The future of family offices: Regulation and the right location

The fittest adapt to survive. Increased scrutiny and legislative pressures for transparency are transforming the family office industry. The global drive toward systemic reforms has radically altered the regulatory landscape, prompting a search for more efficient jurisdictions and more competitive structures.

Dodd-Frank legislation enacted in 2010 set the stage for financial reform in the United States. “One problem is that those regulations are still constantly coming out,” explains Todd Kesterson at accountancy firm Kaufman Rossin, who has clients in Latin America and the Caribbean. Another issue is that families may not wish to register as multi-family offices, which would expose their holdings to public view. “One solution is to create single-family offices where only family members participate,” Kesterson suggests.

Tax havens and privacy protocols are under siege across the board. “All is in motion. Few traditional tax avoidance regimes — legal and illegal — still exist, and those remaining will be squeezed over the next five years,” says Christopher Geczy, academic director of the Wharton Wealth Management Initiative. “In some spaces, such as carried interest rules, the United States may become more competitive, and in others less so.” Recent American legislation, such as the Bank Secrecy Act and the Anti-Money Laundering Act may propel some residents toward tax regimes elsewhere.

The Foreign Account Tax Compliance Act (FATCA), set up to prevent underreporting by US taxpayers, exemplifies the trend. Elsewhere in the world, the Common Reporting Standard (CRS) is slated to go into effect next year, with countries phasing it in gradually. In consequence, American regulation may actually provide better privacy protection. “A foreign person might not wish to be subject to US taxation, but might still be able to guard anonymity better in states like Nevada, Delaware and South Dakota,” points out Michael Kosnitzky, tax attorney at Boies, Schiller & Flexner.

From London-based lawyer Ashley King-Christopher of Charles Russell Speechlys, makes the case for what he calls “protectionism through legislation.” Know Your Customer (KYC) rules require professionals to ascertain clients’ identities. He therefore counsels his own wealthy clients to set up a base in London for their family office, with key people onsite to build critical mass. Those who can show badges like a UK bank account and law firm will have automatically passed a lot of tests. “Governments can impose subtle rules over time, and they keep getting tighter,” King-Christopher warns, “The wealthy may be stranded.”

Converting structures

In a novel phenomenon, a number of hedge fund managers have converted their structures to family offices in recent years. In 2015, 979 funds were liquidated, including those run by Seneca Capital, Lucidus Capital, BlueCrest, BlackRock, Bain Capital and Fortress Investment Group. In 2016, the exodus continues.

Two principal drivers underlie this movement, according to New York-based attorney Jeremy Berry of Akin Gump. First, Dodd Frank requirements have significantly increased the expense of conducting hedge fund operations. Those who were managing their own money to start with, supplemented with some outside funds, have found it expedient to expel third party investors and avoid registration. “That way, they avoid both costs and fiduciary duties,” Berry notes.

The second driver reflects market fluctuation rather than regulation. Some hedge fund managers may find themselves deep in the hole. To keep their powder dry for another day, funds can terminate and disband, so the founders can retrieve the money to create a family office. A number of managers who have historically run large funds are underperforming with their current strategies. “Some still claim to have faith in the viability of their strategies but attribute current market conditions to their short-term difficulties,” Berry says. In other words, look to both a push and a pull. Berry summarizes: “Investors are withdrawing money, but managers also want to convert to family offices, to know what assets they have available to work with.”

According to the UBS/Campden Wealth Global Family Office Report 2016, “interviews with family offices reveal concerns around the poor performance and high fees of hedge funds. There are also some doubts about the ability of hedge funds to generate alpha going forward, even with the benefit of volatility.”

Jurisdiction

Another central issue is the most attractive location for a family’s imperatives. The EY Family Office Guide: Pathway to Successful Family and Wealth Management provides a list of pertinent considerations. Criteria include available legal and tax structures, ease of maintaining employees, economic and political climates, filing requirements and the flexibility for future restructuring. The guide emphasizes, nonetheless, that a location close to the family may be more important than tax or regulatory aspects.

Kosnitzky starts with an analysis of his clients’ needs, outlining the pros and cons of various jurisdictions. Some families resist an unrelated person making decisions for operating their trust company, which local requirements may demand. Some jurisdictions, such as Ireland, necessitate annual meetings, and all require some boots on the ground. Will time zone differences pose a problem, for example, for distant tax-friendly locations such as New Zealand? Is the banking system stable? How protective are the trusts? “Some courts won’t admit a case on a contingency basis, and others refuse comity of judgment, so plaintiffs must start from scratch. Does the client have creditor issues? We factor all that in,” Kosnitzky explains.

Different jurisdictions may dovetail with the family’s priorities — from Bermuda, the Caymans or the British Virgin Islands, to Ireland, Luxembourg, or possibly the United States. Singapore, for instance, offers a prime example of a location where English is spoken and UK law is followed. “It’s easy to get to, which has made it a magnet for wealthy Asian family offices,” says Fred Tannenbaum, managing partner at Gould & Ratner. He notes, “They like its dynamism and energy and 21st century outlook.”