By Simon Gray – It’s an ill wind that blows nobody any good, and if anything positive has come out of the global financial crisis for Bermuda’s fund industry, it is that the jurisdiction’s longstanding focus on effective regulatory oversight is now seen more as a positive signal of concern about compliance with global standards and protection of fund investors than a tiresome impediment in the way of getting to market or a cost drag hampering performance.
Not that Bermuda’s regulatory framework for the alternative investment sector is particularly irksome – simply, participants say, that the new international focus on regulated service providers, transparency toward investors, tax compliance, robust know-your-customer due diligence and anti-money laundering provisions has not required a significant change in regulatory culture.
Bermuda’s history as an alternative fund domicile and servicing centre dates back some four decades and reflects its unique political and geographical situation poised between North America and Europe, with ties going beyond either: a UK overseas territory that uses the US dollar, with a population of some 69,000 spread over 181 islands covering less than 54 square kilometres, and located in the Atlantic just over 1,000 kilometres west of North Carolina’s Cape Hatteras.
Investment is very far from the only string to Bermuda’s bow; it is the world’s leading domicile for captive insurance and reinsurance companies and a global force in the reinsurance sector as a whole, as well as being an important centre for trust services. Its long history as a home for hedge funds and other offshore investment structures has left a legacy of specialist fund administration providers; Bank of Bermuda was a global name in financial services until its acquisition by HSBC in 2004.
“We were the first jurisdiction to domicile hedge funds, going all the way back to the 1960s,” says Cheryl Packwood, chief executive of promotional organisation Business Bermuda. “Our location is right between the world’s two major financial markets, London and New York, and we have the major fund service providers, comprising lawyers, accountants and fund administrators, including Citi and Bank of New York Mellon as well as boutique firms.”
However, industry members acknowledge that recent years have seen Bermuda lose ground as a fund centre in certain respects, especially to the Cayman Islands. Over the five years from the end of 2006 to December last year, the number of classified Bermuda investment funds has fallen from 1,302 to 872, the total number of investment portfolios (including segregated accounts) from 2,190 to 1,353, and the net assets of Bermuda funds from USD211.52bn to USD159.51bn.
On the fund services side, some of the island’s leading administrators have been subsumed within larger groups, like Bank of Bermuda within HSBC and Butterfield Fund Services within Butterfield Fulcrum. Other administrators such as Citco and Citi Hedge Fund Services have cut staff in the jurisdiction, and a number of Bermuda firms have established operations in the new fund services hub of Halifax, Nova Scotia, or in the United States.
Yet the overall picture is far from bleak. For a start, the decline in fund numbers is far from unique to Bermuda and reflects contraction throughout the global alternative fund industry, stemming largely from the worldwide financial crisis and economic downturn, and its particular impact on hedge funds. Perhaps significantly, the figures for Bermuda funds, investment portfolios and fund assets were all up in the final quarter of 2011.
It can also be argued that the factors driving alternative fund business away from offshore jurisdictions and toward onshore centres have slackened since 2009, and to some extent may have reversed. Offshore centres make a less obvious scapegoat for the financial crisis and for the fiscal problems of governments now that they have embraced regulatory co-operation and exchange of tax information.
Meanwhile fund promoters facing a blizzard of new regulation, especially in Europe, are being reminded that using an offshore domicile can avoid, for instance, funds targeted at Asian investors becoming subject to the European Union’s forthcoming supervisory regime. And industry members in Bermuda believe the jurisdiction is now better placed to capitalise on these trends than ever before.
For one thing, the crisis and its aftermath have demonstrated the robustness of the territory’s legal infrastructure, according to Alex Erskine (pictured), a partner and leader of the Bermuda funds and investment services team at law firm Appleby. “It has weathered very well the storms of the market meltdown, and the cases that emerged from the plethora of disputes regarding investor complaints about the arbitrary imposition of gates, delayed redemptions and issues affecting segregated accounts,” he says.
“The various court cases that took place enabled Bermuda to show that its legal and regulatory structure actually works, and was able to withstand the test. This has actually been a very useful marketing tool for us, demonstrating that the jurisdiction has a robust legal framework within which funds can not only be formed but operate in the most volatile of market circumstances.”
