Nigel Poh, Director of Advisory Services
Starting a Hedge Fund
Differing definitions of a hedge fund abound (which are sometimes confused with other funds such as private equity or real estate investment pools) but for our purposes, and with the view of setting up an international hedge fund in Singapore, the following assumptions are made: that it is deemed to be a “collective investment scheme” as described by the Securities and Futures Act of Singapore, and will have a strategy of investing in instruments where valuations are readily discernable with minimal dispute (such as listed equities, bonds); and that the manager is remunerated generally on a manager fee based on the entire value of assets under management, as well as an incentive fee based on a proportion of profitable capital gains made from those assets. The offerings are not meant for the general public but for accredited investors and operate within strict limits to general solicitation and advertising.
Fund and Fund Manager Domicile
Location is one of the first things that a start-up fund manager will wrestle with. For example, single-tiered hedge fund structures will usually mean two domicile jurisdictions of the fund and of the fund manager. Generally the fund entity will find itself located in familiar international tax havens such as the Cayman Islands or the British Virgin Islands, but in recent years, countries eager to tap into the hedge fund sector have rolled out plans for special status trusts or corporate entities that mimic the tax-free status of the traditional jurisdictions. Generally, fund managers are slow to move from the established jurisdictions, as they feel that investors may be dissuaded by “non-standard” term sheets.
Investors are the life-blood of any hedge fund, so in determining a fund manager location, that location should also be considered and contrasted with the specific segment of international investors that the hedge fund seeks to target during its start-up phase as well as life cycle.
Consistently ranked as the fourth most active foreign exchange trading centre in the world (after London, New York and Tokyo), Singapore lies within what is called “the path of the investor visitor” who travels to Asia in search of primary and secondary diversification investment opportunities. Singapore is also a major wealth management centre in Asia and has well-developed sub-financial spheres in the areas of real estate, venture capital, private equity and a growing development even in otherwise new-to-Asia strategies such as distressed debt and arbitrage. This buoyancy in terms of the available choices of alternative instruments attracts the investor who may have more than one or two diversification strategies in their portfolio, so the concentration of the different alternative instruments, although in one sense may be competing, in another sense profit from their concentrated presence given that most institutional investors have more than one instrument in mind. (In other words, they may have set aside assets for both a long/short hedge fund strategy as well as a REIT.) This range of instruments certainly develops the pool of service providers, who have a wider range of potential clients on which to build their businesses and resourcing.
Singapore is perceived as having high levels of transparency and reliability in business, economic and regulatory affairs. The city boasts a stable political structure, a well-established judicial system and a forward-looking financial authority. Coupling this with the wealth management industry and an active trading exchange, the hedge fund manager is able to make a number of persuasive claims to the investor during the due diligence review of the choice of Singapore as a fund manager domicile. First, the financial activity and buzz place the hedge fund manager in the centre stage of the region in terms of operational and strategic effectiveness for their investment trading decision-making, and can claim that the telecommunications, workforce competitiveness, geographic location (for Asia-centric hedge fund strategies) and other macro advantages of doing business in Singapore are leveraged by the hedge fund from day to day. Secondly, the established and respected judiciary provides assurances to the investor that their claims will be heard in a reasonably short time and at a reasonable cost; there are also effective alternative dispute resolution avenues should conflicts or unresolved issues arise. This is a growing concern in a global climate of increasing calls for regulation of the hedge fund industry.
Nevertheless, despite strong fundamental reasons supporting Singapore as an excellent fund manager locale, the fund manager must still consider alternative venues which may provide advantages specific to their business or investment strategy (and in some cases an essential element), or for a particular investor segment, and where possible, gain insight and opinion from initial seed and pillar investors.
Previously, one of the requirements that would keep a fund safe from Singapore tax was that no more than 20% of the investors into the fund could be Singapore tax resident, commonly known in the industry as the “80/20” rule. In accordance with the budget announcement of the year, the MAS recently released a circular detailing a new scheme which is anticipated to replace the 80/20 rule. This new scheme involves defining the characteristics of a ‘qualifying fund’ and a ‘qualifying investor’ – the terms meant to determine whether a particular fund would be subject to tax. A number of safety determinants are identified, for example, a qualifying fund would be defined as such so long as less than 100% of the investors in the fund are Singapore tax resident. This is a clear improvement on the 80/20 rule, reducing the bar in which the foreign fund manager needed to source for assets to fit the exemption tax criteria previously, and also a clear signal that fund management of foreign assets in Singapore is being encouraged, as the tax burden is now essentially been shifted to non-qualifying investors as determined by the scheme.
