Ireland funds

An overview of the Irish funds market 

Leading Irish law firm Matheson Ormsby Prentice examines key investment fund vehicles

The advantages of Ireland as a fund domicile include the following:

• Ireland is a member state of the EU and benefits from the harmonisation of EU financial services regulation. It therefore qualifies as a UCITS domicile and as a home or host state for the provision of EU investment services under MiFID.
• Ireland is a participating member of the European Monetary Union.Ireland is an OECD member state availability of a range of tax-exempt fund vehicles (including investment companies, unit trusts, investment limited partnerships and common contractual funds) which can be tailored to suit investor requirements availability of structured fund vehicles which can access Ireland’s extensive and expanding network of double tax treaties.
• The Irish Stock Exchange is an internationally recognised, regulated exchange for the listing of Irish and non-Irish domiciled investment funds and it is widely regarded as one of the leading exchanges in the world for the listing of investment funds.
• It has flexible regulators which are approachable and receptive to tight time limits, prudent but practical regulation of investment funds, fund managers, administrators and custodians with regulatory sensitivity to the needs of international fund managers and service providers.
• Well developed infrastructure with sophisticated telecommunications networks and local availability of highly educated labour, well developed and experienced professional services infrastructure with specialist legal, tax and accounting skills.
• Ease of access, with direct daily flights from the US and from all of Europe’s major financial centres. As Ireland is in the same time zone as London, business can be conducted with Japan, Hong Kong and Australia in the morning and North America in the afternoon.

The choice of an appropriate vehicle through which an investment fund will be constituted will depend on a number of factors. As indicated above, there are several legal forms available for the establishment of an investment fund in Ireland and a summary of the key features of these legal forms is as follows:

• An investment company as a corporation, an investment company is a separate legal entity, managed and controlled by its board of directors, which can enter into contracts in its own name. The assets are the property of the company, and each investor holds shares in the company. A custodian is appointed to safe-keep the assets on behalf of the company.
• An investment fund established as a company may be self-managed, or appoint a management company. It must have as its aim the spread of investment risk. The paid up share capital of the company must at all time equal the net asset value of the company, the shares of which have no par value.
• An investment company may be structured as a stand-alone fund or an umbrella fund. An open ended investment company with variable capital may be regarded as similar to a SICAV or an OEIC. For UCITS, there is an additional ability to establish a fixed capital investment company similar to a SICAF. In practice. however, fixed capital companies are relatively rare as variable capital investment companies offer greater flexibility in the issue of redeemable shares. In terms of applicable Irish company law, non-UCITS investment funds which are established as investment companies are governed by Part XIII of the Companies Act 1990 and the Financial Regulator’s notices on non-UCITS.

For UCITS established as investment companies, the provisions of the Companies Acts 1963 to 2006 apply, except to the extent that the Companies Acts are amended by the UCITS regulations. The Financial Regulator’s notices on UCITS also apply. The constitutional document of an investment company is the memorandum and articles of association. Liability of shareholders in a UCITS or non-UCITS fund established as an investment company is limited.

Unit trust

A unit trust is created by a trust deed entered into by the trustee and the manager of the fund and the use of a management company in this structure is a necessity. It is a contractual arrangement and is not a separate legal entity, with the result that a unit trust does not have power to enter into contracts in its own name. In general, the manager or trustee enters into contracts for the account of a unit trust. The trustee is registered as the legal owner of the assets on behalf of the investors, who receive units, each of which represents a beneficial interest in the assets of the unit trust. In distinction to a non-UCITS investment fund formed as a company, there is no requirement for a non-UCITS unit trust to operate on the principle of risk spreading. A UCITS unit trust is governed by the UCITS regulations and a non-UCITS unit trust is governed by the Unit Trust Act 1990, and each is governed by the relevant notices issued by the Financial Regulator.

