Some 12 years ago the Mutual Funds Act provided regulation of the investment fund sector in the British Virgin Islands for the first time.
Some 12 years ago the Mutual Funds Act provided regulation of the investment fund sector in the British Virgin Islands for the first time. Now a comprehensive overhaul of the legislation, which will also bring other areas of investment management and securities offerings into the ambit of the BVI Financial Services Commission, is seen by many industry practitioners as an important step that will consolidate the islands’ position as the world’s second-ranking offshore fund domicile and perhaps help it start to catch the Cayman Islands, for now the industry’s undisputed leader.
At the end of March, according to the regulator, the BVI had a total of 2,781 active mutual funds, of which 1,740 were professional funds, which are restricted to high net worth and institutional investors, 821 were private funds, which distribute shares on a private basis and have fewer than 50 investors, and 220 were public funds, which are available to a retail market directly and through intermediaries by virtue of having a lower minimum investment than professional funds.
The total represents an increase of just over 25 per cent in two years, from 2,216 active funds at the end of the first quarter of 2006, and maintains the BVI’s lead as a fund domicile over Bermuda, which it overtook a few years ago. The sector has continued to grow, albeit slightly more slowly, through the credit crunch and the consequent economic downturn, with the quarterly increase in fund numbers slipping from 97 in the first quarter of 2007 and 114 in the October-December period to 77 in the first three months of this year.
The Securities and Investment Business Act, as it will be known, has been several years in the gestation. As Brodrick Penn, director of investment business at the Financial Services Commission, acknowledges, the process of re-examining the jurisdiction’s regulatory framework for investment began under his predecessor’s predecessor. An earlier plan simply to revise the Mutual Funds Act was discussed with the industry a few years ago but eventually was subsumed into an all-encompassing legislative framework for the industry as a whole.
One of the aims of the new legislation, Penn says, is to codify existing practice and understanding. The BV Islander took charge of the Commission’s investment division at the beginning of this year following a five-month secondment in Dublin with GAM Fund Management, a fund administration firm belonging to investment manager GAM, which has nearly 200 traditional and alternative funds domiciled in the BVI.
According to Penn, the Securities and Investment Business Act will continue to strike the balance embodied in the Mutual Funds Act between the protection of investors and the ability of managers to innovate with funds aimed at sophisticated investors. ‘We strongly agree there should be a differentiation between private and professional funds and those aimed at retail investors,’ he says. ‘We set what we think are appropriate minimum standards for private and professional funds, such as ensuring that all functionaries such as the investment adviser and custodian emanate from jurisdictions that have a prudent system of regulation for fund business.
‘Managers have to be allowed to be innovative, because that’s what sets them apart. The fact that the BVI regulates fund managers in a way that most of the offshore world does not testifies to the fact that while we may acknowledge the manager’s need for innovation, we are also aware of the need for some level of regulation. Even if we are not prescriptive about strategies and objectives, we at least bring managers within the regulatory remit of our enforcement and other powers.’
With the SIBA legislation still to go through the final stages of the consultation and enactment process, Penn is reluctant to discuss its planned provisions in detail, but he notes that it will extend regulation to new areas of investment business. ‘We recognised that the regime only covered managers and administrators of mutual funds as well as the funds themselves. We have been talking about regulating other areas of the investment business for a while, and trying to find the right balance in creating the new regime.
‘The new act should cover what we loosely call other investment business intermediaries. It should encompass the promotion of and dealing in investments, managing or administering investments, and providing investment advice. We plan to bring more people in the industry under the act. For example, investment advisers are currently only covered where they provide investment advice to mutual funds, and promoters and securities issuers are not necessarily covered.’
It is an open secret that the act will require most BVI funds to be audited, although there will be no requirement for a local audit sign-off, as exists in Cayman. Says Penn: ‘All retail funds must already be audited, and most professional funds, more than private funds, are in practice also audited. We don’t think it would cause difficulty to require audits for a wider range of funds.’
Robert McIntyre, head of investment funds at the BVI office of Cayman-based law firm Maples & Calder, says that in some ways the surprise was that the audit requirement was not included in the original Mutual Funds Act, and that even a provision stipulating a local sign-off might not deter business. ‘When it was introduced in Cayman around five years ago there was initial concern that it would narrow a client’s choices, but in fact the sector has gone from strength to strength. With more than 9,000 registered funds, it clearly hasn’t held them back.’
For the time being, however, the BVI has no plans to embrace the regulatory model adopted in jurisdictions such as the Channel Islands, Ireland and Luxembourg, where under new regimes for sophisticated investor funds the local regulators have delegated promoter due diligence oversight to licensed service providers in order to speed up the fund approval process.
‘This to my mind is almost equivalent to self-regulatory organisations, and we do not envision that kind of model,’ Penn says. ‘We believe people trained in regulation are best able to achieve its objectives. When you pass on to an administrator the power to license a fund, you are delegating core regulatory functions. Despite their vast experience, the private sector will have competing interests, and while the most prudent might be able to balance those interests, I don’t think it’s appropriate for the BVI.’
In addition, he argues, the fact that most BVI fund administrators are niche businesses means it is in a different position from centres where they tend to be part of global fund services businesses. ‘Because the industry in the BVI is just getting past its infancy, this may not be appropriate at this stage,’ he says.
