Guernsey fund values show welcome rise due to new fund launches

The value of Guernsey Funds has increased over the quarter ended 31 March 2012 with the net asset value of total funds under management and administration up by £8.7 billion (3.3%) to reach £270.1 billion.  For the year since 31 March 2011, total net asset values increased by £6.4 billion (2.4%). The recovery of the majority of the previous quarter’s decrease of approximately £10 billion can be attributed to a number of closed-ended funds and non-Guernsey schemes launching during the quarter.

JFSC releases findings on Trust Company Reviews. Time for businesses to get their houses in order.

There are some statistics which are inherently difficult to interpret.  It could be argued, for example, that a reduction in the number of reported rapes is a good thing (because it shows that the offence is on the decrease) or a bad one (because it shows that fewer people are reporting incidents to the police).  What spin to put on the findings depends largely on the motivation of the author.  The JFSC figures in relation to the outcome of its 2011 Trust Company Business site visits present just such a conundrum. 

On the face of it, the figures are fairly poor - a total of 47 examinations were conducted during 2011, and in six cases this resulted in enforcement action being taken.  A further 4 cases required heightened supervision, and 24 cases required monitoring of a remediation plan.  So, if we are to put a gloomy spin on the figures, 72% of investigated businesses failed to meet all of the regulatory requirements, and only 28% were given a clean bill of health.

This seems to be a marked deterioration on previous years.  In 2008, enforcement action was taken in respect of only one business following an examination. This number increased to four in each of 2009 and 2010 with a further increase to six in 2011. Whilst, on the face of it, this represents a disappointing trend, it is also a reflection of the Commission’s reduced level of tolerance in the event that businesses are found to be materially non-compliant in key areas, rather than a deterioration in the level of compliance.

And in fact, the percentage of businesses requiring either heightened supervision or enforcement action (the two most serious categories) has fallen from 25% to 21% in the last year. Furthermore, the number of cases requiring formal monitoring is increasing as a consequence of the fact that the JFSC now takes the approach that any findings identified as a result of an examination will now, ordinarily, result in a report being issued, with any required remediation being subject to formal monitoring – ie the threshold for a formal follow-up being implemented is much lower than it used to be.

So where are trust companies failing to adhere to best practice?

Findings relating to poor corporate governance were identified in five of the six examinations which resulted in enforcement action being taken, indicating that shortcomings in this area can result in serious consequences including business failure.  The most common finding when reviewing the records of the boards of businesses concerned the lack of documentation relating to the thought process and deliberations of the board when reaching decisions.

Most businesses utilise committees in managing their affairs. Commission findings in this area included a lack of formal approval by the board with regard to the formation of a committee, lack of or inadequate terms of reference, no reporting back to the board or inadequate consideration by the board of the activities of the committee.

In 2010, JFSC highlighted that conflicts of interest were an area of common failings in trust companies, and it seems that this remains the case.   A range of findings in 2011 arose in respect of conflicts of interest. These varied from relatively minor findings relating to the requirement to update policies and procedures through to more fundamental failures such as failing to recognise and record the conflicts of interest arising where shareholders and board members of businesses were co-investing with, lending to and borrowing from both customers directly and customer entities for which they were responsible

Deficiencies in the area relating to CDD represented the most common findings with respect to the 2011 examination programme. Findings included: a lack of certification of CDD information or other additional checks where businesses were relying on such information to satisfy non face-to-face identification and verification; illegible address verification and unrecognizable photographic identification; and a lack of understanding of the nature and level of CDD records required in respect of higher risk customers.

Another common area of findings related to businesses not obtaining enhanced CDD when required or not documenting the additional measures undertaken to fully address this segment of business.

A further common theme to emerge was the lack of appreciation of the requirements when using group introduction certificates. In these circumstances, the Commission found examples where no assessment of risk had been undertaken, nor had there been any testing to determine whether the group company held the required CDD and could provide copies upon request. The certificate itself in some instances had failed to contain relevant CDD information, such as an individual’s date of birth.

