The theme of digitalisation took centre stage at the annual Meet the Regulator Forum held by the BVI’s financial regulator, the Financial Services Commission (‘FSC’) this July. During the forum, Deputy Managing Director, Corporate Services of FSC, Jennifer Potter-Questelles emphasised the importance of embracing digitalisation, stating that “digitalisation is our ticket” and that as the FSC continues to innovate, so the industry is encouraged to do the same at all levels of their organisations.
As BVI Finance highlights on its website, Potter-Questelles said that integrity and sustainability of the industry are dependent on all the collective parts and more importantly on our connections to each other. “Weak links, whether large or small can have significant effect and impact. Sometimes size doesn’t matter, but strength always does. We need every connection to be strong,” she was reported to say.
Offshore jurisdictions are placing great importance on digital transformation in financial services. Not only does blockchain technology have the potential to revolutionise asset servicing (think smart contracts, AML/KYC processes, automated reconciliation and investor subscriptions), it could open up a huge array of investment opportunities as entrepreneurs seek to finance their ideas with security token offerings (STOs). Not to mention the continued evolution of crypto strategies.
Christopher Simpson is Partner, Corporate Finance at O’Neal Webster. He notes that the digital assets space continues to grow “but I have seen somewhat of a levelling off – where managers and investors now understand that not all digital assets are created equal and that some are extremely volatile and are unlikely to succeed in the long term.”
On the other hand, he says, others have found a niche and are gaining traction.
“It is still a wait and see approach generally but there is no doubt that this is the future. We have worked on a few and are currently working with clients on structure and documentation for their chosen investment vehicle. Investing in bitcoin and other well-known cryptocurrencies seems to be the leading trend,” remarks Simpson.
The BVI has really made a concerted effort to embrace the digital asset revolution.
Recent amendments to the BVI’s anti-money laundering rules now permit digital ID verification and the receipt of electronic copies of documents, so businesses are able to use a blockchain provider to double check identities.
Speaking recently to Hedgeweek, Simon Gray, Head of Business Development & Marketing, BVI Finance, said: “We have already seen a number of businesses and individuals using digital Know Your Customer service providers as a result of this change, illustrating the overall improvement of due diligence via crypto technology.
“As an aside, it is interesting to note that the BVI Government is pressing ahead with the implementation of blockchain technologies to help better prepare for future weather emergencies. Earlier this year, the BVI Government announced a partnership with blockchain company, LIFElabs.io, to provide a ‘Rapid Cash Response’ enabling people on-island to purchase goods and services with digital currencies.
“This is a great example of the spirit of the BVI demonstrating that we are always ready to embrace new technology if it can be shown to offer us improved solutions.”
A couple of years ago, there were still concerns over the quality and pedigree of crypto traders, in particular, seeking to launch new funds in the BVI (and other offshore jurisdictions). This is understandable given it is still a relatively nascent asset class.
When it came to interrogating corporate governance frameworks, it is fair to say (based on conversations with BVI service providers) that they were not well thought through; if at all. This led to service providers declining a lot of work.
“The last thing we want is to put all the work into setting up these structures, appoint independent directors, only for the approved manager to get shut down for non-compliance reasons,” comments David Payne, Director, AMS Financial Group, which provides corporate, trust and legal services to investment firms, including independent directorship services.
That’s not to say that all crypto funds are an accident waiting to happen. As with any new asset class, it is maturing, along with the calibre of those wishing to run robust funds with good corporate governance in place.
“We recently sat down with two individuals from England and had a three-hour long dialogue, by the end of which we did feel comfortable with their offering,” confirms Walter Reich, founder of Tovel Investments Ltd. “Every question we put to them on custody, valuations, etc, was met with a considered response. They had put the time in to really give us comfort and on that occasion, we proceeded to work with them. They came to the BVI in person, which we really appreciated.
“One of the principals has now decided to move down to the BVI with his family and will trade as an approved manager. We are looking forward to him bringing his knowledge to the BVI and working closely with him.”
At a wider level, the BVI’s key value proposition has always lay in its compelling combination of ease, speed and cost-effectiveness of formation, and flexibility in terms of structuring and governance, as supported by a regulatory regime which is robust but appropriate for private fundraising globally.