Common contractual fund

The CCF has a similar structure to Fonds Commun de Placement (FCPs) established in Luxembourg. A CCF is an unincorporated body established by a manager pursuant to which the investors by contractual arrangements participate and share in the property of the fund as co-owners of the assets of the fund. As a co-owner, each investor will hold an undivided co-ownership interest as a tenant in common with the other investors.

The CCF is constituted under contract law (and not company law or trust law) by way of deed of constitution executed under seal between the manager and the custodian. As the CCF is an unincorporated entity, it does not have a distinct legal personality. The CCF cannot therefore assume liabilities and, in the same way as for a unit trust, the manager and the custodian enter the various agreements for and on behalf of the CCF. The assets of CCF belong to the CCF and are entrusted to a custodian for safe-keeping. A CCF may be structured as a stand-alone fund or an umbrella fund. There is no requirement for a non-UCITS CCF to operate on the principle of
risk spreading.

The main feature which differentiates CCFs from other investment funds is that a CCF is totally tax-transparent. This means that investors in a CCF are treated as if they directly own a proportionate share of the underlying investments of the CCF rather than shares or units in a entity which itself owns the underlying investments.

UCITS established as CCFs are governed by the UCITS regulations, and non-UCITS CCFs are governed by the Investment Funds Act 2005, and each is governed by the relevant notices issued by the Financial Regulator.

In addition to the structures outlined above, a non-UCITS can be established as an ILP. UCITS funds cannot be structured as ILPs. ILPs can be established under the ILP Act for investment in property or securities of any kind with the authorisation of the Financial Regulator. An ILP is created by contract between the general partner(s) and one or more investors who participate
as limited partner(s), and will be subject to the Financial Regulator’s notices.

The ILP is not incorporated and is therefore not a separate legal entity. An ILP does not
therefore have power to enter contracts in its own name. The general partner usually enters into contracts for the account of the ILP. As with each of the structures referred to above, the custodian is required to safe-keep the assets. There is no requirement under the ILP Act for an ILP to operate on the principle of risk spreading. ILPs can be dedicated investment vehicles or offered on a private placement or public basis. There is no limit on the number of limited partners permitted for an ILP.

The general partners of an ILP are responsible for the management of its business and are liable for the debts and obligations of the ILP. In general, a limited partner’s liability will not exceed the amount of its capital contribution or commitment to the ILP. However, a limited partner who participates in the conduct of the business of an ILP in its dealings with third parties may be liable
on the insolvency of the ILP for debts incurred by the ILP in the period during which it participated in the conduct of its business, as if such limited partner had been a general partner during this period.

A limited partner’s liability in this regard is limited to debts or obligations incurred by the ILP in favour of a third party who, at the time that the debt or obligation was incurred, reasonably believed, based upon the conduct of the limited partner, that the limited partner was a general partner. The ILP Act specifies certain activities which will not be deemed to constitute
participation by a limited partner in the business of an ILP. In practice, given the availability of establishing a non-UCITS investment fund through an investment company, unit trust or CCF, the use of an ILP as a fund vehicle has been limited.

Appropriate regulatory status

UCITS

UCITS are a creation of the EU UCITS directives, implemented in Ireland by a series of domestic UCITS regulations. UCITS are diversified, limited leverage, open ended investment funds whose
object must be to invest capital raised from the public in transferable securities including shares, other securities equivalent to shares, bonds, securitised debt, money market instruments, units
or shares in other collective investment funds, and liquid financial assets (deposits with maturities of 12 months or less, standardised derivatives, and certain OTC derivatives). UCITS are open ended insofar as investors must generally be entitled to redeem their shares or units on request at least once in every two week period. Following the successful implementation of UCITS III in Ireland, we are seeing a large increase in the range and diversity of UCITS III funds being authorised in Ireland. UCITS are permitted to use derivative instruments, as well as leverage through the use of financial derivative instruments, up to 100% of net asset value. The migration of what were previously considered hedge fund strategies into the UCITS arena is now firmly underway. In particular, the UCITS regulations facilitate certain long/short investment strategies (typically 130% long/30% short strategies), which would traditionally be regarded as alternative investment strategies. UCITS can achieve short positions synthetically through swaps or contracts-for-differences (or other derivatives), while staying within the applicable leverage limit for UCITS. In addition to long/short strategies, an increasing number of structured products (including funds whose strategies are linked to eligible indices, funds which use systematic trading models and/or funds that have capital protection features) are being established as UCITS.

