Jersey – taking hedge fund regulation to the bottom

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"The race to the bottom" is a well known phrase in offshore tax. It is the seemingly inevitable way in which tax havens are used to reduce both the headline and effective rates of tax charged on capital (such as corporation tax, taxes on investment income, capital gains and wealth). No one can deny that the downward trend in the rates of these taxes is real.

There is though a second race to the bottom which is as pernicious, and which the tax havens also facilitate. This is that in regulation abuse. Contrary to what those in the capital markets say (unless they're faced with an impending financial crisis, when they rapidly change their tune) regulation is a good thing fort the efficiency of markets. The reason is simple. Whatever benefits unfettered markets bring on the blackboards of economics lecturers, they cannot deliver the goods in reality precisely because the assumptions that economists make to show that they are beneficial cannot be reproduced in real life. Just look at the 'requirements' section here and you'll see why.

So regulation is needed to ensure that the failures of the market are corrected so that the imperfect market that we have can deliver the best results possible for all. Nowhere is this more necessary in finance. As the recent credit crisis has proven, markets need strong and directed regulation if they are to neither fail or abuse those involved.

So Jersey's latests foray into modifying its hedge fund regulations is both staggering as to timing, and as to intent. Put simply Jersey has announced that it will no longer regulate any hedge fund that requires that an investor have at least $1 million invested in it. The Wall Street Journal is incredulous about this. It says:

This summer's credit crunch showed just how little investors and regulators know about the assets owned by financial companies. But even as regulators and politicians around the world push for greater oversight of hedge funds, the small English Channel island of Jersey -- a haven for funds thanks to its light regulatory touch and low taxes -- is relaxing its rules even further.

It is a shift that could trigger a race to the bottom among offshore financial centers: The demands that the Financial Services Commission, Jersey's regulator, places on some funds where investors have put in a minimum of at least $1 million will effectively fall to zero as of January.

Funds that choose to set up shop in Jersey -- already home to hedge funds with a total of more than £40 billion, or $81 billion, under management, including the $2.8 billion Ermitage Group and the $640 million Altis Partners Ltd. -- will be able to opt for a regime that requires no regulatory authorization to register, no outside audit and no public filings of prospectus changes, Jersey officials say.

As they note:

Jersey's decision to introduce a new regime "was based on demand from the hedge-fund and other alternative-investment management community, which wanted an unregulated product," said Robert Kirkby, a technical director at Jersey Finance

You bet they did. No one who wants to exploit the abuses that unfettered markets allow wants regulation: it gets in the way of exploitation; exploitation that Jersey has just licenced.

As the WSJ puts it:

Offshore financial centers are outside the purview of U.S. and European regulators, placing oversight of the funds out of reach, even if fund managers are based in financial centers like London and New York.

Too true, and which makes a complete nonsense of Jersey Finance's comment that:

because funds already face regulatory requirements in places like London, they'd rather not suffer an extra layer of time-consuming and duplicating regulation where their funds are incorporated.

They know that's complete nonsense. These funds are incorporated in Jersey to avoid regulation in London and now there won't be any for many of them in Jersey either. Financial Armageddon here we come, care of the States of Jersey - a parliament in name, a small town council in aptitude and a prisoner of the financial services industry in practice.