Fund land

Property continues to be a strong-performing asset class, but many funds are heading offshore. Nick Kershaw reveals why

More than £100bn has been invested in UK property funds in the last 10 years. Predictions are that this will continue to grow in 2004, reflecting the strong performance of property as an asset class.

A significant number of the large property funds are based in Jersey; in particular, Schroders has some £4bn of property held through Jersey funds, including the Hercules, City of London and West of London unit trusts, with a 50-strong property team on the island. Merrill Lynch, Threadneedle Investments and Henderson also have property funds in Jersey, and there are many others. An estimated £17bn of UK property is held through UK limited partnerships. In the last six months alone, there has been a significant number of these effectively relocating to Jersey, including Morley Fund Management, Legal & General and Aberdeen Property Investors.

So what is driving this move offshore? There are a number of factors. First of all, in December 2003 Stamp Duty Land Tax (SDLT) was introduced in the UK. From July this will be extended to cover transfers of interests in partnerships, which are currently exempted. This leaves the prospect of any transfer of an interest in a UK limited partnership being subject to SDLT at the rate of 4 per cent – not an attractive prospect for institutional investors who may wish to buy and sell such investments. In contrast, transfers of units in Jersey unit trusts are not subject to SDLT, hence putting a Jersey unit trust over the top of a UK limited partnership is an attractive solution and one followed by a number of institutions.

SDLT is by no means the only driving force behind the growth in Jersey property funds. Indeed, Schroders set up its Jersey funds before SDLT existed. The alternative UK vehicles for property funds are authorised and unauthorised unit trusts. The problem with authorised unit trusts is that they allow only a limited degree of leverage and are generally cumbersome to operate, hence the unauthorised unit trust being the preferred UK vehicle. However, the key difficulty of the unauthorised unit trust is that it is not possible to include both exempt and non-exempt investors in the fund without compromising the tax position of the exempt investors. There is no such difficulty with a Jersey unit trust, though, which can be offered to both exempt and non-exempt investors. At the same time, it is transparent for income, distributions can be paid gross, and provided it is managed and controlled offshore, it will be exempt from capital gains tax (CGT). Hence it is an attractive, tax-efficient vehicle.

But why have so many of the key fund managers chosen Jersey as opposed to other offshore jurisdictions? Time-zone and ease of access are two factors. In order to be CGT-exempt, the fund must be managed and controlled offshore, which means that board meetings must be held offshore. Jersey is only a 35-minute flight from London and, critically, is in the same time-zone as the UK.
Another key factor is that it has a sophisticated infrastructure, with many of the world’s leading financial institutions and accountancy firms having branches on the island, together with a wealth of legal and administration expertise in relation to property funds. Total bank deposits exceed £150bn, while more than £95bn is invested in Jersey funds.

However, probably the key attraction of Jersey most recently has been the launch of the Jersey Expert Fund. This provides a fast, flexible and streamlined regulatory regime for the authorisation of investment funds aimed at institutional and high-net-worth investors. The key benefit of the new regime is that a fund can now be authorised within a matter of days. Indeed, the first expert fund to be established was a property fund, which was authorised within 48 hours of the application being made.

How has Jersey achieved this? The Jersey Financial Services Commission (JFSC) has refocused its regulatory approach and moved away from a detailed and time-consuming regulatory review of the fund itself to a regime based on the fund and the key Jersey functionary being required to self-certify that the fund meets the relatively limited regulatory requirements applicable to expert funds.

The key regulatory requirements are as follows: the investment manager or adviser must have no convictions or disciplinary sanctions; be solvent; be regulated in an Organisation for Economic Cooperation and Development (OECD) member state or approved by the JFSC; have relevant experience in managing or advising on investors’ funds using similar investment strategies to those to be adopted by the fund; and it must have an adequate span of control over the business.

An expert fund must appoint an administrator, manager or (in the case of a closed-ended unit trust) trustee which is regulated and has staff and a physical presence in Jersey. An open-ended expert fund must also appoint a Jersey custodian and an expert fund established as a limited partnership or unit trust which must have a Jersey general partner/trustee with at least two Jersey resident directors.
The offer document must contain certain specified information, including all information that investors would reasonably require to enable them to make an informed judgement about an investment in the expert fund. There are no other structural or documentary requirements applicable to an expert fund, and if an expert fund does not comply in all respects with the above requirements, it is possible to obtain derogations from the JFSC in relation to such non-compliance.

There are no prescribed investment or borrowing restrictions for an expert fund and no requirement to adopt a risk diversification strategy. In addition, there is no concept of approval of the ‘promoter’, as applies in the case of retail funds. In order to qualify as an expert fund, each investor must either invest at least $100,000 (£53,700), be a professional investor, have a net worth of $1m (£536,700) (excluding their private residence), (if an entity) have assets available for investment of $1m, or be connected to the investment manager or adviser.

A further recent development in Jersey that enhances the attraction of Jersey property funds is the recognition by the Financial Services Authority of the Channel Islands Stock Exchange (CISX). This is in addition to its recognition by the US Securities and Exchange Commission and the UK Inland Revenue. The importance of this is that units of a property fund listed on the CISX become eligible investments for a wider range of investors, including, for instance, self-administered pension schemes.

The UK is, of course, currently looking at a new form of property investment vehicle; but the consultation process has thrown up significant issues around the tax treatment and the flexibility of the investment and borrowing restrictions, which both mean that the process of introduction of such a vehicle is likely to be somewhat delayed and that the vehicle ultimately may not have the flexibility or tax efficiency to rival what is currently available in Jersey. All the indications, then, are that Jersey can expect to see continued growth in the property fund sector.

Nick Kershaw is a partner at Ogier & Le Masurier and chairman of the legal and regulatory subcommittee of the Jersey Funds Association