As has been noted in the previous three feedback reports from JFSC, the requirement to prepare a Business Risk Assessment and strategy was introduced by the AML/CFT Handbook in February 2008. The lack of compliance with this requirement has remained a common finding, but the nature of the issues arising, generally, are of a lesser degree of importance in terms of risk, than those identified in previous years.  The most common finding relating to the BRA was again the failure by businesses to consider and identify the specific risks applicable to their own business, rather than the generic risks applicable to the trust company business sector.

In relation to business acceptance procedures, the Commission found some good examples of best practice being instigated where businesses were carrying out a detailed acceptance process which included full consideration of the risks to the business in establishing a customer relationship.  Some of the more common adverse findings occurred where businesses were approving new customer entities and commencing activity prior to obtaining appropriate CDD or undertaking enhanced CDD for higher risk customers.

The Commission identified repeat findings where some businesses had not completed and signed off client acceptance forms until some months after the business relationship was established. This included examples where businesses had undertaken transactions for customers without adequate CDD being held, thus breaching anti-money laundering legislation.

Finally, the Commission has again noted the failure of some businesses to obtain copies of the relevant tax advice in respect of customer structures established primarily for the purpose of efficient tax structuring. In all but the most simple of cases, the Commission considers it would be difficult for businesses to demonstrate an adequate knowledge and understanding of the rationale for a tax driven structure, without sight of the tax advice supporting it.  Given the constant changes in tax legislation it is also important that the relevance of the tax advice held for a customer entity is considered as part of a business’s periodic review process.

Based on my personal review of trust companies over the past couple of years, my own assessment of the statistics would be that trust companies are by-and-large improving their regulatory compliance.  Most trust companies have now significantly reduced or eliminated backlogs in KYC, risk assessments and periodic reviews and are more focused on fully documenting business take-on process than may have been the case in the past.  However, trust company directors cannot afford to be complacent, as the JFSC is now clearly taking a tougher line on enforcement.  The days when businesses might expect to be given some lee-way to allow for historic non-compliance to be rectified, or for failures in documentary proof of matters where there is no evidence of actual wrong-doing, are numbered.  Purchasers of trust company business would therefore do well to understand fully the regulatory compliance status of entities they are buying, as any weaknesses are likely to be exposed and result in a period of monitoring by JFSC, if not more draconian action.

The JFSC has for many years been seen as one of the toughest regulators in the offshore world for regulatory matters, and there is every indication that this approach will continue.  

£572 million sale of fund administrator GlobeOp to SS&C close to completion

The sale of hedge fund administrator GlobeOp Financial Services to SS&C Technologies, a Carlyle-backed financial services software business, now seems almost inevitable.  The deal will place the combined GlobeOp/SS&C third (up from 6^th and 9^th respectively) in a competitive hedge fund administration sector behind Citco and State Street, and will see Citco and GlobeOp as the only two non-bank-owned players in the top 10.  The fact that independent companies will sit in the number 1 and number 3 spots in a market otherwise dominated by global banks is evidence of the fact that there is a considerable appetite for services from specialist independent businesses who can maintain clarity of core focus and independence from on-selling of products. 

SS&C has offered £572 million (£4.85 per share) for the GlobeOp business, trumping an earlier offer by TPG of £4.35 per share, which valued the company at £508 million.  The TPG offer had received acceptances from more than 40% of the shareholders, represented a premium of almost 50% to the early January share price, and the acquisition was widely expected to be completed before the arrival of SS&C’s materially higher counter-offer.   SS&C’s offer has now been declared unconditional, and they have received valid acceptances in respect of approximately 76.8% of shares.

SS&C believe that some of the big investment banks will withdraw from the alternative fund administration market due to pressures to focus on core activities, despite the strong growth prospects for the industry, and are therefore looking to become a consolidator in that market. 

GlobeOp Financial Services was founded in Luxembourg in 2000, primarily by a group of alumni of Long-Term Capital Management (LTCM), a well known hedge fund that had collapsed in 1998, to offer outsourced middle- and back-office and administration services for hedge funds. At the time, most hedge funds, particularly in the United States, were self-administered and the independent fund administration industry was therefore very small, and focused principally in offshore territories.  

