Ambitious but realistic, slow and steady. This characterises Gibraltar’s approach to the hedge fund industry. As more funds look for a well-regulated jurisdiction, Gibraltar believes it should be near the top of the list for consideration.

Gibraltar may be a tiny jurisdiction, but it is beginning to pack a punch. Slow, steady and careful progress, coupled with what many had seen as an obsession with regulation, may have made fund managers and promoters pass the state by in the past. Not so now.

Like other EU jurisdictions, it is beginning to attract a lot more interest. And, unlike the others, its UK overseas territory status coupled with EU membership is a plus point, particularly as more managers question the wisdom of the UK government in raising personal tax levels and creating what many are beginning to see as an environment that is rather hostile to free-wheeling fund managers.

Gibraltar, on the other hand, offers the comforts of London (common law, English language and EU membership) with a Mediterranean climate, low tax and the solidity of an international financial centre with robust fund regulation but a regulator that is both approachable and willing to listen to managers and industry about adaptations and changes that may be needed.

While Gibraltar shares many of the same qualities as Malta, it is realistic about its prospects of developing a fund industry. Gibraltar’s emerging funds association, known as Gibraltar Investment Funds Association, is aware that a lot of work needs to be done to get the jurisdiction on the radar of existing and new funds.

It is also realistic about its size. While it may be able to draw on a workforce based on the Spanish side of the border, space is not infinite in Gibraltar. In fact it is slowly reaching its maximum, although there are still some projects that may reclaim more land from the sea.

Already one of the most densely populated areas of Europe, Gibraltar knows space is at a premium and cannot hope to attract the large-scale operations of some of the global fund administrators.

That is one reason why the industry is likely to ask the regulator and government to consider allowing Gibraltar-domiciled funds to have an administrator based outside the jurisdiction, as long as the administrator they choose comes from a reputable, well-regulated country.

Nevertheless, many within the reorganised Gibraltar Funds and Industry Association (Gfia) are anxious to attract at least one big-name fund administrator to the territory. They believe the presence of Capita Financial Administrators has given the jurisdiction a fillip but think the presence of larger fund administrators will help to drive fund business to Gibraltar.

At the centre of Gibraltar’s growing hedge fund hopes is the legislation that launched the sector in 2005, the experienced investor fund (EIF) (article, page 13). This piece of legislation, together with the protected cell company (PCC) rules, has given the industry the foundation it needed to be attractive as a domicile.

The financial crisis has also helped boost Gibraltar’s prospects. Alone in continental Europe, Gibraltar’s economy has maintained its steady growth, albeit at a slower pace. However, 6% GDP growth in 2009 is an outstanding accomplishment. At the same time the jurisdiction’s banking community and financial services in general have weathered the crisis well, and in fact, almost all have recorded growth with recruitment continuing. Indeed, at KPMG, which only re-established itself in Gibraltar in late 2008, numbers have trebled and are continuing to grow. Legal firms, fund administrators and accountancy groups also report growth and not only retention of clients but expansion of business.

The jittery institutional investors who want to see better-regulated funds and a robust approach to the industry have seen Gibraltar as fitting the bill. Not only is the regulator, the Financial Services Commission (FSC), considered to be comprehensive in its oversight of the industry, it is also known to be approachable and open to innovation.

Regulatory direction
The FSC, led by CEO Marcus Killick, has pursued a measured and open approach to regulation as well as to the industry. Coupled with the Gibraltar government’s own philosophy of encouraging financial services within a strong regulatory framework, Killick believes it is important to listen to what the industry suggests. Now with Gfia the industry has a stronger and more coherent voice. It intends to carry on working closely with the FSC to ensure new product development keeps pace with industry innovation and keeps Gibraltar competitive with other hedge fund jurisdictions without losing quality.

For his part Killick is very clear what he thinks a regulator should do and, perhaps just as importantly, when it should not meddle with the industry. An example of this is his view of the UK Financial Services Authority’s (FSA) pronouncements on bonuses. “We’ll do what the EU says through directive but we’re not following the FSA. Philosophically a regulator should not be involved in remuneration unless it creates a risk in an organisation or a systemic risk in the system as a whole,” says Killick.

He is more concerned about managers understanding risk. “Effective corporate governance is important,” he says, adding that the issue was poor management and risk control. “We have a very specific, statutory role to reduce systemic risk and protect the reputation of Gibraltar,” said Killick at a seminar in Geneva in 2009. “But rather than act as a brake on growth, our objectives require us to be a partner in it, complementing government and industry in developing the finance sector.”

