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Investor Due Diligence in Alternative Investment



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In an industry where reputation is one of the most highly valued assets that anyone can possess, due diligence is imperative in the world of alternative investment. A reputation is maintained through track records and achievements, but also, and perhaps more importantly, through the stringent monitoring of those who are associated with said track records and achievements. trinity logo

This article expands upon the necessity of investor due diligence which is carried out by investment funds on prospective investors prior to their admittance as shareholders of the fund. As part of anti-money laundering (AML) and counter terrorism financing (CTF) legislation in most jurisdictions, directors of a fund are faced with a regulatory obligation to verify who the investors are, and that they do not pose a threat to the legitimacy of the fund.

The majority of start-up funds use existing contacts to generate seed capital, however even in this case stringent procedures and documentation need to be processed and approved in order to demonstrate that investors have been fully identified. This is a legal requirement in almost every jurisdiction in the world, and there are reforms taking place in order to strengthen these requirements, as part of the current global trend to increase regulation in the financial services industry in an effort to curb money laundering and terrorist financing. A recent global study at the Centre for Governance and Public Policy at Australia’s Griffith University on the ease of opening a shell company without sufficient identity documentation found that there was a high degree of variation among the jurisdictions studied. Some of the results run counter to popular perception as will be discussed further in this article.

Regulatory Considerations
Depending on the jurisdiction in which they are domiciled, investment funds are subject to legislation which aims to detect and prevent terrorist financing and money laundering through the fund. The Financial Action Task Force (FATF) is an inter-governmental policy-making body which sets international standards to combat money laundering and terrorist financing, set up by the G7 countries in 1989 . Many jurisdictions subscribe to these standards when writing their own policies, including Ireland and the Cayman Islands, two key renowned jurisdictions for alternative investment vehicles which form the focus of this article. In the study conducted by the Centre for Governance and Public Policy as aforementioned, Cayman Islands firms were in the group of countries which are the most compliant with international AML standards out of a sample of 182 countries, where no examples of non-compliant firms were found in the Cayman Islands. The study also found that so-called “tax havens” are far more compliant with international AML standards than most rich, developed countries including the United States and the United Kingdom.

Cayman Islands
The following legislation relates to anti-money laundering in the Cayman Islands:
•  Proceeds of Crime Law (2008)
•  Misuse of Drugs Law (2009 revision)
•  Terrorism Law (2009)
•  Anti-Corruption Law (2008)

This legislation requires determination that the source and use of the money invested in a fund by an investor is not linked to criminal activity. Such legislation states for example that it is an offence to neglect to report any suspected money laundering activity to the Cayman Islands Monetary Authority (CIMA). It is also illegal to inform a party if they are being investigated for money laundering or that such an investigation has been suggested.

As a result of this legislation, financial services providers located in the Cayman Islands are subject to Money Laundering Regulations (2010 Revision) which specify mandatory anti-money laundering policies, procedures and practices to facilitate adherence to Cayman AML legislation . By abiding by these regulations, companies can ensure that sufficient due diligence is employed to identify customers, and in the case of a fund; the investors and the source of their funds, as well as all counterparties.

In Ireland, the relevant AML legislation is the Criminal Justice (Money Laundering and Terrorist Financing) Act, 2010 (“the Act”) which transposes into national law the EU Third Money Laundering Directive (2005/60/EC) and the associated implementing Directive (2006/70/EC), as well as subscribing to FATF recommendations. The Criminal Justice Act, 2010 aimed to facilitate the more effective investigation of white collar crime and to reduce associated delays and amongst the new provisions introduced were measures to protect whistle blowers.

Similar to the Cayman Islands’ regulations on financial services providers, the Irish Act also places obligations on a wide range of “designated persons” including credit and financial institutions, lawyers, accountants, trust and company service providers, and others in relation to money laundering and terrorist financing.  The designated bodies covered by the legislation must identify customers, report any suspicious transactions to the Irish Police and Revenue Commissioners (and similar to Cayman legislation, Irish legislation creates an offence of ‘tipping off’ whereby it is an offence to alert a party that they are the subject of a suspicious transaction report), and carry out procedures which provide to the fullest extent possible for the prevention of money laundering and terrorist financing.