However, GlobeOp effectively bet on the fact that this dynamic would change over time, and they were proved right. Although hedge funds are still not required to outsource their administration to third party administrators, there is an increasing tendency to do so because of the importance of transparency, the increasing complexity of regulatory compliance and the desire to show investors the existence of third party checks and balances from a risk management perspective.

Given the strong double digit revenue growth that many are forecasting for the hedge fund administration sector over the coming years, buying scale in the industry now could be considered a shrewd move. 

However, the deal is not all about pure industry growth potential – it is also believed to factor in a significant level of cost savings: GlobeOp has a large Mumbai-based operation which materially lowers its cost base, and SS&C will doubtless be looking to take advantage of that structure for its existing client base.

Vistra acquires HT Group and adds Audit Capability

Vistra, the rapidly expanding fiduciary firm which forms part of the OV Group, is continuing its growth plans with the recent acquisition of a small Luxembourg based company formation, accounting and audit firm HT Group.

As HT Group are Réviseurs d’Entreprises Agréé (similar to UK Chartered Accountants), Vistra will now be able to offer clients annual and statutory audits, due diligence checks in acquisition cases and valuations.

Founded in 1992, HT Group currently employs 10 staff and focuses on delivering personal solutions to owner-managers and high net worth individuals from around the world, especially in the English speaking community.  Although the acquisition may be small in size, it is notable from a strategic perspective given its addition of a new service line to Vistra.

As has been noted in earlier posting on this blog, he OV Group has been highly acquisitive in recent times, and this is the latest in a string of deals which is rapidly turning Vistra into one of the larger players in the international fiduciary market.

HSBC to move its Jersey private banking business to Guernsey

In a welcome move for Guernsey, HSBC has announced that it is moving part of its Jersey-based business to the sister Island.

The bank confirmed that its private banking arm – which provides banking services to high net worth clients – will be relocating next year and will relinquish its HSBC Private Bank (CI) Ltd licence in Jersey.

The move is all part of a rationalisation for the bank, which announced two weeks ago that it would be shedding 90 Jersey jobs as part of a national restructuring programme.

Independent Research shows Offshore Centres are much more Compliant than Onshore Counterparts

The accepted wisdom in most onshore jurisdictions is that offshore finance centres are hotbeds of crime and tax evasion, which turn a blind eye to nefarious practices and let criminals launder money without compunction.  It’s an easy jibe to make – offshore centres are, by-and-large, small places which generally lack the resources adequately to make their voices heard in opposition.  Add to that the fact that if you’re an onshore politician, it’s much easier to point the finger of blame for the collapse of the world economy on offshore centres rather than having to acknowledge that the root of the problem probably lies much closer to home, and you have a heady mix of anti-offshore rhetoric. 

The difficulty with the usual “he said” “she said” presentation of the arguments is that the parties on both sides almost invariably have a vested interest, or an entrenched position from which they make their arguments.  It is necessary, therefore, to take the arguments from both sides with a pinch of salt.  It is interesting therefore, to see some apparently genuinely independent research by a professor who specialises in offshore finance which has found that the offshore centres are in fact much more compliant in applying international money laundering regulations than many of their onshore counterparts.

According to CNS Business, Professor Jason Sharman of Griffith University in Australia, whose work focuses on offshore centres, wrote to thousands of service providers as if he was intending to set up a shell company to ascertain what types of identity would be requested by way of identity verification. Under the Financial Action Task Force’s Anti Money Laundering regulations, service providers should collect certified identity documents of the beneficial owners of the shell company.  Professor Sharman found that the 500 corporate service providers in offshore jurisdictions which he contacted were much more likely to be compliant and ask for all the ID documents, than their onshore counterparts.

The Professor singled the Cayman Islands and the Isle of Man out for particular praise, commenting that in all cases they had requested everything that the regulations require.  The US and the UK, however, were much less compliant.  He believes that, contrary to conventional wisdom, in reality when it comes to secrecy, OECD countries, and in particular Britain and the United States, are far worse offenders in relation to global standards mandating financial transparency than the small countries usually labelled as ‘tax havens’, and do a much worse job collecting information on the owners of shell companies than offshore financial centres.