Confirmation of eligible assets for investment by UCITS, exposure to hedge fund indices and use of subsidiaries

Since the adoption of the UCITS directives, the variety of financial instruments traded on financial markets has increased considerably. To avoid uncertainty in determining whether certain categories of more sophisticated financial instruments are within the UCITS directives framework, the European Commission adopted the eligible assets directive in 2007. Rather than establishing exhaustive lists of specific financial instruments and transactions, the eligible assets directive elucidates criteria for assessing whether or not a class of financial instrument is UCITS permissible. As such, the eligible assets directive removes uncertainty as to whether UCITS can properly invest in the following categories of financial instruments:

• asset backed securities 
• listed closed ended funds 
• euro commercial paper 
• index based derivatives 
• credit derivatives

The eligible assets directive also seeks to ensure that eligible assets definitions are understood in a manner consistent with the principles underlying the UCITS Directives, such as those governing risk diversification and limits to exposure, the ability of the UCITS to redeem its units at the request of the unitholders, and to calculate its net asset value whenever units are redeemed. A further important matter which has been clarified, through guidelines issued by CESR, relates to exposure to hedge fund indices by UCITS. Hedge fund indices have now been classified as permissible financial indices for investment by UCITS, subject to compliance with conditions for financial indices relating to the degree of diversification; the market to which the indices refer; the way the indices are published; compliance with additional criteria for hedge fund indices which relate to index methodology requirements; and that the UCITS must perform appropriate due diligence on the hedge fund index before gaining exposure.

In relation to the eligibility of unlisted securities as permissible investments for UCITS, the Financial Regulator has confirmed that it will permit UCITS to invest up to 10% of net assets in aggregate in unlisted securities and unregulated investment funds, including hedge funds, provided that the investment complies with the eligibility criteria for UCITS. Subject to certain confirmations and conditions, the Financial Regulator will also permit UCITS to establish wholly owned non-EU based subsidiaries.

The technical guidance on the use of hedge fund indices by UCITS from CESR, together with the criterion-based approach adopted by the eligible assets directive and the extent of clarification provided in respect of transferable securities, money market instruments, liquid financial assets,
embedded derivatives, efficient portfolio management techniques and instruments and index replicating UCITS, are welcomed developments in terms of the evolution of the investment profile
of UCITS. These legal and regulatory developments will ensure that UCITS remain competitive and continue to prosper throughout, and beyond, the EU.

Investment and borrowing restrictions

UCITS established in Ireland must invest in accordance with the investment and borrowing restrictions imposed by the UCITS regulations. The UCITS regulations also impose conditions on the use of various instruments and techniques for efficient portfolio management. The Financial Regulator may grant a derogation from certain fund investment limitations for up to six months following authorisation, provided that the UCITS continues to observe the principle of risk spreading.

If investment limitations are exceeded for reasons beyond the control of a UCITS, or as a result of the exercise of subscription rights, the UCITS must take steps to remedy the situation taking due account of its investors’ interests.

EU passport

One of the primary objectives of the UCITS directives is to facilitate the harmonisation of financial services across EU member states by introducing an investment vehicle which could be established and regulated in one EU member state and which would have an EU passport enabling its units or shares to be marketed and sold in all other EU member states. This is the significant advantage in selecting the UCITS regulatory framework over a non-UCITS vehicle for an Irish domiciled investment fund.

In principle, by authorising funds as UCITS, all EU member states must operate in accordance with the same conditions derived from the UCITS directives. In practice, however, there have been divergences between different EU member states in their interpretation of the UCITS directives. The track record of the Financial Regulator, as the competent authority in Ireland, has been to apply a sophisticated and enlightened approach in its interpretation of the UCITS directives.

