Following the banking crisis of 2013, which wreak havoc on the local economy triggering an avalanche of bankruptcies, high unemployment that picked to historical levels as the crisis reached its climax and ultimately leading to a bail-in and a haircut of depositors with saving accounts above €100K and a mountain of non-performing loans in the banking sector, a glimpse of hope appeared when the country exited, earlier than expected, in march 2016 the bailout program it entered into with the Troika (IMF, ECB, EC) which provided the country with a lifeline worth €10 Billion that were vital to rescue the collapsing financial system. The country managed to exit the program with a balance of 30% of the credit line not used, which is testament of the efficacy of the crisis management that was implemented.
Since then, the country returned to international markets for capital raising and enjoyed a robust economic recovery achieving growth rates above 4% in 2016 and 2017, which were hard to come by in the Eurozone at that time and kept growing at sustainable growth rates in 2018 and 2019, thanks to historical tourist arrivals, the governmental investment program which boosted the real estate market and not least the Emerging Fund Industry.
Now that the days of the oversized banking sector, which reached 6 times GDP at the height of the crisis are over, and the non-performing loans burden brought under controllable size, the Investment Fund Industry is opening a new window of opportunity in the post COVID world and emerging as a key pillar of the financial services ecosystem at country, regional and EU level.
To get a better insight into this emerging sector, we looked at its shape and size back in Q1 2013 and analysed the key milestones it hit down the road until the sudden emergence of the COVID-19 black swan in 2020.
A shift from ICIS Schemes to the UCITS new paradigm
Until Q2 2012, the prevailing Fund Legal Framework was in the form of International Collective Investment Scheme (ICIS) and most of the funds in the market were in the Closed-End form, meaning less liquidity for the investors and less fund units in offer as Closed-End funds issue a limited number of Units when they start up their operations and during the life of the fund. Consequently, the growth of the fund industry back then was lukewarm, and Funds’ total Assets under Management were just shy of €2 Billion.
Cyprus transposed the UCITS IV Directive (2009/65/EC) into national law during the second quarter of 2012 (The Law 78(I)/2012), paving the way for the introduction of the first UCITS fund in the country through either local managers setting up their own funds or via distribution of funds that are domiciled in other EU jurisdictions through the passport which was introduced by the UCITS Directive. Following that, for the first time Open-End Funds’ AuM overtook that of their Closed-End peers reaching €1.1 Billion and €1.03 Billion respectively in Q3 2012. (Exhibit 1).
Data Source: Central Bank of Cyprus as of 30/09/2020.
No doubt the introduction of the UCITS Directive signalled the decline of the Closed-End fund types and their share as a percentage of total AuM decreased from 51.87% in Q3 2012 to reach just 4.62% in Q3 2020 as can be seen on the charts below (Exhibit 2&3). Nevertheless, the expected take-off of the UCITS funds did not materialize due to some exogenous reasons such as the dominance of the UCITS markets by Luxembourg and Ireland, but also endogenous problems such as the bad timing of the occurrence of the banking crisis in Q1 2013 which wiped out the trust in the financial system, a condition sine qua none for the normal functioning of an economy and society. The verdict is obvious: Just one fund management company succeeded in establishing a substantial number of UCITS funds (16 funds in 2014) offering various strategies across all asset classes.
Data Source: Central Bank of Cyprus as of 30/09/2020.
Transposition of AIFMD Directive and the rise of the RAIF Structure
The transposition of the AIFMD Directive (2001/61/EU) into national law (AIFM Law 2013) provided a breathing space to aspiring local managers who braced to take a market share in the Alternative Investment Funds as there is no a clear dominant jurisdiction in that space; the harmonization of the Alternative Investment Funds regulations in the EU and the ability to distribute these investment vehicles to professional investors across the EU through the Marketing passport fuelled the interest of both investors and product makers as demand for alternative investments kept rising amid low and negative interest rate environment and stock market valuations shooting over the roof.
The AIFM Law of 2013 provided the possibility to create Alternative Investment Funds with Limited Number of Investors, up to 50 well informed or professional investors (AIFLNP) and the AIF with Unlimited number of Investors which can also be marketed to retail investors under certain conditions; the AIFLNP turned out to be the favourite investment vehicle amongst fund promoters and the number of such funds offered in the market witnessed a steady increase between 2015 and 2017. However, this picture has been altered by the AIF Law of 2018, which added another AIF type into the existing ones, namely the RAIF (Registered Alternative Investment Fund).