This does not come as a great surprise to me.  I recall that in the course of my career, the only occasion on which I was opened a bank account for my company without being asked for any verification documentation whatsoever, was in the early 2000s when dealing with one of the major banks in the USA.   

People in glass houses should perhaps learn not to throw stones.

FATCA is resulting in financial institutions refusing to do business with Americans

For some time now there has been speculation that the new FATCA rules will lead to some businesses deciding simply to refuse to do business with Americans. 

Doubtless many believed that this was sabre rattling by banks and asset managers in a bid to get the US Treasury to water down some of the more draconian provisions of the new legislation, and that they would ultimately back down when faced with the reality of the loss of income from the citizens of such a rich and powerful nation.  But according to a recent Bloomberg report, the reality really is that some of the world’s largest wealth-management firms have decided that it will simply be too complex in the future to service American clients. 

The Singapore arms of HSBC, Deutsche Bank, UBS and DBS are amongst those quoted in the report as institutions which have already turned away business as a direct consequence of the proposed new rules.   These are not small fly-by-night organisations based in shady locations – they are amongst some of the world’s leading and most respected financial businesses and based on one of the world’s fastest growing financial centres.  If they close their doors to US investors, then it is likely that others will follow suit and, whilst the US banks themselves may well benefit from many of their competitors withdrawing from the market, it will be a serious limitation of choice for wealthy Americans – and particularly and unfortunate enough to live in cities not serviced by US banks.

The IRS is believed to have received more than 200 representations in response to the almost 400 pages of proposed rules issued by it in February of this year, and it is probably a fair assumption that the vast majority will be protesting about the huge administrative burden (and associated costs) that FATCA compliance will entail.  The IRS plans to hold a hearing on 15^th May and, whilst it can’t rescind FATCA, it could amend how and when some aspects of the rules are implemented.  It will therefore be interesting to see whether the reality of investment opportunities for Americans being limited (or, in the most extreme cases, Americans living in countries without an American bank being unable to open a bank account at all) will cause them to water down the provisions any further in a bid to make them more palatable.   But I suspect it won’t.

One of the difficulties that many governments are facing at the moment is that there is a political need to be seen to be getting tough on tax havens, and FATCA is an important element of the US government’s attempt to do just that.  Many onshore governments have sought to point the finger of blame for many of the world’s current economic woes on offshore centres, and so cannot be seen to back down on measures to crack down on the offshore industry and stop perceived “leakage” of money from the onshore Treasuries.  The bandwagon is a big one, and many have jumped on it.  The political imperative to crack down on “tax dodging” is so strong that the credibility of many a world leader depends on it, and as a consequence some governments appear to be taking draconian action even when that action may not confer any benefit on it (such as the abolition by the UK government of the Low Value Consignment Relief in the Channel Island) or may even positively harm its interests, as the most extreme opponents claim is the case with FATCA.  In this climate, it would be very difficult for the IRS to be seen to be backing down.

Of course, as I have noted in prior postings on this blog, avoiding the FATCA complexities by choosing not to do business with Americans is not as simple as it sounds. Financial institutions are obliged to consider many more criteria than simple citizenship or primary residence in order to determine whether clients are U.S. persons for the purposes of FATCA.  For example, green-card holders and non-Americans who spend at least 183 days in the US over a three-year period, would be US persons for these purposes.  A bank wanting to be sure that it is not dealing with US clients will therefore still have to go through a costly and time-consuming checking process. So it seems that opting out of FATCA is in itself highly complex, and only avoids some of the administrative burden.

Penalties for non-compliance are likely to be severe.  Foreign firms that don’t make the required disclosures will be subject to 30 percent withholding of certain dividends, interest or proceeds from the sale of assets they or their customers receive from U.S. sources.  

This is, not surprisingly, angering many financial institutions.  It is a perfectly legitimate aim of the US government to try to prevent tax evasion, but to impose huge additional costs on foreign businesses, even if they are actively trying to avoid dealing with Americans, is extremely draconian.  It seems, in effect, to be the IRS outsourcing its own tax compliance responsibilities. 

