Offshore funds – what determines the jurisdiction?
By Vanessa Molloy, Maitland
This article discusses the factors that promoters need to consider when deciding on the most appropriate
jurisdiction and structure for a new mutual or hedge fund product.
Let it firstly be said that no investor will invest in a fund, onshore (meaning a high tax jurisdiction) or
offshore (meaning no tax or a relatively low level of tax paid by the fund vehicle), unless the investor is
confident in the quality of the fund’s service providers and particularly in the persons tasked with the
investment decisions, be this the fund’s directors or the investment manager. An investment manager with a
successful track record will have no problem attracting investors for a fund.
By far the most popular vehicles for establishing offshore funds are limited liability companies (with or
without segregation of assets and liabilities), limited partnerships, and unit trusts. The vehicle will to a large
extent be determined by the choice of jurisdiction and its regulatory environment.
Traditionally, there are several jurisdictions to choose from, all of which have relative advantages and
disadvantages, depending on the nature of the fund. These jurisdictions can be divided into three groups:
• The Caribbean, which includes the Bahamas, the British Virgin Islands (BVI), and the Cayman
Islands. These jurisdictions have mutual-fund legislation in place that primarily focuses on the
“quality” of the investment manager, the type of investor targeted, and the minimum subscription
amount rather than imposing restrictions on what investment strategy may be followed by the fund.
However, there are important practical aspects to be considered in these jurisdictions, such as
whether corporate directors are permitted, the need for audited accounts to be signed off by a local
audit, running costs, and the like.
• Bermuda, the Channel Islands, and the Isle of Man. The regulatory framework in these jurisdictions
is more rigorous than that of the Caribbean Islands, but not as strict as the two European centres
• Dublin and Luxembourg. These centres have adopted the European Union directives dealing with
Undertakings for Collective Investments in Transferable Securities (UCITS), and are the most
regulated of the abovementioned jurisdictions.
Target markets influence the decision
Traditionally, the investment strategy adopted by the fund determines to a large extent to whom the fund will
be marketed. It is unlikely that a highly leveraged hedge fund will fit into the regulatory framework for retail
investors in either Dublin or Luxembourg and would therefore most likely only be aimed at sophisticated,
professional and institutional investors. Nonetheless, access by EU retail investors to European-domiciled
funds investing in hedge funds is possible in number of ways, for example by these funds investing in hedge
funds or index hedge funds subject to certain diversification requirements. It is also possible for retail
investors to indirectly invest in offshore hedge funds via a wrapper instrument.
If the fund is aimed at retail investors, it is appropriate that either Luxembourg or Dublin be chosen as the
domicile of the fund. It will also be necessary for the fund and the investment manager to comply with the
local marketing and distribution rules in the jurisdiction of the retail investors.
A fund aimed at professional investors is normally able to rely on a number of exemptions from registering
with the local regulatory body in the jurisdiction of the investor. For example, United States marketed funds
that are “privately placed” with fewer than 100 US investors are not normally required to register under the
US Investment Company Act.
The distribution of foreign funds to South African retail investors requires the approval of the Financial
Services Board (FSB) and approval will normally only be given if a number of conditions have been met,
including that the fund is registered in a jurisdiction acceptable to the FSB (this normally excludes the
Cayman Islands and the BVI). In theory, European funds of hedge funds could be approved by FSB for
distribution, but time will only tell if this will happen. South African investors are also normally restricted by
exchange control limits on how much they can invest outside South Africa.
For other, non-retail investors, a less regulated jurisdiction may be the answer, although bear in mind that an
offshore fund may have to be listed on the Luxembourg, Dublin or Cayman Exchange for the purposes of
attracting the investment of pension funds. The main advantage of a less regulated jurisdiction is a relatively
flexible and non-intrusive regulatory framework, which reduces the hassle factor of ongoing compliance.
This keeps the ongoing running costs down, which means a higher net asset value for the fund’s investors.
Traditionally, funds are established in financial centres where little or no tax is paid on the revenues
generated within the fund. Such a fund is obviously much more attractive to investors who are not liable to
tax on their investments, or who can defer meeting such tax liabilities until they realise their profits.
Furthermore, many of the discriminatory tax measures imposed in some EU countries have been removed
(such as those through which investors were previously penalised for investing in an offshore fund as
opposed to a domestic EU fund).
Investment managers have in the past preferred to receive their management and performance fees through
offshore management companies, with a margin retained in the offshore company and the remainder remitted
onshore. Such structuring has however come under the scrutiny of the tax authorities and the retention of
monies offshore can now only be justified where the management company can prove “real substance”, such
as the employment of staff and rental of its own premises in the offshore jurisdiction.
How long will it take?
Obviously, the stronger the regulation in a particular jurisdiction, the longer the approval process takes and
the more expensive the set-up will be. It may sound absurd, but hurricanes and tropical storms can also
delay the set-up in some of the Caribbean jurisdictions during certain times of the year. Promoters also need
to note that the authorities in offshore jurisdictions will scrutinise the individuals who will take investment
decisions and that these people have to meet the relevant “fit and proper” test set by the authorities.
Supporting documents such as references and police clearance certificates may have to be obtained and this
will also have an impact on how quickly the fund can be set up. Generally speaking, if the investment
manager is regulated in its home jurisdiction by the appropriate authority, the set-up is relatively quick and
hassle-free and can usually be completed within two months.
In summary, these are the main factors that need to be considered when deciding on the jurisdiction for a
mutual or hedge fund:
• The targeted investors and their countries’ regulations.
• The investment strategy of the fund.
• The tax-free or tax-favourable nature of the jurisdiction (profits, capital gains, distributions,
withholding taxes, deferral of incentive fees, etc).
• The public image of the country, since this will directly affect the fund.
• The availability of competent local service providers, such as banks, lawyers, accountants,
administrators and staff.
• The available types of investment vehicles.
• The operating costs.
• The convenience of the location in terms of travel time, time zone difference, language, etc.
• The local regulations regarding confidentiality and secrecy, money laundering, restrictions on
investment policy, etc.
Vanessa Molloy is a senior manager with Maitland in Luxembourg where she specialises in setting up
offshore investment funds.
Tel: +352 402505 1; firstname.lastname@example.org
Local PR contact: Chantal Cantin – tel +27 (0)21 480 8626