Much of my consultancy work involves advising potential acquirers of
fiduciary services and fund administration businesses regarding the risk and
compliance aspects of target businesses.
This usually involves, amongst other things, conducting file reviews to
ensure that the practice implemented within the business meets best practice
and complies with all applicable regulatory requirements.
In a perfect world, the reviews would reveal no deviations from best
practice at all, but we don’t live in a perfect world and keeping these
businesses fully compliant is a task akin to painting the Forth Bridge –
periodic reviews have to be done on schedule, risk weightings have to be
reassessed, corporate governance standards change on a regular basis, identity
documents need to be updated when they expire etc – and so there are invariably
some weaknesses which need to be remedied at any given point in time.
But the raw data showing the level of discrepancies that can be found
are of surprisingly limited value. The most important thing in my view, is to
be able to answer the “so what?” question once the results are in, and clients
are often surprised at how much the answer varies from jurisdiction to
jurisdiction. Weaknesses which in some
jurisdictions might earn you a gentle admonition from the regulator may in
other locations put the entire business at threat of closure. It is therefore critical that investors
understand the subtleties and distinctions of application of regulations in
different territories.
Nor are the jurisdictions which take a more “relaxed” approach to
regulation necessarily the ones you would expect. Although the press tend to paint the offshore
Islands as the weak link here, the reality is far more complex than that.
A recent point in case can be seen in the Grand Duchy of Luxembourg. In
the past week, Luxembourg’s financial regulator, the CSSF, has been under
attack for refusing to help a group of investors who lost money in a fund (Petercam’s
L Bonds Eur Inflation-Linked fund), despite the fact that the CSSF acknowledges
that the fund violated the jurisdiction’s investment laws in a number of
different respects including investing in prohibited investments and
deficiencies in the Fund’s prospectus.
Luxembourg has in place the panapoly of legislation and regulation that
you would expect to see to keep investors safe, but the key issue is whether it
is implemented with adequate vigour. There is a suspicion in some circles that the
CSSF is wary of taking a hard line with Petercam, for fear of upsetting the
many fund managers who structure their business through the territory. After all, there is big money involved in the
industry; Luxembourg has risen to become the second largest centre for
investment funds in the world and naturally would not want to kill the golden
goose - or to lose business to arch rival Dublin - by gaining a reputation for
taking a hard line on regulated businesses.
It might seem an odd notion that regulators can feel the impact of
market competition, but they are only human.
If the success of their country depends on keep certain key client
sectors happy, then there is a natural tendency to want to play down any issues
that may arise. It takes a brave
regulator (and there are some out there) to ignore the pressure and to do the
right thing. Perhaps this explains why
the Cayman Island regulator was so apparently slow to step in and take action
as the Axiom Legal Financing Fund debacle unfolded. Nor are onshore locations immune – the FSA,
amongst other onshore regulators – was heavily criticised for being too “cosy”
with banks and not sufficiently robust to address the risks that they were
taking.
But although taking a lax line (which, incidentally, the Luxembourg
authorities vehemently deny doing, despite appearances) might be seen as good
for business in the sense that it keeps the regulated businesses happy, in the
long run it must be a strategy doomed to failure if investors lose confidence
in a jurisdiction as a consequence. That
doesn’t appear to have happened in Luxembourg yet, but if there are too many
instances like the Petercam one, then it will become a real possibility.
There are some jurisdictions who appear to have taken this threat very
seriously, and where the regulators are notoriously tough – Jersey being one example
where the regulator is widely viewed as taking a hard line on businesses which
fail to meet the required standards. It
is not uncommon in Jersey to see businesses subject to special regulatory
supervision or ordered to cease taking new business altogether if the authorities do not believe that standards
are being properly enforced. By and
large, practitioners in the Island applaud this stance, but there are still a
reasonable number of those involved in the Island’s finance industry who
complain that the JFSC’s approach means that the Island loses business to
Guernsey, or to Cayman, both of which are seen as locations where regulatory
action is less likely.
Getting the balance right is not an easy one. All of these places, whether onshore or
offshore, want to retain thriving financial services businesses and in order to
do that they cannot afford to scare off regulated businesses or their
investors. But a savvy investor (whether
a client of a fund manager or a PE house looking to buy a financial services
business) will take the time and care to understand the regulatory environment
in which they are investing in order to be able properly to evaluate the
risks. And that means doing a lot more
due diligence than just reading the regulations.
