The sands of time are running out for hedge fund managers wishing to continue distributing their funds to Swiss investors. As of 1 March 2015, any foreign hedge fund looking to raise assets in Switzerland from qualified investors will be required to appoint a Swiss legal representative and paying agent.
Qualified investors are defined under CISA (Collective Investment Scheme Act) as including pension funds, corporates and individuals with at least CHF5m in financial assets. Previously, only those funds that were registered for public offerings – which is now referred to as distribution to non-qualified investors – had to appoint a Swiss representative.
The good news for managers is that their foreign fund will not come under any regulatory oversight by FINMA; indeed, this is why the Swiss legal representative needs to be appointed, as they will effectively take responsibility for the fund and act as the point of contact with FINMA. The appointed legal representative’s name will be included in any fund marketing materials and offering documents.
Managers still have the option of privately placing their fund(s) to regulated financial intermediaries such as private banks and insurance companies. However, the risk to this is that fund materials that should only ever reach the bank’s qualified investors could inadvertently end up in the hands of retail investors; what this means is that banks will be very cautious about going down this road and potentially exposing themselves to regulatory risks under CISA-CISO.
“We are an alternative investment specialist. Our whole process is geared towards serving alternative managers, rather than coming at it from a long-only, retail perspective,” comments Roman Pelka, founder of Montfort Funds, a specialist provider of Swiss fund representation services whose client base accounts for over USD400bn of hedge fund and private equity assets.
Appointing a paying agent is mandatory under the new rules, but it’s up to the hedge fund investor to decide if they want to use the Swiss paying agent. “Our partner banks have so far not been involved in transactions involving qualified investor funds,” says Gabriel Kurland, Montfort’s COO.
Pelka notes that the average time it takes, from start to finish, to get the Swiss legal representative in place, is two to three weeks “so the reality is, the deadline will arrive and most managers simply will not be ready”.
One thing is certain; if managers don’t have the representative in place on 1 March 2015, any fund marketing activity, even if it involves sending a newsletter to existing Swiss investors, will be illegal and carry the threat of criminal charges.
“I’m not sure that managers outside of Switzerland are sufficiently aware of this. I think this is a point that needs to be emphasised. I know several London and NY-based managers who are rushing to find out what is required. This is not just for funds that are actively marketed, it’s for all funds. Going forward, all fund documentation will need to go through a Swiss representative,” comments Leila Khazaneh, general counsel at Jabre Capital Partners, one of Switzerland’s most established hedge fund managers.
There is an important difference between the way FINMA describes “marketing” from other jurisdictions. In the UK, for example, handing over a fund prospectus is the point of sale. Beforehand, the manager can have discussions with investors etc. In Switzerland, however, it’s more stringent. Any activity that promotes a CIS is considered distribution; a phone call, an email, a meeting.
There are essentially four options available to managers at the moment.
Option one is to rely on reverse solicitation, which really is becoming a foggy area, legally speaking. Option two is to work with private banks. Option three is to avoid Switzerland altogether, whilst option four is to take the safe bet and put in place the representative.
There is nothing in theory to stop Swiss investors reaching out to managers. That is genuine reverse solicitation. But the reality is quite different; it’s very rare that a Swiss pension fund would pick up the phone to a manager and say ‘Hey, we’d love to meet you’.
Most managers will, in all probability bite the bullet and choose option four. Not that getting compliant is a particularly costly exercise.
“The commercial argument is that the cost of compliance is covered by the management fee of USD1m raised from Switzerland. Combine the low cost of compliance with the breadth and depth of the Swiss fundraising market and you will quickly understand why most managers pick Switzerland as one of the markets they want to focus on,” says Pelka.
“There are no grandfathering provisions – as of 1 March 2015, the shutters come down. Any foreign fund that wants to interact with qualified but unregulated Swiss investors will need to have the representative and paying agent in place. A lot of people are going to get caught out by this. If they market to those investors after the deadline without a representative in place they’ll be breaking the law. The Swiss definition of “marketing” includes sending of fact sheets. It remains to be seen if managers decide to stop sending materials altogether.”
Khazaneh confirms that Jabre Capital took careful consideration selecting their legal representative. What was important was that they could demonstrate first-class compliance and that the team had a strong legal and auditing background. There was no requirement at all to use the representative for distribution support.
“I wanted to separate that. We have a global distribution company in the Cayman Islands and they work with local distributors worldwide, including regulated distributors in Switzerland. I sought to keep that activity independent of our relationship with the Swiss representative of our funds,” confirms Khazaneh.
By extending the requirement for all funds to appoint the representative, FINMA’s aim is simply to regulate fund distribution activities at the point of sale, just as it has done historically with UCITS.
The representative has to ensure that the fund is relevant for distribution under the new rules and has two key roles to play:
Firstly, ongoing compliance and regulatory support. That is, focusing on the monitoring side, making sure the relevant fund information is being distributed and that it adheres to Swiss law. Secondly, to act as the appointed representative to Swiss investors and the point of contact with FINMA.