Erskine also points to a host of less tangible factors, such as easy access to major markets, especially New York and London, and the legal and constitutional ties between Bermuda and the UK. Also important are long-standing relationships with financial industry players such as capital providers and brokerage firms and the links between the Bermuda and Lloyds reinsurance markets that have been strengthened by the expansion of Lloyds businesses into Bermuda and of local reinsurers into London.
He adds: “There’s also the advantageous tax regime and the human infrastructure that has built up here in terms of knowledge and skills, but one of our most important assets is speed to market. Bermuda has always enjoyed a real advantage over other jurisdictions because when a dislocation in the market creates an investment opportunity, people don’t want to wait six months and wade through red tape to get their funds established. In Bermuda the timeframe is normally a week, and two weeks at the longest.”
Dawn Griffiths, head of the Bermuda funds practice at the territory’s other leading international law firm, Conyers Dill & Pearman, argues that while for almost a decade Cayman was more successful in attracting new fund business with keener prices and lower barriers to entry, the landscape has now shifted. “The same international pressures are coming to bear on all offshore jurisdictions, and nowhere is immune,” she says. “Rival jurisdictions have had to up their degree of regulation somewhat, and they are no longer as cheap as they used to be.
“The fact that there is now a fairly level playing field for international fund business operates to Bermuda’s advantage. Our challenge now is not only to retain our loyal clients, the large blue-chip fund players that have always been happy to be in Bermuda, but to encourage start-up managers to take another look at Bermuda and remember why it was so popular for so long.”
Griffiths – whose firm is active in both jurisdictions – says there is probably little to choose between Bermuda and Cayman in terms of regulatory set-up costs and time to market, but that Bermuda’s experience of carrying out client vetting procedures, long before money-laundering and terrorist financing became major international concerns, has helped earn its regulator the reputation of being “a safe pair of hands”.
She says: “The Bermuda Monetary Authority does enjoy the perception being particularly robust and a reputation for producing flexible and sensible regulation. For instance, corporate governance is now a hot topic, but the BMA have been vetting service providers to Bermuda funds for a long time and carrying out checks on fund directors for the past five years. Bermuda funds – indeed all companies – have always been obliged to hold an annual general meeting here and at least two board meetings, although many do more than the minimum.”
Bermuda offers a range of fund structures including companies, partnerships, unit trusts, private act structures, infrastructure funds and segregated account companies, as well as unregulated funds and closed-ended funds. The regulatory framework is based on the Investment Funds Act 2006, the Investment Business Act 2003 and the Companies Act 1981, which underwent significant amendment last year. There are four types of authorised open-ended investment fund: institutional funds, administered funds, specified jurisdiction funds (launched last December with the introduction of regulations tailored to the requirements of Japanese investors) and standard funds.
“The specified jurisdiction regime makes it possible to draw up legislation under the Investment Funds Act that will satisfy oversight in another jurisdiction,” says Craig Bridgewater, a partner in the Bermuda alternative investments and banking practice at KPMG. “The first opportunity we have identified involves Japanese funds, and the rules are designed to make managers targeting the Japanese market comfortable setting up funds here. The BMA will continue explore further opportunities and establish jurisdiction-specific legislation that satisfies their requirements.”
The changes to the Companies Act include authorising companies to have just a single director, as well as the use of corporate directors. At a time of enhanced focus on the effectiveness of corporate governance, these provisions might not seem particularly useful to fund investors, but Erskine points out that, for example, a corporate director might be appropriate to reduce costs in cases such as an SPV required within a fund structure for purely strategic purposes.
Adds Griffiths: “Under the revised Companies Act, the requirement to hold an annual general meeting can be waived under certain circumstances. That is probably not something that the average fund would seek to use. But new funds that are still in the process of establishing a track record and that don’t yet have outside investors might waive the AGM requirement in their early years. Equally, investors in funds that are in run-off may have other ways of tracking the liquidation process, and may not want to bear the cost of an AGM.”
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