By Simon Gray – Much of the alternative fund administration industry has been located in offshore financial centres since the 1990s, when the so-called ‘10 commandments’ obliged funds to carry out various functions outside the United States to avoid tax complications. While the position has since changed, and a number of onshore centres in the United States and Canada are now significant fund service hubs, jurisdictions such as Bermuda that have provided administration as well as domicile to hedge funds for several decades remain centres of excellence within the sector.
While some of the activity once carried out in Bermuda has moved to centres such as Halifax, Nova Scotia, the jurisdiction has also seen business moving in. An example is Apex Fund Services, which was established on the island in 2003. Today it is the headquarters of a network of 24 offices around the world, and the group’s founder and managing director Peter Hughes (pictured) says the jurisdiction is if anything even more competitive in the global market than it was a few years ago.
“The reason we set up our first office and our headquarters here is that Bermuda has been one of the premium jurisdictions for fund servicing for a long time,” he says. “The advantage of being the longest-established alternative fund centre is that a huge skill set and knowledge base has been built up not only among administration staff but other providers of services to funds such as bankers, lawyers and auditors.”
Today Apex has 25 staff in Bermuda, out of a worldwide total of around 270. “We started out as one of the smaller administrators here, but we have grown while some of the big names have left,” Hughes says. “That has been ideal because it has enabled us to recruit really talented staff to focus on some of the new opportunities in the asset space, such as insurance-linked securities.”
In terms of fund numbers Bermuda has slipped well behind its main rival, the Cayman Islands, over the past decade, but Hughes argues that it scores better as a fund administration centre, in part because the market for human resources is larger and more buoyant. “Pricewise Bermuda is very competitive these days, and the cost of recruiting staff is much more favourable than in alternatives such as Cayman,” he says.
“We have a small office in Cayman, but not a fund administration licence there because the minimum capital requirement is USD500,000. That does not make sense if you're only going to have three or four people there. In addition, the work permit fee is USD2,000 a year in Bermuda, compared with USD21,000 a year in Cayman. That gives it a huge competitive advantage because margins are tight in the administration sector. In addition, Bermuda’s talent pool means you can recruit very experienced staff cost-effectively.”
It’s a theme that Business Bermuda’s Cheryl Packwood is keen to stress, arguing that the idea Bermuda is a high-cost place to do business is simply untrue. “We are very cost-effective, and in fact not as expensive as certain other jurisdictions,” she says. “Government fees for funds are competitive, at a time when other jurisdictions have had to increase their fees in order to raise revenue and finance the enforcement of new regulations. That we are expensive is a myth that needs to be dispelled.”
Packwood says the growth of the financial sector over many decades has created clusters of expertise in areas such as fund services and, especially, reinsurance. “We have the intellectual capital, the talent and the skill sets in Bermuda, which is one of our major strength because these are critical issues for offshore jurisdictions,” she says. “We are the no. 1 reinsurance market in the world ahead of Lloyds, around which you have the expertise of lawyers and accountants, and that spills over into the hedge funds and investment sector.”
Business Bermuda’s efforts to promote the growth of the fund industry include outreach to expanding markets, especially China, other parts of Asia and Latin America, as well as the development of specialist areas such as Islamic investment. “We have been doing a lot of promotional and marketing work in the Middle East, and some of our law firms and fund administrators have offices in Bahrain or Dubai,” Packwood says. “That has been a strong area of the world for us for decades.
The organisation has also been targeting other markets such as southern Africa. “We were in Cape Town in November, and we met with the director of South Africa's National Treasury, because they were looking at issuing a sukuk,” she says. “We were also talking to people there who are already doing business with Bermuda. It might not be an obvious traditional market, but we have had corporate and individual clients in countries such as South Africa, Kenya and Uganda for decades, while Orbis, a big South African asset management firm, has been in Bermuda for some time.”
Hughes believes that regulatory changes elsewhere in the world, especially the European Union’s Alternative Investment Fund Managers Directive, could drive more business to centres such as Bermuda. “It will be very interesting to see what happens in the next two or three years,” he says.
“Some people see the AIFM Directive as a threat to offshore domiciles, but I think it's a real opportunity. It will become increasingly expensive to do business in the onshore European jurisdictions, because of the regulatory and compliance burden, which for a small or medium-sized fund manager could be a significant drag on performance. Fund managers that are not necessarily marketing into Europe may be looking for alternative domiciles.”
In the meantime, the island’s authorities are seeking to ensure that funds domiciled there will be able to benefit from the ‘passporting’ regime for non-EU funds that is scheduled to come into effect from 2015. “Bermuda is working hard to make sure that it will be able to take advantage of the passport regime in due course,” says Dawn Griffiths of Conyers Dill & Pearman. “The government is very committed to ensuring that the required tax information exchange agreements are in place, and it has now signed more than 30.”