Global Shift towards a Risk-Based Approach
In June 2012, an amendment to the Irish Criminal Justice Act, 2010 was proposed which aims to make clearer the policies and procedures which designated persons must use to prevent money laundering, including a greater emphasis on the importance of keeping customer due diligence documentation up to date. Furthermore, the amendment portends that when a designated person carries out a service or transaction with a non EU Member State, it will no longer be sufficient to merely rely on the list of countries currently designated under section 31 of the Act. Instead, the designated person would be required to carry out their own assessment of the risks of money laundering or terrorist financing.

A Fourth EU Money Laundering Directive is also imminent, following an assessment of the Third Directive in early 2012. The Fourth Directive is predicted to incorporate more risk elements which place further emphasis on companies knowing exactly who their customers are, and the nature of their business .

The financial services and investment industry is currently going through a challenging phase in terms of adapting to a myriad of new legislation and subsequent regulation, which impacts on all areas of the industry including investor due diligence. The overall trend is towards lowering risk in the financial system, and in terms of investor due diligence, requirements are increasing and greater time and resources are needed in order to fulfill these stipulations.

Whilst the fund directors remain ultimately responsible for investor due diligence, delegating the task of investor due diligence to an independent service provider such as the fund administrator is a popular and efficient way of carrying out investor due diligence. Using a service provider with stringent AML policies and procedures to carry out due diligence demonstrates legitimacy on behalf of the fund. It is a fundamental way of reducing the risk of the service provider and the directors of the fund from becoming implicated in legal proceedings/regulatory sanctions

or penalties stemming from an investor who has not been subjected to proper due diligence.
Investor identification is carried out by fund administrators, directorship firms, custodians, investment managers, banks and prime brokers. All of these firms aim to protect their clients, as well as themselves from regulatory penalties as well as the resulting reputational damage. It is therefore recommended that all service providers err on the side of caution when establishing investor due diligence policies and procedures.

In order to reduce risk, where a service provider is dealing with various clients who are based in more than one jurisdiction, it is recommended that the most stringent regulations which the service provider comes under be used companywide. For example, although it is usually only an obligation to verify the source of wealth of a Politically Exposed Person (PEP) or Senior Foreign Political Figure, some service providers may suggest identification of the source of wealth for every investor.

The Role of Fund Directors

For a director of a fund, is it extremely important to understand and approve of the due diligence carried out by a third party service provider on behalf of the Fund. Directors remain responsible for the actions of the fund notwithstanding the delegation of certain functions such as investor due diligence, and therefore will need to actively monitor the position, for example, to seek that the third party service provider advises as to any missing AML records for investors within the reports presented at Board Meetings. If there are underlying investors who are investing through an institution and the due diligence on these investors is therefore taken care of by the institution, where the service provider carries out due diligence on the institution only, a director will need to be sure that the service provider takes the necessary measures to ensure that the institution has carried out sufficient due diligence on the underlying investors and that they can access the information when required. It is also important that investor due diligence and on-going monitoring remains a continuous process, including prior to any payment of redemption proceeds, rather than a one-time practice at the time of the investor’s first subscription.

In conclusion, the alternative investment fund industry is undoubtedly going through many changes which bring into focus the existing corporate governance practices of funds. Transparency has been touted endlessly by regulators as the end goal for hedge funds, and it is also important to seek transparency on the investor side too in terms of knowing who your customer is. All investors in a fund should be fully identified, and verification obtained so that they do not pose a risk to the legitimacy of the fund through association with criminal activity. The most effective way to ensure this is to have strict due diligence policies and to make sure that documentation is up to date.

Legislation in various popular investment vehicle jurisdictions is very clear about the AML and CTF requirements for both funds and financial services providers, thus creating a strong framework for carrying out this process. When this is done by an independent third party service provider who can demonstrate that it has robust AML and CTF policies and procedures in place, directors can be satisfied that the fund has far less chance of being compromised by its investors, thereby maintaining a high standard of corporate governance.

