On the face of it, the past couple of years have not been kind to the British Virgin Islands and its role as a domicile and service centre for hedge funds. The alternative fund industry has had a rough ride, with losses averaging around 20 per cent in 2008 (although much of that was recouped last year), accompanied by large-scale redemption of capital by investors.
In recent months, the drama of the Bernard Madoff scandal, which cost investors as much as USD65bn in assets that turned out to be imaginary, has been played out in courtrooms in the BVI, where two of the biggest feeder funds to Madoff’s bogus investment management business, Fairfield Sentry and Kingate, were domiciled.
The island’s corporate establishment, domicile and management business, which leads the world with 433,164 companies at the end of September 2009, according to the BVI Financial Services Commission, the industry regulator, have also had a rough couple of years, according to local law firms. The number of new incorporations of BVI Business Companies has fallen off sharply, from 77,022 in 2007 to 35,546 in the first three quarters of 2009, although the total number of active companies did rise by 3,130 over the 18 months to the end of September. The corporate sector, too, has seen plenty of litigation, notably regarding loan defaults by BVI companies.
All this has taken place against a backdrop of external pressure as the leaders of onshore jurisdictions, both unilaterally and within international forums such as the G20 group of leading economic powers and the Paris-based “rich countries’ club”, the Organization for Economic Co-operation and Development, have sought to finger offshore jurisdictions such as the BVI as scapegoats for the financial crisis and ensuing economic downturn.
In North America, Europe and other parts of the world the authorities are preparing legislation that could well have a significant impact upon international financial centres such as the BVI, including the European Union’s Directive on Alternative Investment Fund Managers and proposed legislation in the US that would impose new regulations on hedge fund managers as well as curbing what politicians view as unfair tax advantages enjoyed by offshore entities.
The islands’ fund services industry also took an appreciable blow last year with the decision by the BVI’s largest fund administrator, Fortis, to close down its operation. The arrival of Fortis in early 2005 through the acquisition of existing firm Hedge Fund Services had given the sector an important boost to its international profile, and there were hopes that other leading administrators might follow suit.
However, there’s certainly evidence that the decision was at least influenced by the internal problems within the Fortis group, which had to be rescued by European governments in 2008 and which has seen many of its businesses sold off. And other service providers such as Folio Administrators, International Financial Administration (Ifina, which uses an operational base in the UK) and Conifer Fund Services, while not necessarily in the same league as a global administration giant like Fortis, are continuing to grow steadily and to reassure managers that having their funds serviced in the BVI is a viable option.
There remains hope that as the market continues to recover, other major administrators will see the benefit of an on-the-ground presence in the BVI. And overall the mood in the jurisdiction is far from despondent, and with reason, even though the threat of unfriendly legislation in onshore markets still hangs over the jurisdiction. The EU directive, for example, continues to undergo repeated redrafting as member states argue over a wide range of issues, including how the legislation would treat non-European managers and funds.
However, the BVI was quick to conclude more than a sufficient number of tax information exchange agreements and more, qualifying last August for the ‘white list’ of countries and territories that have not only signed up to but substantially implemented the international standards on tax transparency and information-sharing promulgated by the OECD.
At a time of sustained international pressure for increased efforts to combat criminal use of the financial system, the BVI government has pushed through new legislation bringing anti-money laundering measures up to date and, most importantly, it is on the point of bringing into law the new Securities and Investment Business Act, a long-awaited piece of legislation that will, among other things, replace the 14-year-old Mutual Funds Act.
SIBA, as it is familiarly known, will not bring revolutionary change to the way the fund industry operates in the BVI. However, by embodying in formal law many of the existing practices informally required of fund operators and service providers by the commission, the legislation will bring certainty to fund managers and reassurance to investors that the BVI will not lag behind other jurisdictions in the quality and thoroughness of its regulation.