While Griffiths does not anticipate any major problems in meeting the eligibility criteria according to the current state of the EU legislation and its implementing measures, she acknowledges that the European market is not the only focus for the fund managers that use Bermuda – and other regions may grow in importance if the continent’s investment sector remains depressed by its lacklustre economic growth. “We do have some domestic groups for which Europe is their traditional market, but it’s not a huge growth area at the moment,” she says.
Most financial services professionals in the jurisdiction believes that Bermuda will not face significant problems meeting whatever requirements the EU imposes, but it will be down to managers to decide whether the European market is worth the trouble. Compliance with the AIFM Directive “will involve more time and more cost,” says one industry member. “It will force people either to commit to marketing in Europe or to ignore it entirely.”
KPMG’s Craig Bridgewater says: “That extra regulatory burden makes Bermuda more attractive. If a manager is not necessarily looking to market to European investors, they have an opportunity to bifurcate their products. They can offer the EU market a product that is compliant with the directive, with all the compliance costs involved, but outside the EU they can offer a fund that may not require that level of oversight and cost. Bermuda allows managers to create customised products according to where their investors are based.”
Jason McAlpine, a partner in the financial services office of Ernst & Young in Bermuda, also sees potential for Bermuda to make progress toward its longstanding ambition of building up its fledgling on-island asset management base. “We have a number of asset managers operating in Bermuda,” he says. “Others, from the UK and elsewhere, continue to be attracted by our regulatory environment, proximity to the US, on-the-ground talent and tax neutrality.
“The industry has put together a task force to look at what competitive advantages Bermuda can offer and what asset managers are looking for in an offshore jurisdiction. From a strategic and business development standpoint, that is where Bermuda is putting its focus. We are interested in asset managers with a headcount of between 15 and 25 that are looking for the flexibility to market their skills globally to their best advantage.”
Attracting fund managers to bring all or part of their business to the jurisdiction is a key focus for promotional activities. “This is a great opportunity,” Hughes says. “A lot of asset managers are put off by the high taxes in Europe or in the US. Some managers have moved from the UK to Switzerland, but tax is not insignificant even there. From a quality of life perspective and from a tax viewpoint, Bermuda is a very good place to be based, especially if your business is focused on South America or the US.”
The government has introduced various measures designed to make Bermuda more appealing to managers tempted to establish a physical presence. “Requirements have been eased for managers that can be classified as job-creators, exempting them from work permits and offering them the opportunity to obtain permanent residency more quickly,” Griffiths says. “A few managers have already made use of the new legislation to set up offices here and recruit staff.”
She adds that the development of the insurance-linked security sector is also a spur. “Because there is such a huge market here, management firms want senior executives on the ground,” she says. “One firm that has long had an extensive suite of funds domiciled in Bermuda is now looking to relocate. Due diligence teams have been coming to look at the infrastructure, assess living conditions for their staff, and examine the work permit situation. One team had five work permits approved in a matter of days, which is a very quick turnaround.”
Appleby’s Alex Erskine believes that while Bermuda has opportunities to develop both its fund administration and fund management sectors, it needs to do more to boost the choice of available custodians. “The area in which we probably don't have sufficient traction is custody, the inevitable result of having a very limited number of banks on the island,” he says.
“The Bermuda government should look at this area again, because if a jurisdiction is looking to exert effective oversight over the fund sector and minimise risk, the closer the assets are, the better. I would advocate examining whether we could introduce a robust and aggressive custody service provider without them having to be part of the mainstream banking sector. This would provide Bermuda with an additional string to its bow.”
Interest in insurance-linked assets has grown because of their lack of correlation with other hedge fund strategies and with traditional investments, as well as the potential for high returns at a time when performance has been subdued across the industry. “There is a combination of managers looking for alpha, because it’s harder to find, and looking for diversification,” McAlpine says.
“This strategy offers managers both, because if properly structured, performance can be almost entirely uncorrelated with traditional markets. With double-digit returns, it becomes a very attractive prospect. And Bermuda is the jurisdiction of choice in this market because of its reputation and a long track record in both investment funds and global reinsurance. That is something that few if any other jurisdictions can boast.”
Erskine says: “In order to develop the fund sector, we will need to leverage our expertise in the insurance industry, and perhaps also look at how we use the listing facility of the Bermuda Stock Exchange to encourage the establishment of funds that require listed status. We could also possibly examine whether Bermuda could in the future play some role in clearing.
“Bermuda’s future lies in developing innovative products, and providing New York-based asset manager with short-haul access to the facilities required to establish a real offshore presence. To put it in very simple terms, Bermuda could become for the US what the Channel Islands are for London. Because of its geographic proximity to the US, and particularly New York-based asset managers, that is a major strength we have the potential to develop.
Erskine adds: “Bermuda will have to box clever. It will not be a simple numbers game, and certainly any fund lawyer will tell you that formation is not necessarily high-end work, because it is very commoditised. What is crucial is to develop our own specialist niches in the fund space, as is already happening in the insurance-linked securities market.”