Malta’s growth challenged by custody conundrum

The AIFMD, the Alternative Investment Fund Managers Directive, has brought new opportunities and challenges for this little island in the heart of the Mediterranean.

Malta, which boasts a rich cultural heritage and natural beauty, has been building a reputation for itself as a credible financial centre and fund domicile over the past 10 years, particularly after the country, also part of the Commonwealth, became a member of the European Union in 2004.

While keeping the Professional Investment Fund (PIF) regime introduced in 2000, which had acted as a major catalyst in particular for start-up hedge funds, the island was one of the first EU jurisdictions to begin processing AIFMD-compliant applications for hedge fund managers, after implementing the directive in 2013.

With the AIFMD marketing passport and pan-EU approval associated with the AIFMD brand, EU managers are no longer confined to Ucits for pan-European distribution.

Rising costs of compliance have driven managers, largely from the UK and Switzerland, to set up their fund management operations in Malta. Today there are 140 managers on the island, of which around 40 arrived over the past couple of years. 

An advantageous “secure, tried and tested” tax regime, as well as very competitive costs, are combined with several other advantages, including speed to market, an efficient and approachable regulator, as well as a solid operational and fund services infrastructure, which make this English-speaking country an attractive jurisdiction. 

 “With AIFMD there has been a shift in emphasis from funds to markets, which essentially is driven by the market,” says Joe Bannister, chairman at the MFSA regulatory authority. “A manager is a far bigger contributor to the economy than a fund.” He accepts a small jurisdiction such as Malta is not a place for larger managers. “Companies with five to 10 people are the ideal.”

Some of these managers are now becoming Super ManCos (Super Management Companies), able to support both Ucits funds and AIFs through one structure. This trend may boost the reputation of the island as a Ucits jurisdiction, although today Ucits funds represent around 25 per cent of the total €9bn ($10bn) of assets managed by 600 funds and sub-funds domiciled in Malta, and mainly cater to the domestic market. The majority of assets are still PIFs, and most funds are small, with €10m to €60m in assets. PIFs offer solutions for non EU AIFMs or for funds structured with a pre-defined investor group in mind or other types of funds which do not require pan European passporting but are happy to rely on private placement.

Malta was one of the first jurisdictions in Europe to adopt the Notified AIF, a structure which offers managers a straightforward process for bringing funds to market. Under the framework, AIFs assume full responsibility for the fund, which can be launched without the need for pre-authorisation by the regulator and is registered within 10 days of the notification.

“Time to market is critical when you have competition and the delay with getting authorisation through various authorities is commercially compromising,” says Jeremy Leach, CEO at Managing Partners Group, an international boutique asset manager with Ä600m of AuM. Malta’s legislation around securitisations was a key factor in the firm’s decision to open an office there last year, as Malta is the only EU state outside Luxembourg to have it in place. “This move is a game changer.”

However, the big challenge for Malta is the upcoming deadline of July 2017. This is when the derogation the Maltese government negotiated from the AIFMD’s requirement for Maltese AIFs to use Maltese custodians expires. 

Indeed, one of the requirements of the EU directive is that AIFs based in a particular jurisdiction use a locally licensed depositary institution to act as the custodian of their funds. 

With the 2017 deadline looming, funds are either seeking a solution with local depositaries, restructuring in order to seek different custody solutions, or are looking at other jurisdictions.

But Malta’s limited number of licensed depositary institutions may become a serious threat to the growth of the fund industry. 

At a time when global custodians are not looking to expand their operations in other countries, but are in a consolidation phase, “these rules will prejudice jurisdictions which are new entrants in the financial services world or not in the ‘financial highway’ but at the periphery of Europe,” says André Zerafa, who heads the investment services and funds team at law firm Ganado Advocates.

Because of onerous requirements and liabilities, margins are so slim that if custodians don’t have volume of business they cannot survive, explains Kenneth Farrugia, chairman at FinanceMalta, the public-private initiative which promotes Malta as an international financial centre.

Reflecting the views of many practitioners in Malta, Mr Farrugia strongly advocates for the European Commission to introduce custody passporting within the EU. National regulators, he says, should be given the right to decide which types of funds are allowed to use foreign custody services, for example leaving pension funds under the direct supervision of the local authority, given the sensitive nature of their assets and the huge custody fees they bring to the jurisdiction.

Some believe that if Malta was able to attract large funds from known brands, then the jurisdiction would become more appealing to large custodians. But large Ucits funds generally choose Luxembourg or Ireland, and prefer to be closer to the market in which they distribute. Hedge funds, irrespective of size, tend to prefer global custodians able to work with prime brokers.

“It is a chicken and an egg situation,” says Sarah Camilleri, director, investment services and funds at KPMG. A key differentiating factor for Malta is that funds domiciled there can be administered from any other licenced jurisdiction. “If this was possible for depositories too, it would assist us greatly to grow.”

In the last year or so, however, three Swiss banks, Reyl & CIE, Swissquote and Zarattini International started custody operations in Malta, taking advantage of the market opportunity. They generally provide custody services to specific types of investment strategies or smaller funds. 

Automation and operational efficiency are key to offering added value, says Francesco Scotto, CEO at Zarattini, and enable price reduction. His firm has onboarded specialised funds, such as non-performing loans, for the first time in the jurisdiction’s history, thanks to automated systems. 

Recent and more accurate analysis carried out by the MFSA found that assets under custody in Malta rises to around €110bn when adding managed accounts, assets of life insurance companies or retirement schemes, as well as non-Malta funds managed in Malta with foreign custody. Whether this new figure would make a difference to a global custodian’s decision to enter the market is debatable, considering Malta is competing with giants like Luxembourg and Ireland. 

But  MFSA’s Mr Bannister says he is in talks with three medium to large banks interested in opening custody operations. “These banks understand the first big names that move in will get all the business.”

Looking forward, alternative funds are believed to continue driving the growth of the Maltese financial industry. Private equity in particular is believed to be a growth area, and Malta offers “robust legislation and human capital” to support it, says Paulianne Nwoko, managing director at Apex Fund Services.

Another card Malta can play is the manufacturing of financial products, particularly around shipping and aviation. Malta is Europe’s largest flag ship register and one of the world’s top five. It is particularly strong in the maintenance, repair and overhaul of aircraft, including their engines – a tradition whose roots go back to the departure of the RAF, following independence from Britain in 1964.

“We have an opportunity to market Malta as a place for alternative finance for ships and aircrafts using capital markets,” says Max Ganado, senior partner at Ganado Advocates, reporting a recent securitisation structure for the financing of two ultra-large container vessels from the Middle East, worth €180m. 

Others believe it is important Malta focuses on its strengths. “We don’t need to reinvent the wheel,” says Kevin Valenzia, territory senior partner at PwC. Malta should continue to build in the niche sectors it already has, such as PIFs, taking advantage of its natural attributes. “We have an English way of doing things mixed with Mediterranean flexibility, which no other financial centre has.”