27 July 2009
Ireland’s funds industry has been positively thriving so far this year, cashing in on the global trend towards exchange-traded funds. Barry McGrath and Elaine Keane report
Despite the credit crunch and the contraction of financial markets globally, Ireland is still open for business as a leading European domicile for internationally distributed funds and structured finance products.
During the past six months, the Irish funds industry has advised on and brought to market a number of new exchange-traded funds (ETFs). This reflects the global trend towards ETF establishment and investment, with asset managers and investment banks capitalising on the inherent advantages presented by ETFs over traditional mutual funds, including lower costs, improved transparency and increased liquidity and diversification. The obvious benefits associated with ETFs have been directly reflected by the net inflows into ETFs during this period, while other types of funds, particularly traditional mutual funds, have seen large-scale outflows.
Although ETFs may be established as Ucits or non-Ucits funds, the European preference is to establish them as Ucits funds so they can then be easily passported into any EU jurisdiction for sale to retail and institutional investors alike. In terms of structuring, the ETFs can be based on a replication model (ie settled in specie) or can gain synthetic exposure (cash-settled) using derivatives.
While the focus in the funds market since the start of the year has been the emergence of ETFs, an associated area of development in the debt securities market has been in exchange-traded securities, with an increasing number of exchange-traded products being launched. This increase is an indication that despite recent market turbulence, there is investor appetite for transparent, simpler risk structures in the structured finance area.
The most successful and arguably the most innovative of these exchange-traded products are exchange-traded certificates (ETCs), which are designed to reflect the performance of commodity indices or individual commodities, such as precious metals. The benefit of the ETC is that investors can gain exposure to individual commodity-based returns without the complications of buying and storing the specific commodity or buying and managing future positions.
The certificate structure enables these debt instruments to match the daily trading flexibility of fund products through accessing platforms such as Xetra or Sets. A further positive feature of the ETC is that, within certain circumstances and where the security or certificate provides an unleveraged exposure to the underlying commodity or commodity index, the ETC is an “eligible asset” in a Ucits context and can, therefore, be sold to Ucits funds, widening the potential investor base for the ETC.
In the non-ETF sphere, investment banks continue to develop structured Ucits products. The utilisation of indices and the myriad opportunities they present has lead to a new class of product that provides investors with access to asset classes as diverse and sophisticated as life settlements, credit and commodities with risk/reward appropriate for retail investors. Moreover, they combine robust and consistent levels of investor protection and regulatory compliance by virtue of their status as Ucits funds.
The unstable and weakened markets - and the trading difficulties associated with them, which have been compounded by a reduction in liquidity - have resulted in traditional long-only and long/short-asset managers reducing the number of new products they have brought to the market. Rather, they are looking to consolidate their book by merging and amalgamating existing fund platforms.
However, this decline in business has been tempered by the resurgence in popularity of the Irish common contractual fund (CCF), which is Ireland’s bespoke pooling product. The CCF enables pension funds and institutional funds to pool their investments in a tax-efficient manner. In terms of potential investment strategies, the only limitations are those imposed by either the Ucits or non-Ucits regulatory regime. The benefits of the CCF are that promoters and asset managers can avail of economies of scale, diversification of risk and exposure to specialised investment manager knowledge.
The past six months has seen a number of the larger hedge fund and institutional asset managers utilising the Ucits regime to implement hedge fund-type strategies. This new focus could potentially herald a new era of Ucits funds, where such hedge fund and institutional asset managers can adapt their existing strategies into Ucits-eligible hedge fund indices or baskets of stocks that can be referenced or accessed by Ucits funds.
There has been a recent market rise in interest in the Irish special purpose reinsurance vehicle (SPRV) regime. This allows for the establishment of an Irish bankruptcy remote entity that (i) issues bonds or enters into loans to fund its exposure to reinsurance risks, which it assumes from reinsurance undertakings, (ii) has minimal capital requirements, and (iii) has no solvency or technical reserve requirements, provided that it is “fully funded” in accordance with the SPRV regime’s stipulations, and any additional charging of the assets comprising such full funding to relevant noteholders/lenders is subordinated to the rights/claims of the reinsurance counterparties.
The benefits associated with the SPRV regime are that it provides for the establishment of vehicles to securitise insurance risk without the onerous capital or other requirements usual for regulated insurance entities. SPRVs are not otherwise regulated under Irish or EU law as carrying on insurance business or reinsurance business in Ireland and the ongoing operation of SPRVs under the Irish regime is not radically unlike the operation of a structured finance special purpose vehicle.
The confidence of international investors and market participants in the Irish funds and structured finance industry remains steadfast during these unforeseen market conditions. Against that backdrop, Ireland’s professional service providers and the commercially focused Financial Regulator, Irish Stock Exchange and legislative bodies continue to facilitate and nurture the establishment of innovative investment and structuring solutions.
Barry McGrath is a partner and Elaine Keane an associate in the Dublin office of Maples and Calder