Time to Bite the FATCA Bullet

Over the past year or so I have spoken to many dozens of fiduciary businesses about the impact that they expect the FATCA regulations to have on their business.  By and large, most struggle to answer the question – they are aware that the regulations are coming in, and broadly what they concern, but are very lacking in any detailed knowledge or preparation.  For understandable reasons, many are adopting a wait-and-see approach, and aim to follow others once it has become clear what most industry participants are doing to comply rather than be at the forefront of analysing the impacts for themselves; after all, nobody wants to have to invent the wheel themselves.  But as time marches on towards implementation date, I have a growing concern that many fiduciary businesses may be kidding themselves about the extent to which the regulations will impact on them, and that failing adequately to prepare now is likely to cause great difficulty in the months to come.  

Based on my conversations with trust company directors, I believe there is a significant number of fiduciary businesses who do not expect to have to concern themselves with FATCA because they “do not do business with Americans”.  In many cases, they are over-confident in this assumption – even if the end client is not an American passport holder and doesn’t have his main address in the country, the trust company will also need to be able to analyse whether any of the other “markers” of a US involvement are present. 

The FATCA regulations stipulate a number of “indicia” which must be considered in making a determination - having one of these indicia does not mean that the account is owned by a U.S. person, but it does mean that it must be given closer scrutiny and that additional documentation may need to be gathered in order properly to make the determination.

The indicia are:

•         U.S. citizenship or lawful permanent resident (green card) status;
•         A U.S. birthplace;
•         A U.S. residence address or a U.S. correspondence address (including a U.S. P.O. box);
•        Standing instructions to transfer funds to an account maintained in the United States, or directions regularly received from a U.S. address;
•       A “care of” address or a “hold mail” address that is the sole address with respect to the client; or
•       A power of attorney or signatory authority granted to a person with a U.S. address.

The majority of trust company IT systems that I am familiar with have fields which have to be completed which would show the country of residence of a client, and in many cases the country of citizenship.  The better systems would allow a report to be produced sorted by the jurisdiction populated in these fields on the system (although a good number would not, and although the data may be on the system it would need to be manually checked on a case by case basis).   But I know of no IT systems which currently cover all of the 6 indicia, and indeed in my experience it is not routine for administrators to even ask the questions which would be needed to cover all of the indicia.  As a consequence, many are likely to lack the basic information they need to make the determination, even if they do have a system on which they could theoretically record the information.  Very few trust companies routinely record in any systematic way, for example, the addresses of people who may be authorised signatories on a bank account, or whether a client holds a green card, or whether a client owns a second home in the US. 

The reality is that for many trust companies the only way they are going to be able to be confident that they are not inadvertently falling foul of the regulations is to do a manual trawl through every single file to ascertain whether they have all of the information they need on each of the indicia for each client, and to request information from the clients to fill any gaps.  Given that trust companies often have thousands, if not tens of  thousands of clients (and indeed, there may be multiple persons who need to be checked for every client entity - such as beneficiaries of a trust, or investors in a fund), this will be no mean feat and will take a great deal of time to achieve, particularly given the fact that it can be notoriously difficult to get information and documentary evidence of such matters from people who may have been clients for years. 

So there are 2 questions that trust companies need to start asking themselves very quickly.  Firstly, do we have all of the information somewhere on file to enable us to know whether any of the indicia are present in every case we manage?  And secondly, if we do have that information, do we have it stored in a place which is easy to access, update and report on?

There are those who have been postponing acting in the hope that some of the initiatives which are being discussed (such as exchange of information on a country basis, rather than each reporting entity having to deal directly with the IRS) may significantly lessen the impact of FATCA compliance, but I believe this is a forlorn hope.  None of the initiatives currently under discussion, so far as I am aware, change the data that will need to be gathered and reported - the only thing that may change is to whom the reports are sent and in what format.  Whilst these discussions may therefore be welcome in many ways, they will not provide a magic solution for the very real practical problems that trust companies are likely to face.

Like it or not, the time has come to bite the bullet.

Anyone wanting further information on this subject can contact me on np@mp-csl.com.

PLEASE NOTE THIS BLOG POST IS NOT INTENDED TO PROVIDE LEGAL ADVICE AND SHOULD NOT BE RELIED UPON FOR THESE PURPOSES.