Largely unnoticed save by those working in the offshore funds industry, a remarkable upheaval has been occurring in one of the most important segments of Guernsey’s offshore finance sector.
Over a period of almost two decades, widespread spin-offs and consolidation have occurred among the many local entities formed to administer the massive global flow of money into investment funds.
These businesses have been highly successful at creating value, and their founders and shareholders have reaped enviable rewards. The good news is that the process continues. But the important question is whether the dominance of non-island interests in these businesses makes them vulnerable if times turn tough.
You have to go back to the early 1980s to find the touchpaper which lit this particular trail. Names like Guinness Flight and Rothschild Asset Management (RAM) were early in the Guernsey funds game, taking advantage of regulations allowing open ended funds to be marketed within the UK.
Several dedicated fund administration companies were soon established in Guernsey, led notably by the Bank of Bermuda and Bank of Butterfield. If you track the evolution of the latter’s joint venture with Barings (called Barfield), you can see how individuals in its fund administration department – known as GIFM (Guernsey International Fund Managers) – later built successful businesses of their own: International Private Equity Services (IPES), IAG and Heritage Fund Administration.
IPES is now the island’s second largest group with more than $40bn under administration. The largest, with more than $60bn under administration, is Northern Trust, the US entity which made its arrival known in the island in 2005 when, in another echo of history, it bought the rump of the old Barfield business.
The IPES story is emblematic of this evolution. Those who created it not only expanded the business, they then sold it for what was then a sizeable sum. IPES has since been sold a second time, and it is no secret that it is now for sale again. In both cases, it was private equity firms which bought the business in what is now regarded as a classic model.
Under this model, such firms are attracted by the reliable cash flows on offer in a fund administration business. They offer to pay a huge sum, most of it borrowed, they load this debt onto the target they are acquiring, and then use modern IT systems plus talented executives, business finders and accountants to bolster revenues and cut costs. The hope is that the business can be sold on at a profit or – in the final end game – floated on a stock exchange to enthusiastic investors.
Such cases illustrate how fund administration groups can be created, merge and be taken over. But the other angle to this story, and the key to understanding these changes, is the growth in funds under administration and the evolution in the type of funds administered.
Back in the early 1980s, total funds under administration were less than £1 billion. All types of fund were taken on – from open-ended retail funds to venture capital funds. Risk management, compliance and anti-money laundering did not play a prominent part.
By 2008 the total had reached £150 billion, of which just under 50% was in open-ended funds. In December 2017 the figure pushed above £200 billion, with only £43 billion (less than 25%) in open-ended funds.
These trends were driven in part by changes in tax and fund regulation. Back in the 1980s, anti-avoidance UK tax legislation and the requirements of UK distributor status undermined the successful money market funds promoted and serviced by the likes of RAM. Later, happily, the desire to place more complex funds in tax neutral locations has made jurisdictions like Guernsey highly attractive.
In fact, Guernsey’s response to this second trend – namely the emergence of more complex funds – became testimony to its adaptability. Earlier, the introduction in Europe, and especially in Luxembourg and Dublin, of the open-ended funds structure called UCITS dealt a blow to Guernsey because such retail funds business is highly labour-intensive. The larger pools of staff in Europe therefore meant the UCITS product became the go-to vehicle for promoters wanting to market open-ended funds on a pan-European basis.
Guernsey therefore had to focus on a different type of business. This meant closed-ended funds, particularly if they were to be listed and particularly specialist “alternative” funds for professional and institutional investors – real estate funds, hedge funds, private equity funds, debt/credit funds, infrastructure funds, energy funds and so forth.
This has proved to be a notable success. But as the years of growth have gone on, Guernsey has eventually had to outsource many aspects of the administration of these funds because of the costs of doing business locally. Indeed, it is now less easy to establish an owner-led small fund administration business than even ten years ago. Competition has intensified, the compliance and anti-money laundering regulations now dominate regulated businesses, and the cost of IT investment has soared.
The upshot of these developments is that there are now broadly three types of fund administrator in Guernsey:
— Large global players where, despite their size, fund administration is not a core part of their business. These include Northern Trust, Royal Bank of Canada, State Street and HSBC.
— Surviving island-centric players which have expanded rapidly through mergers and acquisitions and made fund administration their core business. They may be specialists, as with IPES, or rapidly expanding generalists such as Aztec, Estera and First Names.
— Private equity groups which have established a physical presence in the island to manage the funds they invest. Names include Permira, Apax, Partners Group and Terra Firma
This situation creates vulnerabilities for Guernsey. Perhaps the biggest is that many of the entrepreneurial Guernsey-rooted individuals who had “skin in the game,” and who drove and benefited from this evolution, are steadily leaving the industry and not being directly replaced. This drain of local technical skills is a growing worry. So is any dilution in the marketing effort in favour of Guernsey as a fund administration location.
The industry body GIFA (Guernsey Investment Fund Association) along with the promotional body Guernsey Finance are deploying their best efforts to remedy this, but it is the very internationalisation of the industry which makes this is a hard task. Every fund promoter and asset manager will be deciding which location to use for their offshore administration on the finest of margins in price, skills and, dare one say it, flights, hotels and restaurants.
The second major vulnerability is more general. An industry this successful becomes a target not only for acquirers but also for other jurisdictions. Thus, the international dislike for Guernsey and Jersey, fomented by campaigners against “offshore tax havens,” attracts the attention of centres which would like the business on their soil. This is not just a matter of competition from places like Dublin or Luxembourg; it is also from the UK, as with London’s decision to use its REIT legislation to attract real estate funds back. Such competition may intensify with Brexit.
For now, Guernsey fund administration businesses will look attractive to outside acquirers as long as the requisite returns can be delivered. The evidence suggests that private equity houses typically look to exit these businesses after 4/5 years to a strategic player or another private equity business. The alternative listing route has already seen relatively new entities like JTC (formerly Jersey Trust Company), Sanne and PraxisIFM securing attractive multiples for their existing shareholders.
Overall, the relative maturity of the Guernsey funds industry should enable it to continue weathering regulatory, tax, competition and political headwinds. It has a loyal following with many clients wanting to repeat their Guernsey-based business. Even so, it may prove increasingly difficult to attract new promoters to Guernsey. And the island’s fund administration industry will have no choice but to continue adapting and reinventing itself to survive.
