how to StARt A hEDGE FUND IN EURopE 2010

peter hughes of Apex Fund Services explains how hedge fund managers can best survive in the current economic climate, and outlines the fund structures and domiciles they should choose

Go forth and prosper

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peter hughes is the founder and managing director of Apex Fund Services. Between 2000-2003 he was chief financial officer of FMG Fund Managers and has been a qualified chartered accountant since 1994..

he hedge fund world has been turned into turmoil during the financial crisis over the past two years. Not only have hedge funds been made scapegoats and been blamed by some for the financial crisis itself but frauds such as that carried out by Madoff, an obvious lack of performance in 2008, funds locking-in investors and a significant loss of assets has made it a very different environment from how it looked in 2007. There is no question that it is more difficult to set up a hedge fund now than it has ever been in the past 20 years. The AIFM EU Directive has been causing a large amount of uncertainty as to what will happen to the regime in Europe, which it makes it hard to know what type of structure to use and what the most suitable domicile is. This Directive caused uproar globally when it was first released in April 2009 as it threatened the viability of a global financial services industry with a protectionist EU. The dangers of reactionist legislation drafted quickly and without any industry consultation have been witnessed. Some of the provisions have been sensibly adjusted under the Swedish Presidency but more changes are needed under the Spanish Presidency before it can become law if a vulnerable industry isnt to be damaged further. Lord Myners in the UK has been quick to recognise the negative impact that this will have on the UK asset managers some have already packed their bags given the recent UK tax changes, and so he needs to be successful in amending the Directive if he is to avoid others following them. A need for global capital An even larger challenge to setting up funds in the current environment is the lack of global capital. The importance of seed capital can never be underestimated. The break-even asset size for most managers is $15-20m on traditional fee schedules. There is capital in Asia as its banking regime was largely intact through the crisis, and there is a large amount of capital in the Middle East sitting with their sovereign wealth funds. It is difficult for European managers to access these capital pools. The scarce capital elsewhere is able to negotiate good

deals from fund managers where investors now have the power to dictate the terms. Lower fees, managed accounts, full transparency, daily liquidity these demands would not have been entertained by fund managers two years ago; now they are gladly accepted. Choosing the right domicile So, if you are lucky enough to have been able to find some seed capital, what next? The plan for an asset management business depends on what the market is. What domicile do your investors like? What are they used to? The important thing in most fund set-up decisions is to take away as many reasons for investors not to invest as you can. Offshore funds continue to be domiciled in Cayman, not because it is better or cheaper than jurisdictions such as Bermuda but because investors are used to it. The same applies in Europe: mainland Europe investors are used to Luxembourg structures if thats your target market then thats where to set up. Ireland is popular in the rest of Europe, but 60% of European funds are currently based in Luxembourg. This rule of thumb works for larger funds but there is a flaw when funds are under $100m. The more established centres can be expensive and the requirement for a local custodian may be a hurdle as to their business models they arent making enough margins on funds smaller than this. Malta has been able to take advantage of some funds being unable to be serviced in more established centres. Having an equivalent regulatory regime to Ireland and Luxembourg, but with a lower cost structure has made it an attractive option. A year ago investors may have questioned the decision to set up a fund in Malta; now it is understood to be a credible alternative with lower cost solutions, a well-managed regulatory system and quicker fund set-up times. Healthy competition between fund domiciles is a good thing as it allows a wider choice of options and better pricing for investors. Globally fund managers are setting up funds in Europe. It isnt just for assets managed from Europe. Many investors in Europe are finding it hard to get good returns in their own markets and the banks are paying minimal interest in Europe. Many
HOW TO START A HEDGE FUND IN EUROPE 2010

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ADMINISTRATOR

An even larger challenge to setting up funds in the current environment is the lack of global capital. The importance of seed capital can never be underestimated

of the emerging markets are already returning to their pre-crisis growth rates; this makes it logical for European investors to look to invest in these markets. Managers in Asia and the Middle East are now setting up European funds to meet the needs of these investors and also to attract more capital to their funds as it is scarce locally. Having selected the domicile that is most attractive to the target investors, the next step is the fund structure. This depends on the strategy and investment style; if it doesnt meet the criteria for Ucits (which most hedge strategies wont), the usual structure is a Sicav if it is to be regulated. If there are plans to have more than one strategy, umbrella funds are used where new strategies can be launched quickly and cost-effectively from the same legal entity. the all-round administrator Choosing service providers is very important. Lawyers, administrators, prime brokers, custodians, bankers and auditors are all required. It is key to do research about service providers, as there can be a significant difference in service levels and fees between providers. The role that the administrator plays is the most relevant to the success and growth of a fund. The right administrator will streamline the setup process, help provide options for the other service providers and remove the uncertainty from the fund manager who can then focus on raising capital and fine-tuning the investment strategy. The more services that your administrator can provide, the better it is for a fund managers business as it reduces the services that the fund manager pays for. Administrators services benefit the investors, which is why they are charged to the funds. Middle-office functions, global coverage, webbased reporting and a SAS 70 are all achievable for reasonable prices. Bigger doesnt always mean better but can mean

more expensive, so extensive due diligence is important for this role. If you want to have a fast-efficient service, try and find an administrator that physically provides the service in your time zone so that questions are always answered quickly. Lawyers and auditor choices come down to the quotes received and the reputations of those they are received from. Administrators will have experience in working with several and can help guide this decision. Banks come down to personal preferences but a well-known bank makes the investors feel more secure when they send their subscription money to the fund. The hard decision for smaller funds at the moment is finding a custodian or prime broker. As mentioned earlier, this is not difficult for funds over $100m. Smaller funds, as many now are, find it difficult to get accepted as clients by these banks who have more stringent criteria than in the past. Administrators will also have good relationships with brokers and custodians and should help find one that fits with the fund size and strategy. The advice is to start doing the account opening due diligence as soon as the legal entity is formed as this process is usually what causes launch dates to be missed. The fund is ready and set up. Office space and systems are needed. It is possible to get all these services in one place through fund incubators or hedge fund hotels where you can be provided with the whole suite of services needed from an operational point of view. Setting up is the hard part, especially now, with a difficult and uncertain regulatory environment, a lack of seed capital and the need for smaller funds to use their skills in keeping costs down to deliver maximum performance. The easy bit is managing the portfolio and that is what you are good at! Leave the headaches to the administrator, deliver performance liquidity will return in time and you will reach your goal. n
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HOW TO START A HEDGE FUND IN EUROPE 2010