

London Others may wish to select our prime

brokerage offering without the other aspects,

or just come to us for regulatory support while

they build a track record It’s flexible, the choice

is yours

HOW DOES IT WORK?

On the prime brokerage side, Linear and Quant

consolidate flows and business from more than

60 clients, giving us considerable negotiating

power with global brokers and prime brokers

Our assets under management and trading

ca-pacity are such that the smaller player is part of a

big-ger picture to the global or prime broker Through

con-solidation and discounted pricing, we are able to pass on

these lower rates and fees to our partners Often it is the

case that no other prime broker will consider the smaller

hedge fund or prop desk in the first place

Within Linear/Quant Mini Prime, smaller funds pay

less for trading and get competitive pricing (with no

minimums) by taking advantage of our consolidated

flows and negotiating power Linear/Quant provides

tailored prime brokerage services to start-up, small and

mid-sized hedge funds that are not serviced by larger

prime brokers in Europe In essence, funds get better

servicing and pricing through our aggregated prime

broker relationship, as well as legal and administrative

support; day to day trading support and execution; and

an outsourced trading desk and DMA It is effectively a

hedge fund hotel

LINEAR INVESTMENTS – INCUBATION PLATFORMLinear is set up to nurture all types of financial services companies who need to conduct regu-lated investment business under the UK Financial Services Authority (FSA registration 537389) Incubation allows firms to establish a track record and gain experience, as well as competency, while building critical mass

Individual FSA authorisation can be a long and expensive process with a minimum nine-month slog to gain FSA regulated status Post-2008 regu-lation for any size of financial services firm is essen-tial From the client’s perspective it avoids putting

up excess regulatory capital, provides a strong erational structure and allows for a short timeline

op-to be able op-to conduct business

LINEAR/QUANT – MINI PRIME BROKER The prime brokerage offering enables a hedge fund to uti-lise Linear/Quant relationships with multi wholesale bro-kers and a unique set of mini prime offerings Mini primes are viewed as an omnibus account aggregated to the prime brokers, allowing your firm to benefit from favourable pricing and servicing from the prime broker

In summary, the partnership provides operational port in setting up, legal, administration and regulatory ad-vice In addition, we provide an outsourced trading desk and regulatory support such as compliance Access to of-fice space, trading and technology facilities is also an op-tion in the context of a hedge fund hotel With access to multiple trading accounts, we provide one contact to track the different accounts In essence, we build an offering tai-lored to your needs Q

sup-For further information contact Jerry Lees – CEO Quant

& chairman Linear Investments: jlees@quantems.com

LINEAR/QUANT PROVIDES TAILORED PRIME BROKERAGE SERVICES TO START-UP, SMALL AND MID- SIZED HEDGE FUNDS

”

A successful

alternative investment firm needs to grow its business not its list of to-dos.

At Equinoxe, we understand the walk along the efficient frontier taken

by alternative investment managers like yourself So when we administer your account, you have seasoned professionals dedicated to your fund and its investors This experience, coupled with our bespoke operating model and flexible reporting, lifts the weight of every administrative detail from your shoulders and places it squarely on ours

www.equinoxeais.com

Stephen Castree, scastree@equinoxeais.com, global

Chris Foy, cfoy@equinoxeais.com, usa

Rod White, rwhite@equinoxeais.com, bermuda

Alan McKenna, amckenna@equinoxeais.com, ireland

Irfaan Hossany, ihossany@equinoxeais.com, mauritius

L E G A L

M alta has attracted much media

atten-tion as an up-and-coming onshore financial centre, particularly since the 2008 economic slowdown It has become widely acknowledged as an

EU jurisdiction where things get done efficiently and with the right balance between prudential supervision and pragmatic regulation, enabling businesses

to develop lasting and meaningful relationships with their regulators and better business for the regulated operators, while also offering a quality Mediterranean lifestyle with

a strong Anglo-Saxon work ethic This development has most recently been extensively covered by Bloomberg and the Financial Times, both of which have extensively praised Malta’s virtues

The surge in the number of international businesses establishing some or all of their operations in Malta, par-ticularly in the regulated industries of financial services and internet gaming, has created a marked shortage in the supply of certain specialised skills within these industries

These growing pains have been managed by the Maltese government through various initiatives including the in-centivising of advancement into tertiary education and ongoing training However, besides such incentives, the government has also acknowledged the value of attracting additional human capital possessing the technical knowl-edge and experience to advance these industries and se-cure Malta’s position as a centre of excellence in the inter-national financial arena

With this objective in mind, in 2011 the Malta ment introduced specific tax rules targeted at highly quali-fied persons performing particular functions within Mal-ta-based operators duly licensed by the Malta Financial Services Authority (MFSA) or the Lotteries and Gaming Authority (LGA) These rules are contained in the Highly Qualified Persons Rules, 2011 (HQP Rules)

Govern-The HQP Rules are effective in respect of income earned

by qualifying individuals in and from 1 January 2010

THE PROPOSITION

In terms of the HQP Rules, a 15% flat rate of tax would be chargeable on employment income derived by duly qualified, experienced and senior personnel holding an ‘eligible office’

