New York houses many of the world's largest real estate private equity funds and is among the most cities for real estate fund managers. Nearly one-fourth of the largest 100 real estate fund managers globally are headquartered in New York City (PERE June 2019 Report).
In June of 2019 we presented the Global Regulation of Digital Asset Funds, in partnership with Harneys, a leading Cayman law firm, with which we have worked extensively in structuring global digital asset funds. Our June symposium featured a panel of leading authorities on various aspects of global digital asset regulation, including securities law, taxation, and anti-money-laundering compliance.
One of the most important aspects of forming a real estate fund is to set the terms of the investment. When properly structured, real estate fund offering documents contain terms that adequately protect the fund sponsor and are attractive to investors. Real estate fund terms are driven by the fund’s strategy, the market trends within the fund’s specific asset class, and the particular needs and objectives of the fund. It is crucial that the investment fund legal counsel have an in-depth understanding of current investment market trends and how those trends affect the strategy the fund will employ.
As is the case with investment funds in general, real estate funds are trending toward higher levels of specialization. Specialization may be by asset class, strategy, or both. Examples of asset class-specific firms can include office, retail, medical, industrial, agricultural, storage, or hospitality. Real estate fund strategies can be loosely categorized into one or more of the following groups:
The early focus by the SEC and CFTC in the crypto asset space was primarily focused on preventing fraud and assessing risks to investors and the market. In cases not involving fraud, initial enforcement of digital asset investments were somewhat tempered, as regulators exercised a degree of forbearance to allow the budding industry to evolve. This period of early forbearance for digital asset market participants appears to be quickly coming to a close. Crypto asset hedge fund managers should not interpret past forbearance as an indication of current regulatory intent.
Digital asset fund managers face substantial risk in the disclosure of their investment fund strategy and have limited precedent in preparing those disclosures. As an emerging asset concept, distributed ledger technology presents a myriad of potential regulatory considerations, technological complexities, and market uncertainties with few analogous instruments. As with any fund offering disclosure, digital asset fund managers are advised to err on the side of thoroughness and caution in disclosing the breadth of the investment strategy and its potential risks.
Investment into digital assets facilitates anonymity and has the potential to be used by investors to mask various illegal transactions, including money laundering, funding of terrorist activities, and numerous regulatory violations. In addition to the AML procedures that token issuers and various intermediaries must perform, hedge funds must carefully comply with AML regulations when accepting crypto tokens from investors in lieu of fiat capital as an in-kind contribution.
The regulation of cryptocurrency fund managers is heavily dependent on how crypto digital assets are classified. In early analysis, US government regulatory bodies often categorized digital assets differently. Below is a brief overview of the various asset classifications by the SEC, the CFTC, the IRS, and Fincen, which are the US regulators most critical in governing the activities of crypto asset hedge fund managers. Note that US regulation of crypto-asset funds is in a state of flux, with a litany of regulatory issues that have yet to be resolved, and which may change over time.
In the short period from 2014 through 2019, hedge fund management and strategy has varied significantly in response to market forces. Following the significant surge of cryptocurrency funds in 2017 and 2018, there has been a noticeable trend toward increased sophistication of participating fund managers and investors.
Of the several hundred digital asset funds with managers or investors domiciled within the United States, only a minuscule portion have become fully registered investment advisers with the SEC. Instead, most of these digital asset funds have thus far avoided SEC adviser registration in one of three ways:
US Regulation of hedge funds—including digital asset funds—is conducted at two levels: (i) the issuer-level and (ii) the adviser-level. At the issuer level, the SEC and individual states regulate investment into the fund by US fund investors. At the adviser level, managers are regulated by either the SEC, CFTC, or neither based on whether the portfolio assets are classified as securities or commodities.
The structure of crypto-asset investment funds are driven by investment strategy goals, regulatory requirements, and tax considerations. The fund’s entity structure and allocation provisions aim to create efficiencies for fund managers and investors alike. For digital asset funds anticipating only US taxpayers, the fund vehicle is generally structured as a pass-through vehicle taxed as a partnership, either as a limited partnership or a limited liability company. However, as noted below, some crypto asset funds elect to trade through an offshore master-feeder or mini-master structure, regardless of whether the fund anticipates offshore investors.
The CFTC treats certain digital assets as commodities, including virtual payment tokens, utility tokens, and others under Section 1a(9) of the Commodities Act of 1936. CFTC regulated assets interests include: futures contracts, options on futures contracts, and swaps, including foreign exchange transactions. The CFTC has taken the position that virtual payment tokens, such as Bitcoin, are not considered currency because it is not accepted as legal tender in any jurisdiction.
On December 14, 2018, in anticipation of the IRS hearing for the Qualified Opportunity Zone (the “QOZ”) legislation, our firm hosted the Opportunity Zone Real Estate Fund Workshop at Columbia University’s Faculty House.
One of the initial considerations when structuring a hedge fund is whether to form the fund domestically, offshore or both. If a fund sponsor expects to have only U.S. investors, a domestic entity is sufficient. However, if a sponsor anticipates offshore investors or U.S. tax-exempt investors (IRAs, pension plans, endowments, etc.) an appropriate offshore fund will be needed to shield such investors from U.S. tax liability.