Costs will obviously vary depending on the fund manager and the number of funds they intend to market into Switzerland. According to Khazaneh, the cost structure being used by Jabre Capital involves a fixed cost for the first fund – which is usually between CHF3-4,000 per annum – and an additional cost for each subsequent fund thereafter, which is less than CHF1,000.
“A number of smaller funds may decide that the cost is not justified and will avoid marketing into Switzerland but at the same time I think legislators might actually welcome that; the trend they like to see in distribution, as well as in asset management, is that the market is composed of larger managers and fund platforms. That may mean some of the smaller platforms and managers exit the market altogether, but it would deepen the quality of managers and ensure the remaining players can afford the higher cost of compliance. It will be interesting to see how this will impact the diversity of products available to investors.”
“We would welcome that development,” states Khazaneh.
There’s no doubt that the introduction of hedge fund registration and regulatory oversight under the revised CISA is a welcome development for Switzerland; indeed, a necessary one given the state of development in Europe and the US under Dodd-Frank and AIFMD.
Whether the representative and paying agent requirement is needed is up for debate.
“FINMA recognised the need to strengthen regulation of the Swiss financial sector to be considered an equivalent 3rd country under AIFMD. The Swiss representative and paying agent system is used widely in the Swiss long-only space, where the representative submits documents to FINMA and the paying agent handles subscriptions and redemptions.
“For hedge funds, this is not the case. The distributor is usually the fund manager itself, the Swiss legal representative doesn’t send fund documents to FINMA or publish information – as the information is confidential and for qualified investors only – and subscriptions and redemptions are handled by the fund’s administrator rather than the paying agent,” says Pelka.
Khazaneh questions whether the cost and increased burden are necessary considering that hedge funds are intended only for sophisticated professional investors.
“If you look at our investors – HNW individuals, pension funds, family offices, wealth advisers – I think they are adequately protected and are unlikely to request a local paying agent, for example. Regardless, our funds have to incur the cost and offer the service on an annual basis irrespective of whether investors request to use the paying agent or not. When I speak to people offering paying agent services, they don’t foresee their services being used by professional investors. I wouldn’t be surprised if the requirement is eventually dropped, together with the same requirement in the UCITS Directive,” opines Khazaneh.
One firm that is pushing the envelope to help global hedge fund managers distribute their products to Swiss (and indeed global) investors is Fundbase Fund Services: the first FINMA-regulated online platform to offer full representation services for the alternative funds market in Switzerland.
“We are trying to overcome investors missing out on investment opportunities simply because they don’t know the manager exists. Swiss pension funds are poorly advised. We are providing that gateway for these investors,” says Michael Appenzeller, the founder of Fundbase.
“The longer-term strategy is to do things differently to everyone else: to bring investors forward that are willing to share their ideas and concerns on funds with the investor community we are looking to build on Fundbase. We are talking to Swiss family offices, New York seeding platforms that are willing to bring their manager selections forward. Our aim is to create a community. It’s one thing for us to tell investors, “Hey, we’ve got these great funds”. It’s quite another if other investors are saying that too.”
What Fundbase can offer managers is the ability to appoint Fundbase Fund Services AG as the legal representative as well as use the platform as a way to showcase their funds to potential investors. Within a Swiss context, this could potentially get around some of the confusion of reverse solicitation.
“There’s uncertainty among managers as to who they can and can’t work with. How would investors find you without breaching the rules? By putting your fund on Fundbase you can overcome this uncertainty,” says Appenzeller.
Much the same as LinkedIn, an investor whose interest is piqued by a particular manager on Fundbase can send a connection request. At that point, the manager in question can decide whether they wish to share more fund information or not.
Appenzeller says that the goal is to have between 2,000 and 3,000 funds on Fundbase by the end of Q1 2015.
“We are seeing demand picking up in the hedge fund industry, generally speaking. It starts with the big banks allocating more to discretionary mandates. They have to allocate a lot of capital that they sometimes don’t know where to go with it. What we are doing should definitely close the gap and allow people to look at the alternatives asset class more efficiently and more securely.”
“Hedge fund managers can easily find institutional investors in Switzerland and send them emails, provided they’ve got the legal representative in place. We’ve set Fundbase up for qualified investors, with smart capabilities for managers to actively reach out,” concludes Lilian Klose-La Scalea, managing director at Fundbase Fund Services.
The legal representative is a necessary evil for global hedge fund managers. To put things into perspective, Switzerland is home to some 4,998 UHNW individuals according to the latest Research and Markets report. This number is forecast to rise by 24 per cent to 6,847 in 2018.
It might be a nuisance having to comply with yet more regulation, but for managers who are still in active capital raising mode, Switzerland is too lucrative a market to turn their backs on.