For further information on any of the topics covered please contact Trinity Fund Administration (Cayman) Limited at +1 345 743 [email protected] or visit our website at


An outlook on equities and bonds



An outlook on equities and bonds 1

By Rupert Thompson, Chief Investment Officer at Kingswood

The equity market rally paused last week with global equities little changed in local currency terms. Even so, this still leaves markets up a hefty 10% so far this month with UK equities gaining as much as 14%.

The November rally started with the US election results but gathered momentum with the recent very encouraging vaccine news. This continued today with the AstraZeneca/Oxford vaccine proving to be up to 90% effective in preventing Covid infections. This is slightly below the 95% efficacy of the Pfizer and Moderna vaccines already reported but this one has the advantage of not needing to be stored at ultra-cold temperatures. One or more of these vaccines now looks very likely to start being rolled out within a few weeks.

Of course, these vaccines will do little to halt the current surge in infections. Cases may now be starting to moderate in the UK and some countries in Europe but the trend remains sharply upwards in the US. The damage lockdowns are doing to the recovery was highlighted today with the news that business confidence in the UK and Europe fell back into recessionary territory in November.

Markets, however, are likely to continue to look through this weakness to the prospect of a strong global recovery next year. While equities may have little additional upside near term, they should see further significant gains next year. Their current high valuations should be supported by the very low level of interest rates, leaving a rebound in earnings to drive markets higher.

Prospective returns over the coming year look markedly higher for equities than for bonds, where return prospects are very limited. As for the downside risks for equities, they appear much reduced with the recent vaccine news and central banks making it clear they are still intent on doing all they can to support growth.

Both factors mean we have taken the decision to increase our equity exposure. While our portfolios already have significant allocations to equities and have benefited from the rally in recent months, we are now moving our allocations into line with the levels we would expect to hold over the long term.

Our new equity allocations will be focused on the ‘value’ areas of the market. The last few weeks have seen a significant rotation out of expensive high ‘growth’ sectors such as technology into cheaper and more cyclical areas such as financials, materials and industrials. Similarly, countries and regions, such as the UK which look particularly cheap, have fared well just recently.

We think this rotation has further to run and will be adding to our UK exposure. This does not mean we have suddenly become converts to Boris’s rose-tinted post-Brexit view of the UK’s economic prospects. Instead, this more favourable backdrop for cheap markets is likely to favour the UK.

We will also be adding to US equities. Again, this does not represent a change in our longstanding caution on the US market overall due to its high valuation. Rather, we will be investing in the cheaper areas of the US which have significant catch-up potential.

We are also making a change to our Asia ex Japan equity holdings. We will be focusing some of this exposure on China which we believe deserves a specific allocation due to the strong performance of late of that economy and the sheer size of the Chinese equity market.

On the fixed income side, we will be reducing our allocation to short maturity high quality UK corporate bonds, where return prospects look particularly limited. We are also taking the opportunity to add an allocation to inflation-linked bonds in our lower risk, fixed income heavy, portfolios. These have little protection against a rise in inflation unlike our higher risk portfolios, which are protected through their equity holdings.

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Optimising tax reclaim through tech: What wealth managers need to know in trying times



Optimising tax reclaim through tech: What wealth managers need to know in trying times 2

By Christophe Lapaire, Head Advanced Tax Services, Swiss Stock Exchange

This has been a year of trials: first, a global pandemic and, now, many countries facing the very real possibility of a recession. For investors, private banks, and wealth managers, these tumultuous times have manifested largely in asset price volatility, ultra-low interest rates and uncertainty about when things may level out, as well as questions about what can be done to safeguard portfolio performance.

The answer here lies within identifying and creating efficiencies to maximise performance and minimise cost, and while there is a slew of options as to how to do this, they are often siloed or have a single USP. Tax optimisation, on the other hand, provides benefits to all, not just in increasing returns for investors, but also in creating economies of scale across stakeholders, creating millions – if not billions – in savings for banks.