This favourable tax rate applies in respect of such income up

to a maximum of €5m per annum Any income in excess of the €5m threshold is exempt from Malta tax altogether

The ‘eligible offices’ enumerated in the HQP Rules are the following:

• Actuarial professional

• Chief executive

• Chief financial officer

• Chief commercial officer

• Chief insurance technical officer

• Chief investment officer

• Chief operations officer

• Chief risk officer (including fraud and investigations officer)

• Chief technology officer

• Chief underwriting officer

• Head of investor relations

• Head of marketing (including head of distribution channels)

• Head of research and development (including search engine optimisation and systems architecture)

2 Be employed by a company licensed by the MFSA

or the LGA (as the case may be) to hold an eligible office in terms of an employment contract, which

is subject to the laws of Malta;

3 Satisfy the MFSA or the LGA (as the case may be) that:

i the relevant contract of employment relates to work genuinely and effectively performed in Malta;

ii they are in possession of professional qualifications in terms of the HQP Rules; and

iii they perform activities of an eligible office

4 Declare and confirm, inter alia and in the scribed application form, that they:

pre-i are not and have not been domiciled in Malta and do not intend to reside in Malta permanently;

ii have not benefitted from the special domestic tax

H O W T O S T A R T A H E D G E F U N D I N T H E E U 2 0 1 2

Andrew J Zammit

is managing partner of

Zammit & Associates –

advocates and chief legal

officer of the CSB Group,

practising company law,

financial services regulation,

hedge fund registration,

internet law and ship and

yacht finance

ANDREW ZAMMIT, CHIEF LEGAL OFFICER OF CSB GROUP, GIVES AN OUTLINE OF THE HIGHLY QUALIFIED PERSONS RULES, 2011

ATTRACTING THE ‘BEST OF

BREED’ FOR MALTA’S FINANCIAL

SERVICES INDUSTRY

1 2 H F M W E E K CO M

H O W T O S T A R T A H E D G E F U N D I N T H E E U 2 0 1 2

rules applicable in respect of investment services and insurance expatriates with respect to relocation costs and other expenses (under article 6 of the Income Tax Act);

iii are in receipt of stable and regular resources, which are suffi cient to maintain themselves and the mem-bers of their family without recourse to the social as-sistance system in Malta;

iv reside in accommodation regarded as normal for

a comparable family in Malta and which meets the general health and safety standards in force in Malta;

v are in possession of a valid travel document; and

vi are in possession of sickness insurance in respect of all risks normally covered for Maltese nationals for themselves and the members of their family

Th e favourable 15% tax rate prescribed under the HQP Rules would apply for a maximum consecutive period of

fi ve fi scal years in favour of EEA (including EU) nationals and for a maximum consecutive period of four fi scal years

in favour of third country nationals (nationals of non-EEA countries)

It is important to state that the HQP Rules do not ply in respect of any person employed in Malta prior to 1 January 2008 On the other hand, an individual employed in Malta on or subsequent to 1 January 2008 would be entitled

ap-to benefi t from the favourable fl at tax rate, but the said

bene-fi ts would nevertheless be limited to bene-fi ve years from the date

of commencement of the qualifying employment Th us, for example, a Swiss chief investment offi cer employed with

a Malta-licensed asset management company and having

a qualifying contract of employment in an ‘eligible offi ce’

starting in 2008 (basis year) will be able to benefi t from the HQP Rules 15% tax rate for a period of three years – basis years 2010 (the fi rst year in respect of which the HQP Rules became eff ective), 2011 and 2012, – while a third country national will benefi t from one year less

Th e Rules also provide for certain circumstances that would eff ectively exclude the application of the favourable

L E G A L

15% rate, such as where the employer receives any direct

or indirect benefi ts under certain business incentive laws,

or if the individual holds more than 25% (directly or rectly) of the company licensed and/or recognised by the relevant authority, or if the individual is already in employ-ment in Malta before the coming into force of the scheme either with a company not licensed and/or recognised by the respective authority or not holding an ‘eligible offi ce’ with a company licensed and/or recognised by the rel-evant authority

indi-Th e Rules provide that any person abusively seeking to claim benefi ts under the Rules without entitlement may face a penalty equal to the amount of benefi t claimed together with additional tax imposed at a rate of 7% per month or part thereof

REACHING OUT FOR THE FUTUREWith the HQP Rules complementing Malta’s fi scal, pro-fessional and infrastructural framework, international fi -nancial operators have been provided with an additional incentive to consider establishing or expanding their Malta operations Operators already established in Malta have the benefi t of being in a position to att ract top talent from within the EEA and beyond, providing prospective employees with an att ractive net remuneration package In addition, operators looking for an alternative or comple-mentary base for their operations may benefi t from Mal-ta’s att ractive corporate tax system and also facilitate the relocation of staff falling into the eligible offi ce categories set out in the HQP Rules

It is expected that the introduction of the HQP Rules will inject new talent, knowledge and skill into the Mal-tese fi nancial services industry, further contributing to the Government’s target to increase the country’s GDP derived from fi nancial services from the existing 12% to 20% And with the continuing eff orts being made, both in the public and the private sector, to improve Malta’s inter-national service off ering, this ambitious objective appears clearly within reach Q