How to set up a hedge fund successfully - International Law Office

Why choose Guernsey?
Which legal structure to use?
What level of regulation?
Service provider requirements
What is the process?
Summary


You are an innovative fund manager looking to establish a new hedge fund, investing in a diverse pool of equities with a medium to high-risk profile. You are looking to attract a wide range of institutional investors while retaining the option to market it to high-net-worth individuals not averse to taking a financial risk for the potential of high return. Given the recent troubles of hedge funds, you are looking to target investors seeking to invest in a fund established in a trusted jurisdiction with a robust regulatory regime. With this in mind, Guernsey could suit your needs.

Why choose Guernsey?

Guernsey has a solid history in operating collective investment funds, having been in the business for the last four decades. With Guernsey-based funds being promoted and sponsored by leading institutions in 38 countries, it shows no signs of slowing down.

The island has a reputation for providing a healthy choice of experienced fund service providers, together with flexibility of structure and regulation, a stable government that meets international compliance standards, the option to access the Channel Islands Stock Exchange and preferential taxation.

Which legal structure to use?

Guernsey has a reputation for providing a regulatory regime with real substance and service providers with high-end expertise. The flexibility of Guernsey's regimes can suit the needs and demands of investors and competitors.

Guernsey funds may be structured in the traditional way as companies, unit trusts or limited partnerships. The jurisdiction also offers the potential to structure the fund as a protected cell company – a single legal entity with distinct cells, each of whose assets and liabilities are segregated by law from the assets and liabilities of each other cell. The fund may also be structured as an incorporated cell company (similar to a protected cell company, except that each cell is a separate legal entity - effectively, a company within a company).

In short, Guernsey caters for all legal structures commonly used for funds and provides particular expertise with cellular companies. The choice of vehicle will depend on a number of factors (investor preference, familiarity and fund profile, to name a few), and the jurisdiction can cater for each of them.

What level of regulation?

Once the vehicle has been chosen, it is a case of determining the level of regulation to which the fund should be subject. Funds are regulated by the Guernsey Financial Services Commission under the Protection of Investors (Bailiwick of Guernsey) Law 1987.

Guernsey offers four options for open-ended funds, three of those being authorised funds and the fourth being registered.

Authorised funds
Authorised funds are regulated and subject to continuing supervision by the commission. Within this category, open-ended funds are classified as A, B or Q funds and are subject to the Class A, B or Q rules respectively:

• Class A - Class A funds can be marketed to the UK retail mass market through a range of media, including national papers and high-street banks. Given the potentially unsophisticated nature of investors, the Class A rules are rigorous and focused on producing accurate and timely investor information.
• Class B - this is the most popular and frequently used product for hedge funds being set up in Guernsey. While remaining investor focused, the rules are not as stringent as for Class A funds. A Class B fund can be marketed to both institutional investors and personal investors routed through an independent financial adviser.
• Class Q - as the most flexible of the authorised funds in terms of rules, Class Q funds are limited to qualifying professional investors. 'Qualified professional investor' status is restricted to government bodies, trustees of a trust, corporate body or limited partnership having net assets in excess of £2 million and individuals with minimum net worth of £500,000 (excluding main resident and household goods).

Registered funds
Registered funds are subject to ongoing supervision (as opposed to regulation) by the commission. An open-ended registered fund will be subject to the Registered Collective Investment Scheme Rules 2008. These are generally regarded as being less onerous than the rules applicable to authorised funds, and thus registered funds are more comparable to Caribbean open-ended fund products.

Service provider requirements

A Guernsey open-ended fund, whether authorised or registered, must have a Guernsey resident administrator and custodian trustee (exemptions apply in certain circumstances where an established prime broker is used). There is no requirement for a Guernsey fund to have a separate investment manager; however, in practice, an investment manager may still be put in place for commercial and risk management purposes. There is no regulatory requirement for the fund to have a locally licensed manager, meaning that an established manager outside Guernsey can manage a Guernsey fund without having to obtain a separate licence from the commission.

What is the process?

Authorised funds
Once a decision has been made regarding the level of regulation to opt for, the next step is to work through the standard three-stage authorisation process which usually takes between six to eight weeks to complete.

• Eight weeks to launch - outline consent. The commission must be provided with outline details of the fund and, where the promoter is not already known to the commission, information in response to the new promoter's checklist. By six weeks to launch, outline authorisation is granted by the commission.
• Six weeks to launch - interim consent. The commission must be provided with a near final draft of the prospectus. Between a week and 10 working days later, the commission will respond and, on satisfactorily dealing with any queries that may arise, interim authorisation will be granted.
• Three days to launch - application for formal authorisation. Certified copies of final versions of the prospectus and signed agreements with service providers are submitted to the commission. Final consent is obtained within two to three working days. The fund is launched.

Qualifying investor funds
Alternatively, if launch timetables are tight, a streamlined approval process, known as the qualifying investor funds (QIF) regime, is an option. The administrator of a QIF is responsible for undertaking due diligence on the fund promoter and must make certain warranties to the commission as to the promoter's fitness and propriety. The QIF process should take no longer than five weeks from start to launch and the commission will grant authorisation for a QIF within three working days of submission of a completed application. The advantage of the QIF regime is that there is only one step in applying to the commission (as opposed to the three-stage process outlined above). The time it takes to reach this point is within the control of the investor, its legal team and its administrator.

A fund that uses the QIF procedure can be targeted only at certain professional or experienced investors.

Registered funds
As with the QIF regime, registration is streamlined and quick. On submission of a registration application, which again requires the administrator to make certain warranties to the commission as to the promoter's fitness and propriety, together with certified copies of final versions of scheme particulars and signed agreements with service providers, the commission will issue a declaration of registration within three working days.

Summary

Legal structure - protected cell company
This will save time and costs when launching an additional fund, which will simply be a new cell in this existing protected cell company.

Regulatory regime - authorised B scheme
An authorised fund will give target investors the confidence of a well-recognised regulatory regime while retaining the flexibility to adopt the intended investment profile.

Process - three-stage process
If the fund is intended to be marketed to more than just professional or experienced investors, the QIF fast track may not be appropriate.

For further information on this topic please contact Paul Wilkes at Collas Crill by telephone to (+44 1481 734 268), fax (+44 1481 711 880) or email (paul.wilkes@collascrill.com).

An earlier version of this update first appeared in HFMWeek at www.hfmweek.com.