In terms of the procedure for activating permitted cross-border sales and marketing, an investment fund authorised under the UCITS directives in one EU member state cannot be
prohibited from selling or promoting the sale of its shares or units to the public in any other EU member state, provided that the fund has notified the competent regulatory authorities in that other EU member state of its intended activities in its territory and the relevant notice period for such EU member state has expired. The UCITS must however comply with local marketing and advertising requirements. A recent initiative in terms of seeking to improve the efficacy of the EU single market for UCITS, and to reinforce consistency in the authorisation and marketing of investment funds in the EU, is the interpretative communication issued by the European Commission in March 2007. This re-affirms that the investment fund’s home supervisory
authority has sole responsibility for monitoring compliance with EU rules, and that the notification procedure cannot be used by member states to challenge authorisation of UCITS granted
in another member state.

Risk management process

Where financial derivative instruments are utilised by a UCITS, whether for investment purposes or efficient portfolio management, the Financial Regulator requires a risk management process with respect to the engagement and ongoing use of financial derivative instruments. This means that a UCITS must establish an extensive system of risk limitation in order to ensure that the risks involved in using financial derivative instruments are properly managed, measured and
monitored on an ongoing basis. This involves designing, implementing and documenting a risk management process in order to meet key requirements of investor protection.

A UCITS must provide the Financial Regulator with details of its proposed financial derivative instruments activity and risk assessment methodology. The initial filing with the Financial Regulator is required to include information in relation to:

• permitted types of financial derivative instruments, including embedded derivatives in transferable securities and money market instruments 
• details of the underlying risks 
• relevant quantitative limits and how these will be monitored and enforced 
• methods for estimating risks
• A UCITS is required to submit a report to the Financial Regulator on its financial
  derivative instrument positions on an annual basis. The report, which must include information under the different categories identified above, must be submitted with the annual report of the UCITS and a UCITS must, at the request of the Financial Regulator, provide this report at any time.
  

Measurement of risk

In terms of measurement of risk, exposure through the use of financial derivative instruments (limited to 100% of net asset value) can be calculated through a commitment or VaR (value at risk) approach. A VaR approach is appropriate for UCITS using significant or complicated financial
derivative instruments strategies.

The Financial Regulator has provided written guidelines in relation to the requirements for calculating exposure using VaR, indicating that a typical VaR limit for a UCITS would be 5%. The Financial Regulator has specificallyconfirmed in its guidelines that the 5% limit is not fixed and the Financial Regulator will consider proposals to raise this limit where it can be proved that such an increase does not increase the overall risk profile of the UCITS to an unacceptable degree. The Financial Regulator recognises that financial derivative instruments can be used to reduce overall VaR, even where the VaR of the securities alone exceeds the absolute VaR limit of 5% of net
asset value.

Non-UCITS funds

To facilitate fund sponsors who wish to establish funds with features that do not adhere to the restrictions imposed by the UCITS directives, there is also a range of non-UCITS fund vehicles in Ireland which can be used to structure products for the retail or professional investor market.
Non-UCITS investment funds are governed solely by Irish, as opposed to EU, law and therefore, although they do not have the benefit of the EU passporting provisions, non-UCITS investment funds facilitate a broader investment style and range of potential investments. Such funds are
often established for sale to institutional investors and high net worth individuals.

General investment diversification and borrowing restrictions for all non-UCITS funds are applied by the Financial Regulator. These general restrictions are modified, superseded or disapplied
by specific regulations issued by the Financial Regulator for particular types of funds such as venture capital funds, property funds, futures and options funds, feeder funds and funds of funds.
They may also be disapplied on a case-by-case basis for PIFs and they do not apply to QIFs.
Non-UCITS investment funds domiciled in Ireland may be structured as retail funds, PIFs or QIFs.