He continued: “It is Gibraltar’s ability to innovate within a sound regulatory structure that will provide us with an opportunity to become a leading EU fund centre. Like so much in today’s world it will be regulatory-driven.” In Gibraltar, Killick says the territory was “lucky there were a number of measures in place looking at corporate governance internationally.” He believes the regulator’s nature and motives should be related to an understanding of the quality of corporate governance and risk management. His focus is on ensuring the licensing processes facilitate effective risk management. “Our role is not to try to run organisations or tell them what to do. It is dangerous for regulators to be too involved in approving business models. When they do that they are not concerned about regulation any more,” he cautions.

He believes the proposals coming from the industry should be considered. On that front he is currently re-examining the experienced investor fund (EIF) legislation. He believes the jurisdiction has had “long enough and sufficient time” to see how the EIF worked.

Killick wants to make sure the EIF is fully compatible with the EU’s markets in financial instruments directive (Mifid). For example, part of the package of measures expected to come into force some time in 2010 will clarify the definition of experienced investors among other things.

Killick agrees it is important to expand the product range and has been holding meetings with Gfia to look at “ways to enhance fund structures available”. The EIF structure is highly adaptable, he says, but needs “siblings”. One area recently identified by the industry is the impediments to creating Shariah compliant EIF funds.

A stumbling block centres on participation in risk and profit, something that under Shariah law needs to be shared.

One solution that is being looked at is using the PCC structure, creating a different class for the Shariah compliant part of the fund.

“The PCC is a great thing and has more international acceptance than 10 years ago,” Killick says. “It is ideal for fund structures.”

While no one wants to be the one to test the PCC structure in a court in a country where it is not recognised, Killick believes this particular drawback is likely to recede as more jurisdictions adopt the structure.

Another area Gibraltar has not yet developed in the way it has EIFs is a Ucits fund industry. This is likely to change during 2010 as Ucits IV comes into play.  Killick points to the changed market conditions with a switch from unregulated or “under-regulated” hedge funds into the retail Ucits model, albeit for many hedge funds as a wrapper around the more traditional fund strategies.

This option has become more popular and attractive in Europe over the past year and he expects the trend to continue. Gibraltar’s fund industry hopes to be able to make inroads into this area with early adoption of Ucits IV provisions.

Killick says he agrees with a move towards early implementation of Ucits IV and wants to take the opportunity when introducing the directive to also remodel the collective investment scheme legislation of 2005 as well as the EIF. “The EIF could do with a spring clean. We want to look again at that and how we deal with closed-end funds, non-Ucits public, non-EIF and other types of funds. The industry has been very successful in the last three to four years. It has a range of flexible tools necessary to compete in the current and future markets,” says Killick.

Draft decisions
On the draft EU alternative investment fund managers (AIFM) directive, Killick takes a pragmatic approach. “The uncertainty serves us well as funds and management companies consider migration and reallocation. If I were a hedge fund manager based in Cayman with a clutch of institutional European investors, relocating the business to the EU might be an option.”

The trouble is that until there is a final version for the draft, fund management companies and domiciles of the funds will remain uncertain.

Killick believes that it is likely Gibraltar will need to align its current legislation to comply with whatever comes out of Brussels but believes it will be very close to what the regime has now.

He is also careful to point out that Gibraltar is required to “match” UK standards, not “narrowly follow” them. “We will look at the outcomes,” says Killick. He does not agree with a more intrusive approach. “I have not seen the need to change our style of regulation in light of what happened. That doesn’t mean we can ignore the need for far better regulation or that we might have to beef up our own regulation,” notes Killick.

He maintains that the approachable, open-door policy he has pursued works well. “We are robust where necessary,” he concludes.

He does not think there will be an unregulated industry in five years. However, he has some concerns. “My major concern is that investors are not deprived of an opportunity to select their own appetite for risk and that certain benefits of hedge funds – of which there are a number – are not lost as result of the  imposition of regulation,” says Killick.

To back up his views that Gibraltar’s fund industry will continue to expand, he is forming a separate division for funds within the FSC in 2010. “I wouldn’t do that if I didn’t believe there would be continued strong growth of the fund business in Gibraltar,” he comments.

“If the fund industry grows beyond a certain point, we would have to adapt a different regulatory approach simply based on the scale of the industry. But we will deal with that when it occurs.”

Killick welcomes the formation of the trade association Gfia and looks forward to working with it. “It would be foolish not to listen closely to industry, but we will not be led by the nose. I listen to the views of the industry because they are often correct,” he states.

Generally the Gibraltar fund industry is in a buoyant mood, sensing opportunities brought about by a combination of factors: the financial crisis; a push towards better-regulated onshore EU jurisdictions for European managers and funds; and the uncertainty created by AIFM. Whatever the future may hold, Gibraltar’s fund industry is confident the jurisdiction will become a main player.