Acquiring the funds
25 January 2010 | By James Swift
28 January 2013
9 July 2013
21 January 2013
24 June 2013
23 September 2013
After running the gauntlet of Madoff and the recession, Ireland is banking on the funds industry to help it get back to winning ways.
Source: Getty Images
Only Greece, Spain and one or two Eastern European countries have overshadowed the severity of Ireland’s economic downfall. But it does have an ace in the hole, in its hard-earned reputation as a hotspot for funds.
As Ireland focuses on cementing its position as one of the world’s leading financial service centres, and capitalising on investors’ post-crash appetite for more regulation, the spectre of Bernard Madoff and his $65bn (£39.94bn) Ponzi scheme looms, threatening to taint the country’s hard-earned reputation as a safer alternative to the offshore centres.
The implications of Madoff affect the funds industry worldwide, but the speed at which the litigation emanating from the largest fraud in history is moving in Ireland’s Commercial Court has meant that all eyes are on the republic.
The Madoff fraud’s connection to Ireland centred, initially at least, on two funds, Thema International and Alternative Advantage (AA), which launched proceedings against HSBC Institutional Trusts Services, the custodian to their funds, on December 15 2008.
The two funds suffered massive losses (Thema is claiming more than n1bn (£880m) while AA is suing for around n100m) after HSBC used Bernard L Madoff Investment Securities as a sub-custodian in the US.
A year on from the initial claims and the litigation has snowballed to around 47 funds, and with more than a quarter of them claiming more than €1m it has almost certainly become the largest litigation in Ireland’s history.
“The funds industry here is watching these cases very closely,” says Fionán Breathnach, a financial services partner at Mason Hayes & Curran. “Luckily in Ireland there’s previously been no significant litigation relating to funds, so this is the first time Irish courts have considered a number of issues relating to investor protection.”
One and all
Due to the number of claimants, most Irish firms with litigation departments have been engaged, to the point where funds and investors that want in on the action are hard-pressed to find a firm - or at least their first choice of firm - that is not conflicted.
“We’ve been approached by a variety of people,” says David Clarke, a litigation partner at McCann FitzGerald, “and have decided it would be difficult to represent their interests alongside the interests of some of our institutional client investors in Thema, including Aforge [Finance]. And I know of a number of firms that have found themselves in a similar situation”.
The five claimants leading the litigation - Thema, AA, Aforge, UBI Banca and Kalix Fund - are being represented by William Fry (for both Thema and AA), McCann FitzGerald, Arthur Cox and Dillon Eustace respectively. Matheson Ormsby Prentice (MOP) is representing HSBC.
The case combines what is for Irish firms two of the busiest practices - funds and litigation. Litigation in particular has become a cornerstone for Irish practices during the downturn and, according to one top seven firm partner, the practice area now contributes 45 per cent of his firm’s income, up from between 39 and 41 per cent during the “good times”.
Counting on funds
But while litigation may be keeping law firms out of the red, for Ireland’s economy it is the funds industry that will prove key to its recovery.
“It’s obvious that the funds industry was affected by the downturn, but it wasn’t decimated and it’s proved very resilient from both the services and products side,” says Breathnach.
And there is much more than just investors’ money riding on the outcome of the Madoff litigation. The case has raised issues of what it is to be a custodian or manager of a fund, of individual investors’ rights over custodians as well as of investor protection.
“The main aspects under scrutiny are the respective roles of the fund company itself, the custodian - and any sub-custodians - and the investment manager. The issues [in the Madoff litigation] are going to be, what were the respective duties of these parties?” says Declan Black, litigation head at Masons.
The points of law being adjudicated upon go to the heart of the funds industry worldwide, to investors and managers, but the level of interest in the outcome of the case has been piqued in Ireland as the country frets over its status as a hub for funds.
“The unfortunate thing with this issue is that there’s no real happy result at the end of it,” says Breathnach. “If the custodian is found to be liable, what effect will this have on custodians’ fees in the future? And some of the service providers involved in funds may well take a long, hard look at whether they want to accept the risk of being in the industry.
“On the other hand, a key driver of the funds industry in Ireland is the requirement for an independent custodian to ensure that an investor’s money is safely held, and so if the court finds that the fund’s assets aren’t protected, what effect will that have on investor appetite?”
It is a dichotomy, with a decision in favour of either party likely to shape the future of the funds industry. But interested parties will have to wait for a definitive decision.