Evolving tax reclaim

The tax reclaim process used to be a tedious one banks had to manage themselves, and required detailed, industry and country-specific knowledge to stay on top of constantly shifting requirements and regulations. And when we consider that many countries – such as the UK – allow for capital gains exemptions, tax optimisation may not seem like an integral part of the process. However, this isn’t the case for all countries, and can lead to severe after-tax implications on global portfolios.

Furthermore, even if you’re able to avoid double taxation, getting the money back is not always as simple as it sounds. This, combined with the fact that countries often have contradictory taxation rules or requirements, makes navigating the tax reclaim space a challenge even for those with the right expertise and experience.

Ultimately, providing tax optimisation to investors ends up being a heavy lift for private banks and wealth managers, who often don’t have the right solutions, are relying on outdated technology and manual processes. While this is generally fine for business, it is no longer fit for the purpose when it comes to tax optimisation. To date, knowledge and expertise have been the key to protecting and maintaining profitable investments and avoiding tax leakage. However, through tax optimisation services starting to emerge, portfolio managers can now manage and reinvest easily.

Today, technology has evolved the process so that banks are able to access and submit tax reclaim – and the relevant documentation – online, leaving the tech provider to coordinate next steps with custodians and tax authorities behind the scenes. In essence, taking the legwork out of the process while assuring consistency and completeness in execution.

Simplifying tax through tech

While tax optimisation may seem like an easy choice in theory, it is not always the go-to for every private bank or wealth manager. Without the right supports and setup, including innovative technologies and automation, tax reporting must be done manually, leading to labour intensive processes and huge time wastage. Changing these processes can be overwhelming for those used to a certain way of operating.

By making tax reclaim digital, banks will be more able to optimise returns and gain efficiencies while reducing redundancies and unnecessary complexities. Cloud based solutions or platforms can offer a safe and secure solution for banks, wealth managers, and investors to access and submit any information required, processing the data automatically for conformity and completeness.

It is critical that providers who intend to offer tax services are able to do so efficiently with the right software and data processing capabilities. Not only does this drive continuity in service and efficiencies in process, but it is the only sustainable way to handle such a complex landscape sustainably without wasting time or money.

End-to-end, technologically driven tax services offer a huge number of advantages to private banks and wealth managers, the most important of which is the ability to provide continuity through tumultuous times. As we move through the end of 2020 into 2021 this will only be increasingly important as banks, managers and investors look to provide new services to clients and strengthen existing relationships in a difficult market.

As investors seek to find returns amid the global economic downturn, the demand for innovative solutions will only increase. Technology like cloud-based software, AI, and data optimisation can all serve to improve not just the tax reclaim processes, but the overall client experience within capital markets.  Private banks and wealth managers are suitably equipped to provide these innovative solutions, but those who do not prepare themselves effectively and keep ahead of trends will run the risk of losing current and new clients to someone who can offer more for less.

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Equity Sharing – How do you choose the right plan for you?



Equity Sharing – How do you choose the right plan for you? 3

By Ifty Nasir, co-founder and CEO of Vestd, the share scheme platform

In a survey of 500 SMEs, nearly half told us that the pandemic had made them re-evaluate how they operate. That’s not surprising as they’ve been faced with some unique challenges this year. Government support during the early stages of the pandemic, is now being extended till March 2021 but many businesses continue to struggle.

Making good people redundant improves cashflow in the short term but will have a long-term damaging impact on the business. At the same time, motivating employees, who are working remotely and worried for their jobs, is not easy.  It’s therefore not surprising that equity sharing, in the form of ‘share’ and ‘option’ schemes has become even more popular, with one in four SMEs now sharing equity with their employees and wider team

However, sharing equity can be a complex area and is easy to get it wrong. When it goes wrong there is a danger that you create tax issues (for you and your employees), de-motivate your team and even create future funding issues for the company. It is therefore really important that you choose the right scheme to set-up, but make sure you manage it too.