RAIFs are Alternative Investment Funds with Unlimited Number of Persons that can raise capital exclusively from Professional and Well-Informed Investors, with a view to investing it in accordance with a defined investment policy for the benefit of those investors. RAIFs must be externally managed by a regulated entity such as AIFMs. Examples of such funds are Hedge Funds, Commodities Funds, Funds of Funds, Real Estate Funds and Private Equity Funds. They can be set up as an umbrella fund with multiple segregated compartments (Sub-Funds). RAIFs do not require an authorization from CySec, however they need to be notified to the regulator who maintains a RAIF register, which makes them fast to set up.
The introduction of the RAIF structure in 2018 emerged as the vehicle of choice for new fund launches and their number reached 18 and 42 in 2019 and 2020 respectively, eclipsing their AIFLNP peers. 31 out of the 35 new funds which were launched In the second half of 2020 were RAIFs.
Data Source: Cyprus Securities & Exchange Commission as of 20/02/2021.
As of 30 of September 2020, there were 208 reporting active funds in Cyprus, out of which 179 are AIFs (Non-UCITS), making Cyprus one of the emerging AIF centres; total assets under management reached €5.6 Billion, recording a decline of 8% from the historical peak in Q4 2019 when AuM soared for the first time above the €6 Billion mark. No doubt this decrease in assets size was due to the corona virus that wreak havoc across the world economy, but that did not discourage fund promoters to issue new products as the number of new funds launched in Q3 2020 reached 21, which is the highest number of new funds set up since 2009 as can be seen on the chart below.
Data Source: Cyprus Securities & Exchange Commission as of 20/02/2021.
The large increase in RAIFs set up in 2019 and 2020 was mainly driven by the low set up and maintenance costs, light regulation as the regulatory reporting is shouldered by the external AIFM who manages the fund and last but not least the fast time to market which allowed fund promoters to implement new investment strategies within a short period of time without waiting for an authorization from the regulator that could take up to 6 months when using other AIF structures. Business owners, HNWI and entrepreneurs seized the opportunity to shift the management of their assets to a regulated investment fund vehicle, providing more transparency and investor protection. This has triggered a tenfold surge in non-financial assets allocation reaching €1.2 Billion in Q1 2018, registering an increase of 984% compared to 110 Million in Q4 2017. The trend kept upward to date.
Data Source: Central Bank of Cyprus as of 30/09/2020.
Asset class wise, Equity allocation represented 62.63% of total AuMs in Q3 2017, followed by Mixed Assets with 16.45%, Real Estate 8.30%, Bonds 4.32% and Other with 8.30%, however with the emergence of the RAIF structure, the asset allocation picture has metamorphosed into something different, showcasing the increasing importance of Other asset classes such as Shipping, and physical assets; while the Equity Asset class shrinked in percentage terms to 35.14% in Q3 2020, though it registered a slight increase in absolute terms from €1.7 to €1.9 Billion, at the same time the Other asset class’s share increased to 38% of total AuM, reaching €2.1 Billion; most of the funds’ inflows between 2018 and 2020 went into the Other asset class, helping the fund industry to reach €6 billion in Q4 2019 as shown on the charts below (Exhibit 9).
Data Source: Central Bank of Cyprus as of 30/09/2020.
Data Source: Central Bank of Cyprus as of 30/09/2020.
Without any doubt, the introduction of the RAIF structure is boosting the fund industry in Cyprus, making it a critical contributor to the much-needed economic growth now that the Government Investment Program has been terminated and the Tourism industry is passing through its worst moments in record. The country is very well positioned to become a major AIF hub in the years to come and it offers many advantages and benefits to fund promoters and foreign investors alike, such as:
- No Tax on Capital gain from disposal of securities (shares, units of funds, bonds, options).
- No Tax on Dividend income.
- Can claim Notional Interest Deduction (NID) on capital injected.
- Interest income is exempt from Special Defense Contribution Tax (SDCT).
- Corporation tax rate of 12.5% on taxable profits.
- No withholding taxes on dividend payment or redemptions.
- No Tax on Capital Gains from the sale of immovable property located outside Cyprus.
- No tax based on Assets Under Management (Stamp Duty Tax).
- No VAT on services provided by the Investment Manager.
- Low Set-Up and maintenance costs compared to EU Fund Centers (Ireland, Luxembourg)
- Light regulation and reporting obligations (Annual/Semi-Annual, Holdings, Borrowing and NAV Reports)
- Flexible Investment Strategy with little restrictions on asset allocations, allowing the rollout of any alternative strategies such as Hedge Fund, Real Estate, Private Equity, Commodities.
- Easy Distribution in other EU jurisdictions through Passporting regime following a simple notification to the local regulator of the country where the fund will be sold to professional Investors (Non-UCITS Passporting).
- AIFs can be set up as an Open-Ended or Close-Ended Fund.
- AIFs can be listed in a regulated stock exchange in Cyprus and the EU for price quoting.