Retail funds

Retail funds are, as the name suggests, available to the widest pool of investors. They can be effectively classed as funds which have no regulatory minimum subscription. The Financial Regulator has set out general investment and borrowing restrictions for all retail non-UCITS funds.
In practice, because of the similarities between the investment limitations imposed on non-UCITS retail funds and UCITS, the majority of fund sponsors seeking to establish open ended retail funds in Ireland elect for UCITS status in order to benefit from the cross-border marketing advantages of a UCITS.

PIFs

The Financial Regulator may, on request, disapply the general non-UCITS fund investment and borrowing restrictions described above in the case of non-UCITS funds which qualify as PIFs and, as a rule of thumb, the Financial Regulator is generally willing to double each of the retail investment restrictions for a PIF. The Financial Regulator also generally allows a PIF to engage in leverage and the limit for same can be agreed with the Financial Regulator on a case-by-case basis. To qualify as a PIF, a fund must have a minimum initial subscription requirement of 125,000 euros. In the case of an umbrella fund, this minimum initial subscription requirement will be satisfied where the aggregate of the investments of an investor in any of the sub-funds of the
umbrella fund is equal to, or exceeds 125,000 euros.

Institutions which have discretionary mandates over individual accounts may group amounts of less than 125,000 euros on behalf of their clients to satisfy this requirement. In practice, the Financial Regulator will impose certain concentration and leverage limits on PlFs, but the ability
to seek derogations from certain of the concentration requirements makes PIFs suitable vehicles for funds wishing to adopt more sophisticated investment strategies than those which are
permissible for retail funds.

QIFs

The Financial Regulator automatically disapplies all of the general non-UCITS fund investment and borrowing restrictions in the case of non-UCITS funds which qualify as QIFs. Accordingly, the Financial Regulator does not impose any investment concentration or leverage restrictions of any nature on QIFs, save that in the case of investment companies, they must observe the general principle of risk-spreading. This risk-spreading requirement derives from the Companies Act 1990 and so does not apply to unit trusts, CCFs or ILPs. If a fund intends to engage in significant OTC derivatives trades the Financial Regulator will expect the fund to limit its exposure to each
OTC counterparty to 40% of net assets (unless the fund intends to appoint a prime broker, in which case it may have unlimited exposure to such prime broker).

To qualify as a QIF, a fund must:

• have a minimum initial subscription requirement of 250,000 euros.
• The aggregate of an investor’s investments in the sub-funds of an umbrella fund can be taken into account for the purposes of meeting this requirement. 
• sell its shares or units to qualifying investors. Qualifying investors are defined to include: (1) any natural person with a minimum net worth (excluding main residence and household goods) in excess of 1,250,000 euros, or (2) any institution (defined as any entity other than a natural person) which owns or invests on a discretionary basis at least 25,000,000 euros or the beneficial owners of which are qualifying investors in their own right.
• qualifying investors must certify that they meet the second criteria listed above, that they are aware of the risks involved in the proposed investment and of the fact that inherent in such investment is the potential to lose all of the sum invested

The absence of Financial Regulator-imposed investment restrictions has resulted in QlFs becoming attractive vehicles for the establishment of highly leveraged funds, funds pursuing investment policies which involve high concentrations of investments in individual issuers, private equity or
venture capital funds, property funds and emerging market funds.

One-day authorisation for QIFs

Following extensive consultations with industry representatives, in 2007 the Financial Regulator approved a significant overhaul of the authorisation procedures for QIFs by introducing a one
day fast-track authorisation procedure for QIFs. This means that a QIF can now be authorised by the Financial Regulator within 24 hours of a single filing of documents.

Authorisation can be granted on the day following the date of filing of appropriate QIF documentation, once the Financial Regulator receives a completed application by 3.00 pm on
the filing date; all relevant parties to the QIF (eg the promoter, directors and service providers) have been approved in advance of the application; and the fund certifies that it complies with certain agreed parameters which are codified in a revised QIF application form.

This new procedure has been successfully in operation since mid-February 2007. This new authorisation process marks a significant development in expediting the speed to market and attractiveness of QIFs.