30 June 2008
Constructing an investment fund product requires the consideration of a number of competing issues. This can result in compromises that could impact on a product's performance and return to its investors. The importance of providing a flexible framework for the manufacturers of investment funds has resulted in the Irish Financial Services Regulatory Authority tweaking its qualifying investor fund (QIF) product even further.
The Financial Regulator's usual conditions for borrowing, leverage and diversification of investments do not apply to a QIF. A QIF is not subject to borrowing or leverage limits but the prospectus must specify the extent to which borrowing or leverage may be used. In addition, many of the Financial Regulator's requirements for specific fund types also do not apply to QIFs.
On the fund of funds side, the regulator has amended its rules for a QIF investing in certain unregulated funds - such a fund of funds product can invest all of its assets in certain unregulated funds subject to a maximum investment of 50 per cent of its net assets in any one such unregulated fund.
In entering into arrangements with prime brokers, a QIF is permitted to have unlimited indebtedness to a prime broker provided certain conditions are satisfied.
Favourable tax treatment
A fund authorised by the Financial Regulator, such as a QIF, is not subject to Irish tax of any kind. Depending on the tax status of the investor in the QIF in its home jurisdiction (for example, a tax-exempt pension fund), the QIF can be structured in such a way as to preserve the benefits of that tax status so that the investor does not suffer a tax disadvantage in gaining exposure to an underlying portfolio of assets through a QIF rather than investing in that portfolio directly. This was the reason that the common contractual fund form of QIF was introduced in Ireland in 2005.
Similarly, for QIFs that are established as investment companies or unit trusts, it may be possible to use a wholly owned Irish subsidiary of the QIF to gain access to certain double taxation treaties between Ireland and other countries such as the UK and avoid the withholding tax on certain interest payments to the QIF.
Timing of fund launch
Prior to 2007, it could have taken eight weeks for a QIF to be authorised by the Financial Regulator. However, in response to industry pressure, the Financial Regulator introduced a new authorisation process for QIFs in 2007 that enables QIFs to be authorised within one day of filing fund documentation with the Financial Regulator. This expedited fund authorisation process is based on the receipt of certain supporting forms and confirmations from the fund's legal advisers. This response from the Financial Regulator on timing has finally removed the timing advantage that some jurisdictions, such as the Cayman Islands, had over Ireland in the past.
A QIF is a scheme that is marketed to qualifying investors. Qualifying investors must (subject to certain limited exceptions for directors and key employees) satisfy the following criteria: if the investor is a natural person they must have a minimum net worth in excess of e1.25m (£990,000) (excluding main residence and household goods); or if the investor is an institution, it must own or invest on a discretionary basis e25m (£19.8m), or its beneficial owners must themselves be qualifying investors.
Unlike an undertaking for collective investment in transferable securities (Ucits), a QIF authorised once by the Financial Regulator is not entitled to be offered to the public throughout the EU.
Accordingly, the QIF must register for public sale in each jurisdiction in which it is offered or use the private placement regime available in a jurisdiction. As a result of the relaxation of the private placement rules in key jurisdictions such as Switzerland, the UK and Germany, most QIF promoters and distributors are able to market their QIFs without public registration.
Facilitating the creation of an investment fund product that is flexible in terms of product design and quick to market in terms of authorisation time has earned the QIF many plaudits, evidenced by the fact that the Financial Regulator has approved more than 300 QIFs since the introduction of its one-day authorisation process last year.
The following recent trends are also an endorsement of the QIF's success:
• Debt funds: the shift away from collateralised debt obligations (CDOs) and asset-backed securities (ABS) to equity has led to an increase in bank loan funds, leveraged loan funds and funds replicating the investment portfolios of certain CDOs and ABS.
• Maximising core expertise: promoters that have traditionally operated in the Ucits regime are now seeking to take advantage of core investment competencies in bank loans and long/short expertise by establishing QIFs that can take greater advantage of such investment styles than Ucits. In doing so, the promoter can complement its Ucits offering by offering its clients greater exposure to its core investment competencies through investment in their QIF products.
• US-based promoters looking to distribute internationally: although often persuaded by the advantages of the pan-European capabilities of a Ucits product, many US-based promoters are looking to the QIF as a quick interim fix to establishing a track record as soon as possible while focusing on their core institutional investor base on a private placement basis.
All in all, the QIF really does do what it says on the tin.
Kevin Murphy is head of the investment funds group at Arthur Cox