By Matthew Ebbs Brewer, Sally Penrose & Alexis Haynes, Appleby Global – As interest continues to be shown to the growing digital asset industry, attention is being given to the concept of tokenising investments in mutual funds. In 2018, Bermuda implemented a specific legislative regime to regulate activities involving digital assets and has well-established investment funds legislation. This article considers how these two frameworks can work together so that those looking to launch regulated fund products involving digital assets are able to do so from Bermuda.
Initial Coin Offerings (ICOs)
ICOs made from Bermuda are regulated under the Companies Act 1981 (CA) and the Limited Liabilities Act 2016 (LLC Act, together with the CA, ICO Legislation). The ICO Legislation became operative on 9 July 2018 and strikes a balance between market integrity and consumer protection. From a broad prospective, the ICO legislation, in many ways, mirrors the requirements established for an IPO of shares in Bermuda, including the fact that it only seeks to regulate offerings extended to the general public. The ICO Legislation therefore regulates persons who are interested in creating, promoting, investing in and using ICOs and digital assets as well as those seeking to raise capital through initial coin offerings; it does not regulate persons or companies who are concerned solely with private sales or whose ordinary business involves the acquisition, disposal or holding of digital assets.
Under the ICO legislation, an ICO requires consent from the Minister of Finance (Minister). Accordingly, only companies registered under the CA and LLC Act which have such ministerial consent are permitted to issue ICOs in or from within Bermuda.
After a company obtains consent, it must publish an ICO offer document in electronic form that complies with the ICO Legislation and, in many cases, file a copy with Bermuda’s Registrar of Companies.
Once the ICO is launched, the company must maintain and provide an electronic facility such that relevant parties to the ICO have an opportunity to assess and enquire more about the ICO. A statutory “cooling off” period also applies.
Tokenised funds
Tokenised funds in Bermuda are funds where the investor’s interest is represented by a cryptographic token, as opposed to shares or other interests or units offered to investors in a more traditional fund structure. A tokenised fund can be a completely separate investment vehicle or it may constitute an ICO, in which case the ICO Legislation requirements must be complied with in addition to that which follows.
The Investment Funds Act 2006 (IFA) governs the exclusion, exemption and authorisation of investment funds (including tokenised funds) and contains certain requirements for the formation of investment funds, their operation and the offering of shares, units or interests of investment funds. Investment funds are prohibited from being operated in or from Bermuda unless they are authorised or exempted under the IFA.
For a fund to be within scope of the IFA and therefore regulated in Bermuda the arrangement must be such that (i) the persons who are to participate (Participants) do not have day-to-day control over the management of the property (whether or not they have the right to be consulted or to give directions); (ii) the Participants are entitled to have their units redeemed in accordance with the fund’s constitution and prospectus at a price determined in accordance with such constitution and prospectus; and (iii) must have one or both of the following characteristics: (a) the contributions of the Participants and the profits or income out of which payments are to be made to them are pooled; (b) the property is managed as a whole by or on behalf of the operator of the fund. Since a ‘unit’ means the rights or interests (however described) of the Participants in a fund, this is how “tokens” issued by a fund have the potential to be regulated under the IFA.
In practice, whether a tokenised fund would be regulated in Bermuda, is likely to turn upon whether the tokens are redeemable at the option of the Participant. This is usually informally expressed as whether a fund is “open ended” (where such tokens are) or “closed ended” (where such tokens are not).
Under the IFA, investment funds are divided into authorised funds, professional funds and private funds. Authorised funds must apply to the Bermuda Monetary Authority (BMA) to be authorised and operate in Bermuda and must satisfy various statutory requirements depending upon their classification. Professional funds and private funds are regulated with a lighter touch and may be particularly well suited to more experienced and sophisticated investors.
Whether a company launches an ICO or operates a Tokenised Funds, the company must in also consider whether it or an affiliate will be carrying on digital asset business. For example, in the context of a fund, this could be the fund itself or a related entity serving as its investment manager. After such analysis, it may be that a licence is also required under the Digital Asset Business Act 2018 to carry on such activities.
Regulatory considerations
When considering launching a tokenised fund, care must be taken to ensure compliance with any resulting regulatory obligations. Bermuda’s AML/ATF regime prioritises regulatory certainty, investor confidence and compliance with international standards for Know Your Customer (KYC) and anti-money laundering/anti-terrorist financing (AML/ATF) regulations. Companies conducting an ICO are required to establish procedures to comply with the Bermuda AML/ATF requirements. Key components of an AML/ATF programme include conducting a business risk assessment, implementing customer due diligence (CDD) measures corresponding to the customer’s risk rating, employee training and reporting suspicious activities.
In order to comply with Bermuda’s AML/ATF legal framework, any tokenised fund is required to adopt and maintain a robust and compliant AML/ATF programme, and to provide reliable evidence to verify their participants source of funds in addition to CDD on its participants. Subject to certain conditions, the fund may delegate its AML/ATF procedures (including obtaining CDD) to its administrator (or other appropriate service provider). However, the fund retains ultimate responsibility for ensuring that AML/ATF procedures and law are being adhered to.
