Regulators, tax authorities and investors are increasingly focused on the substance of offshore management companies and hedge fund governance.
Managers of hedge funds are facing four highly topical developments: (1) increased prudential supervision under the AIFM Directive, (2) the amendment of the Swiss Federal Act on Collective Investment Schemes (CISA) to bring it into line with the AIFM Directive, (3) increasing scrutiny by regulators and tax authorities of the "substance" of offshore structures, and (4) a heightened interest by investors in the corporate governance of hedge funds.
The European Securities and Markets Authority (ESMA) is consulting on a framework to govern the delegation of portfolio and risk management by managers in the EU to management companies domiciled outside the EU. Separately, the CISA in its amended form will require all Swiss domiciled managers of non-Swiss investment funds being managed or sold in Switzerland to apply for authorization by the Swiss Financial Markets Supervisory Authority (FINMA).
These developments pose a challenge to managers in Switzerland, many of whom manage or sell offshore funds in Switzerland and delegate key functionality (like portfolio and risk management) to an offshore management company. Some offshore management companies are "substance lite", which entails a risk that FINMA will require the manager's Swiss domiciled firm to be authorized under CISA. The Swiss tax authorities are also showing an increased interest in the substance of offshore management companies.