Playing the waiting game
Although the country’s Commercial Court, which was established in January 2004 to deal specifically with large commercial claims quickly and efficiently, is handling the case admirably (the presiding judge, Judge Clarke, in particular has been lauded by lawyers for his handling of the case), any decision will likely be appealed and, with the Undertakings for Collective Investments in Transferable Securities (Ucits) regulation under the spotlight, EU-level involvement is almost certain, since the Irish Ucits regulation was an implementation of a European Commission directive.
And the substantive issues surrounding funds’ claims for damages have been delayed further by a preliminary issue raised by Aforge, which lost around n54m in Dublin as a result of Madoff’s sham investment vehicle, about whether investors are entitled to call HSBC to account to force the bank to tell the story of what happened to the money.
Called to account
Even this preliminary point is expected to have ramifications for the funds industry.
“Just looking at the case at a basic level, with Aforge’s claim,” says Sharon Daley, head of litigation at MOP, “if funds are required to account to individual investors when asked to, it would at a minimum have significant cost implications, and it could lead to huge changes.”
It may be a matter of years before the issues being mooted in the Madoff litigation are resolved, but there are changes happening now within Ireland, changes made with a view to ensuring that the country can compete with Luxembourg and other onshore domiciles.
Dubbed a hub
Irish politicians have made no secret that they regard the country’s status as a financial services and funds hub as being crucial to its recovery. Indeed, the Irish minister for finance Brian Lenihan has spoken publicly about opportunities “for Ireland to become the European hub for the international funds industry following recent European legislative changes”.
The most recent change to the country’s funds regime came with the inauspicious-sounding Companies (Miscellaneous Provisions) Act 2009, which allows an offshore fund to reregister in Ireland while keeping the same legal personality and avoiding certain tax liabilities. The provision was passed in a matter of weeks following close cooperation between lawyers and industry experts.
“The reality was that, when looking at it, you couldn’t really redomicile here, but you could in Luxembourg, and so they had the competitive advantage,” says Barry McGrath, head of investment funds at Maples & Calder’s Dublin office. “And if Luxembourg had it and we didn’t, there was a fear we’d be left behind. So it was a good example of Ireland working quickly since it was done in around eight weeks.
“That’s one of the advantages of Ireland – you can get things done quickly and industry works well along side the government.”
A quick change
According to law firm partners in the region, the legislation has already proved a success. “The ink’s barely dry on the legislation, which was passed just before Christmas,” says Mark White, a banking partner at McCann FitzGerald, “but we’ve already been inundated with queries about it. Clients of ours who have Cayman [Islands] and BVI [British Virgin Islands] platforms are saying that potentially these are places they no longer want to be and they want to move with a minimum of fees.”
Although Luxembourg has similar legislation, lawyers say Ireland’s processes are much more streamlined, since in Luxembourg prospective funds need approval in both the country where a fund was originally domiciled as well as in Luxembourg. Lawyers in Ireland hope that its location and cultural similarity to London and New York will tip the balance in their country’s favour.
“We expect to have an advantage over Luxembourg because the vast majority of hedge fund managers are based in London,” says White. “So if they wanted to move to a regulated jurisdiction and were thinking of choosing between Ireland and Luxembourg, I expect they’d probably prefer Ireland because of the same common law code and the ease with which business is done between London and Dublin.”
But Luxembourg is not Ireland’s only competition. Although investors and fund managers are expressing more interest in regulated jurisdictions and products since the downturn, the perks associated with offshore jurisdictions continue to exude a significant lure.
“There’s certainly more hedge fund managers looking at Ucits products than before,” reveals McGrath. “Although statistically there are still much more funds being set up in the Cayman Islands and other offshore jurisdictions than in Ireland and Luxembourg.”
And although the number of funds administered in Ireland (around 10,000) far exceeds the number in the US, Europe is still lagging behind in terms of fund value, despite managing more than n1,300bn.
Getting it together
“In the US they have only a fraction of the number of funds compared with Europe, but the value of the US funds is much higher,” says Breathnach. “This fragmented EU funds industry results in a lack of efficiencies and the European Commission, through Ucits 4, is trying to facilitate the consolidation of the EU funds industry by making fund mergers easier.”
The Commission is discussing reforms under the proposed Alternative Investment Fund Managers Directive, which may see the desire for consolidation - as well as the desire to see more funds from offshore jurisdictions moving onshore - come to fruition.
Under the proposed directive, hedge funds wanting to market their products in Europe would have to be based within the EU, but would have a passport to sell to investors in any member state once domiciled in a member state.
The focus in Ireland now is to make sure it has the pull to be that member state.