Non-resident individuals and non-resident corporate would constitute a “qualifying investor” (subject to determinants such as a clear intention that their business activities were for genuine commercial reasons, the investments were not made to avoid tax and the non-resident individuals or corporate did not have permanent establishments in Singapore) and hence fall under the new tax exemption scheme. While non-qualifying investors would have to pay what is described as a “financial amount” to the tax authorities, other ways in which a Singapore corporate investors or non-resident corporate investors (which failed any of the determinants) could still become qualifying investors were described, and the final possible exemptions related to the number of investors in the fund and the value proportion of assets being held. While the new tax scheme as of the writing of this article has yet to be market tested for practicability, it is anticipated that there may be adjustments to fit new issues that arise.
Service Providers and Business Environment
Lawyers, accountants, tax advisors, prime brokers, custodians, administrators, IT services, research and market data providers, are some of the essential service providers required by hedge funds. The administrator is the anchor element, as they provide not only critical services such as asset value calculations, but also serve as the third party that requires the most accountability from the hedge fund and provides the investor periodic progress reports. Many investors, seeing the administrator functioning as an outsourced “back office” of the manager, conduct as intensive operational due diligence on the administrator as they do on the fund manager, so the choice of the right administration partner is critical.
Points to consider include:
the capacity of the administrator to take on and service new business efficiently
the administrator’s familiarity with the manager and the type of strategy
the administrator’s “brand” and therefore comfort level with investors
the willingness of the administrator to engage in open dialogue with the manager’s investor clients
the independence of the administrator from any of the other service providers on the fund’s term sheet
Recent years have seen many international administrators set up offices in Singapore in anticipation of hedge fund growth in the region, and this growth has accelerated markedly. Other service providers previously mentioned either already have competent set-ups in Singapore itself, or boast the ability to service all hedge fund needs out of Singapore’s financial centre competitor, Hong Kong. While traditionally the latter had the bulk of headquarters and expertise of prime brokers, lawyers and the like, increasingly this is becoming less so with front and back offices locating in Singapore in recent years.
Singapore’s general business environment factors such as work force competitiveness, telecommunications, language and training, business infrastructure, living conditions, and trading facilities, are viewed favourably from an international perspective and need little further expansion here. While there exists a subjective factor in terms of proximity to target investors/markets, Singapore remains an extremely conducive location for many reasons.
To Wrap Up
Singapore remains a conducive place for fund management in the spheres of investor receptiveness, tax, regulatory oversight, set-up cost competitiveness and operational stability and efficiency. While Singapore is an efficient and generally lower-cost location for a start-up, there are still clear requirements and the elements of cost to consider, so start-up fund managers will need to pay careful attention to issues such as preventing undue delays from the start-up process until launch, forecasting the right number of investors, having sufficient capital for the start-up costs (including ongoing costs), and having a realistic business and marketing plan.
Stages of a Fund Start-up
The following are the main components that need to be addressed during the fund launch phase:
Product and Market Analysis of the Fund Offering
Identifying Investor Segment
Legal and Tax Fund Structure
Licensing and Regulation
Appointment of Key Service Providers
Drafting of Information Memorandum
Providing Due Diligence Documents on Fund Principles
Incorporation of Fund Entities
Opening of Fund Accounts
Office and Staffing Operations
Trading and Research Facilities
Due Diligence and Anti-Money Laundering Procedures
Internal Risk Management
TYPICAL INITIAL FUND STRUCTURING COSTS
Incorporation of Manager / Appointment of Company Secretary
Incorporation of Fund / Lead Counsel and Cayman Legal Fees
Auditor’s fees (fund)
Auditor’s Fees (manager)
Ongoing legal / compliance
CIMA (Cayman) ongoing fees
Assumption: Simple fund structure being registered in Cayman Islands and fund manager incorporated in Singapore.
Note: Start-up costs may vary according to fund size, different service providers and investors’ profiles.