Kieron O’Rourke, a partner and head of investment funds at Harney Westwood & Riegels, the BVI’s largest law firm, says that in addition to the requirement for an audit, the new legislation is also set to impose a requirement for all funds to have a formal offering document. ‘At the moment the legislation requires only public funds to publish a prospectus containing all the information required to make an informed investment decision,’ he says. ‘Invariably private and professional funds do have an offering document, otherwise people wouldn’t invest, but the legislation will formalise that. It will also codify various areas of FSC guidance in terms of notification of certain changes to a fund or its manager or other functionary.
‘In addition, the legislation will likely bring in some form of whistle-blowing provision. At one point the private sector was concerned that this obligation would be imposed on the registered agent or its affiliated entities, which in some cases might mean those providing legal advice to a fund. This would have placed lawyers in an impossible situation, but we don’t expect this to be the case.’ For his part, Penn says: ‘The concern about the whistle-blowing issue was based on a misunderstanding.’
Overall, the legislation will extend the degree of regulation of funds domiciled in the BVI, but O’Rourke, who has just moved to Cayman to spearhead his firm’s new office there, doesn’t believe that a slightly heavier regulatory touch will discourage many of the fund managers and promoters who are currently attracted to the jurisdiction by its flexibility, modern corporate statute, quality service providers and competitive fee structure.
‘I’m less concerned about that now than I was some years ago,’ he says. ‘The trend both in the metropolitan centres and in some offshore centres is toward more formal regulation. It’s clear there will be more rules and more reporting – for instance in Cayman there is the Fund Annual Return, a relatively new and comprehensive disclosure exercise. That is something that is likely to occur in the BVI as well.
‘But in the absence of restrictions on investment objectives and matters of that nature, or of too onerous whistle-blowing obligations that affect funds and service providers, I don’t believe that slightly stricter regulation will deter business. Centres such as the BVI have seen a major shift from start-up managers to larger, more institutional sponsors with a great deal of repeat business, who have large organisations, legal and compliance teams, and are not put off by stricter regulation and more reporting.’
McIntyre says the BVI continues to appeal to smaller managers that appreciate a relaxed regulatory regime, and a more affordable process for setting up a fund than in Cayman, Luxembourg or Dublin. However, funds that start out small can grow into major players: ‘Some managers we have had relationships with over a number of years may have started small but are now coming to us with structuring issues because fairly significant pension schemes and institutions now want to invest in their funds.’
He believes that in recent years the BVI has crossed a line and is now perceived as a top-tier fund jurisdiction by gatekeepers such as US lawyers, in a way that it was not at the beginning of the decade. ‘Several years ago the BVI crossed that divide from being lumped together with the smaller offshore jurisdictions; now people talk about it in the same breath as Bermuda and Cayman,’ he says. ‘That’s down to the efforts of the Financial Services Commission in providing an appropriate level of regulation, as well as the promotional efforts of the government and the private sector.’
Robert Briant, managing partner and head of investment funds at law firm Conyers Dill & Pearman, agrees, saying: ‘The BVI’s appeal is good-quality regulation, efficient infrastructure, good Business Companies and Insolvency legislation and competitive fees. It’s no longer perceived solely as an IBC factory, and there are sufficient anti-money-laundering controls and checks, transparency and effective exchange of information to give that business legitimacy. Initiatives like that of the OECD has created a very clear line where before there was a grey area; Liechtenstein is below that line but the BVI is clearly above it.’
The intense use of the BVI by GAM is no one-off; Briant says most of Conyers’ fund work is for top-50 US hedge fund managers, and Valerie Georges-Thomas, head of investment funds at Appleby, says her firm’s practice is also largely focused on established managers. To some extent, this reflects the fact that the jurisdiction and the alternative investment industry have matured alongside each other, according to managing partner Mark Chapman at Deloitte, the islands’ largest accounting and audit firm.
‘A lot of the funds we deal with have been going for as long as 10 years,’ he says, ‘and some of them are now billion-dollar funds. When they reach USD1bn many managers close the fund and start another one, typically with a similar strategy or maybe a different risk profile, and they become fund families. One manager that just had a single fund now runs 10 entities, and another has eight. This is happening because the managers are now more comfortable with the jurisdiction.’
Chapman says the BVI is also benefiting from the increasing pressure from tax authorities in the UK and other jurisdictions on managers of offshore funds. ‘This has made managers more aware of the need to have real mind and management outside the onshore jurisdiction. Some managers are setting up a physical presence offshore, which can be quite an investment. I’m not sure we’ll get to the point where there’s a substantial amount of trading carried out in the BVI, but people making key decisions and documentation coming out of here makes a stronger case. And you never know when these issues will blow up again.’
Peter Reichenstein, managing director of VP Bank and Trust Company and currently head of fund services at its subsidiary, ATU Fund Administrators, says: ‘The scope and depth of services that are available locally is an important factor in the competitive race, and the other one is regulatory practice and efficiency, which I think is the more important element. The quicker decisions can be reached on the regulatory side and communicated to the industry, the better. It’s not a question of lower standards but time to market, one of the major competitive advantages of one jurisdiction over another.’