Below is a brief summary of the main schemes used by Start-ups and SMEs in the UK today. There are similar schemes and considerations globally.

  1. EMI Option Schemes – This is the most tax efficient scheme. Recipients pay just 10% Capital Gains Tax (CGT) on any value growth. The employer can also offset both the cost of the scheme and the value growth achieved by employees against its Corporation Tax  liability. You can also set conditions to control the release of equity, such as time served or performance. The recipient can’t simply walk away with shares, having delivered no value (which is one of the top concerns of many of the businesses and founders we talk to).  EMI Option Schemes are used by 41% of SMEs (who share equity) and, for good reason, are the most popular. Read our full guide to EMI for more information.
  2. Ordinary Shares  – This is the issuance of  full ordinary shares in the business, often without conditionality and with immediate effect. They are most often issued against cash investment. Once an employee (or any other recipient) has ordinary shares, you have no control over what happens to the shares thereafter. The individual can simply walk away with the shares, so we don’t normally recommend them for contribution that’s yet to be delivered. They’re also not tax efficient, as the recipient will have to pay tax at their marginal Income Tax (IT) rate, on any value the shares have at that point. These are used by 31% of SMEs.
  3. Growth Schemes  – These are a good option when the founders have built value into their company. The recipient only shares in the capital growth of the business from the date that the shares are issued.  You can give growth shares to anyone (not just employees) and you can attach additional conditions. These shares limit the risk of the recipient having to pay income tax on receipt of the equity, as they do not hold any value when they are issued but do pay CGT on the value growth at sale. Growth schemes are used by 31% of SMEs. Read the full details on Growth Shares here.
  4. Share Incentive Plan – SIP –  This is a tax efficient plan for all employees that gives companies the flexibility to tailor the plan to meet their needs.  Share Incentive Plans are used by 23% of SMEs.
  5. Unapproved Options – These are not very tax efficient as the recipient will pay IT on any value inherent in the share, above the exercise price, when they exercise the option. That said, they do provide more flexibility than the other options and are the easiest to set up as you don’t need HMRC approval. Unapproved Options are used by 22% of SMEs.

Is it worth the hassle? Earlier this year (i.e. during the first lockdown ) we carried out a piece of research with  business leaders,  exploring their attitude towards sharing equity with employees and wider team.  We spoke to over 500 owners of SMEs and identified six main business benefits to doing so:

  • Recruitment. You can combine salary with equity, to create compensation packages that match, or improve on, offers made by other more established companies with deeper pockets.
  • Retain the best talent. Share schemes are proven to increase employee retention and can help you reduce if not avoid hiring costs.
  • Increase productivity and performance. Studies have shown that employees who are also shareholders are more committed to their work and contribution because they feel directly vested in the growth in value of ‘their’ company.
  • Improve employee engagement and happiness. The more all employees feel included in the mission, direction, and success of the business, the more they’re motivated to contribute to the company.
  • Relieve cashflow pressure. Equity can be used to reduce the need for finance. Instead of paying people top rates and large bonuses, you can incentivise them via shares or options…giving them a share of the future they are helping to create.

Recruitment and retention are clearly the key drivers. It’s not too surprising to see why. Companies succeed or fail largely due to the quality of the people they manage to attract and retain. However, for smaller and start-up employers, attracting the right people can be difficult.  Good people are typically attracted to the idea of working for a house-hold name brand, they look for job security and are enticed by comprehensive employee benefit packages and high salaries that are unaffordable by most smaller companies. Employee share schemes are an effective way for smaller companies to compete in the job market against larger companies, with that potential for a massive/significant upside.

However, at this challenging time, it’s not all about money, keeping people focussed and motivated during the pandemic is at the top of most employers’ worry list.  If you choose the right scheme, equity sharing encourages employees to align their motivations to that of the long-term success of the business, over the immediate or short-term gains. And, right now, that is perhaps worth more than anything.

If you’d like to get into the detail then check out our guide to employee share schemes.

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