And despite the body blows taken by the hedge fund industry over the past two years, local practitioners say that the impact of the crisis on the BVI has not been as severe as in other leading hedge fund centres such as Caribbean rival the Cayman Islands. This might reflect to some degree the jurisdiction’s tilt toward North America rather than Europe, as well as its particular appeal to small and start-up managers.
Law firms say the number of liquidations of BVI funds and the volume of fund-related lawsuits passing through the courts were probably lower than might have been expected, given the extent of the problems experienced by investors in redeeming their capital from funds grappling with assets that had suddenly become illiquid. In practice, the lawyers say, investors and managers have worked out arrangements that for the most part have kept the managers in business and returned to investors as much of their capital as could be liquidated at an acceptable price.
"Most managers sought to try to return capital to exiting investors as quickly as possible without resorting to fire-selling assets,” says Richard May, a partner and BVI head of funds with law firm Walkers. “We also saw quite a few voluntary liquidations where funds wound down their businesses, returned cash and/or assets to investors and carried out the formal liquidation afterwards. There was a surprisingly small number of those in the market as a whole and most of our clients seem to have got through the crisis quite successfully.”
And now, especially since the last quarter of 2009, law firms and fund administrators are starting to see an uptick in new business – by no means a flood, but evidence that investors are starting to return to the market and that managers with plans for new launches are starting to set up BVI structures even if they have not yet got all the hoped-for capital in place.
“In the fourth quarter of 2009 we saw quite a shift toward new activity and a change of mood among the clientele – they’re more optimistic, which keeps new projects coming,” says Mara Alido Spencer, managing director of administration firm Ace Fund Services, which was launched in 2007 and is now geared to expand beyond the established business base of its parent, the Patton Group. “We’re positive about what we see not just in terms of the market and the interest we’re seeing from potential clients but also about the new legislation and its impact on the BVI.”
All these developments have imbued members of the hedge fund industry in the BVI with an upbeat mood at the beginning of 2010, on the back of last year’s solid investment performance and recognition on the part of especially institutional investors that hedge funds are still an important means of beefing up returns in a continuing low interest rate environment.
Overall, the jurisdiction has emerged from the crisis, if not unscathed, at least without substantial damage, and it should not fear the ongoing debate about tax and transparency, according to industry members such as Ifina’s Derek Adler. “The BVI is ticking over at the moment, but it will recover,” he says. “There is some concern about the finger-pointing regarding tax and trusts, but funds is a legitimate business and is well regulated. After all the chest-beating, things will calm down, as they always do, and life will go on.”
That’s not to say that no lessons have been learned from the crisis. For a start, the industry in the BVI and elsewhere is re-examining investor liquidity requirements, which in the case of some funds were tested to destruction in 2008 and 2009. “There has been a shift in the mentality of people setting up funds and there’s an understanding that in some cases there needs to be greater transparency,” says Rob McIntyre, head of investment funds at law firm Maples and Calder.
“There needs to be very clear mechanisms in terms of liquidity. Some of the standard boilerplate provisions that served well enough in past years have had to be revisited for new fund structures because of what’s happened in the past 12 months in order to match liquidity of the assets with appropriate redemption rights. Potential investors are analysing liquidity terms a lot more closely, and the appetite for lock-ups on new funds has diminished.”
He notes that the BVI continues to benefit from its long-standing competitiveness on costs, which is also an important area of focus in the post-crisis environment. He says: “Some managers are looking at costs more closely now than they were 12 or 18 months ago, and the BVI stands in very good stead.”
McIntyre adds: “It’s also positive that the regulatory regime in the BVI has continued to develop – in keeping with the expectations of the market, which now wants to see a certain degree of regulation. It’s fair to say that regulation as it has been up to now in the BVI and Cayman was acceptable, but is constantly under review to ensure the product meets investors’ expectations. The Securities and Investment Business legislation will extend the regulatory regime to some extent as well as clarify what’s already existing practice for most funds.”