Traditionally, this has been especially appealing to small to mid-cap managers although in more recent times BVI has been proving increasingly attractive to larger and more established fund managers as well.
“Playing to these core strengths, we expect BVI to continue to gain market share in the near term, especially as fund formation and maintenance costs and compliance burdens continue to increase markedly in many other offshore jurisdictions,” suggests Eric Flaye, head of Conyers’ BVI funds practice in London.
Economic substance rules
To continue to build market share, like all jurisdictions it is incumbent upon the BVI to continue to update its regulatory regime to satisfy global standards such as those set out by the OECD. The BVI is rated as “largely compliant” by the OECD Global Forum and meets the standards set by the Financial Action Task Force (FATF) – the global standard setter in this area.
At the end of 2018, the BVI passed a law on economic substance, which came into effect 1st January 2019. All offshore jurisdictions had to do this to get the statute on economic substance enacted. The first draft of the BVI’s guidance notes came out on 22nd April and these were updated and released in early October. It is now called the Rules on Economic Substance in the British Virgin Islands.
The Act imposes economic substance requirements for British Virgin Islands companies and limited partnerships that are not tax “resident” in countries outside the BVI and carry on “relevant activities”.
“There are nine relevant activities but the business of being an investment fund is not one of these relevant activities,” says Simon Schilder, Partner at Ogier. “While being a fund is not a relevant activity, depending on what funds are doing, they may become in scope through virtue of their underlying investment strategy; credit strategies are one example of this, because a fund which makes available credit facilities and derives income from this could be considered to be undertaking financing and leasing business, which is a relevant activity.”
In such an instance, the fund would need to have economic substance in the BVI: by being directed and managed from the BVI, having adequate employees and premises in the BVI and undertaking core-income generating activities in the BVI.
“Potentially feeder funds which are used solely to hold shares in the master fund could also come in to scope on the basis of undertaking holding business. However, entities undertaking holding business are subject to less onerous economic substance compliance obligations, in that they are not required to be directed and managed from the BVI or undertake core-income generating activities in the BVI. If it is just passive holding, which is what a feeder fund typically does, the only obligations are to comply with the statutory obligations of the BVI Business Companies Act and having adequate employees and premises could be limited to having a registered agent (and authorised representative) in the BVI and registered office in the BVI, which is something all BVI funds have to have anyway.
“If you are a Category 3 investment business licensee, and doing fund management activities, then you will be in scope. However, if you are an approved manager, as the law currently stands, you will be out of scope,” explains Schilder.
Another regulatory development has been the BVI Business Companies Act amendments (Oct 2018) in relation to segregated portfolio companies. Under the amendments, SPCs are now permitted for use by unregulated private equity and VC funds.
Flaye explains that such structures are popular with umbrella or multi-class funds “which wish to operate multiple different investment strategies and benefit from statutory segregation of assets and liabilities as between the various investment programmes”.
Schilder confirms that in terms of fund formation work in 2019, “one of the things that typifies the work we’ve done is that sizeable amounts of new business has been for non-traditional areas of the alternative asset space; such as private debt strategies and hybrid strategies using a mix of liquid and illiquid assets in closed-ended structures.”
One of these hybrid strategies specifically sought to avail of the SPC structure.
“SPCs are used in the marketplace for a couple of reasons. Firstly, for the manager to pursue different investment strategies and risk profiles and ring fence those strategies in individual cells. And secondly, where managers are trying to design customised investment products either for specific investors or groups of investors, where everything is housed within one investment fund vehicle. It is a way to avoid having to set up multiple funds,” he says.
BVI funds in action
The BVI has a variety of fund product options that serve the purposes of all fund manager types and sizes. For smaller and emerging managers, the BVI has proven to be well in tune with their needs by offering sensible regulatory oversight without requiring them to set up BVI professional funds from day one. The two main examples of this are the approved fund and incubator fund, in addition to a lighter touch regulatory management structure; the Approved Manager regime.
The BVI incubator fund is ideal for new managers and start-ups and the pursuit of alternative investment strategies since it is not required to have functionaries or an offering memorandum. However, such funds are required to file a description of its investment strategy and give appropriate investment warnings to investors.
An incubator fund is permitted to operate for two years (with the possibility of one additional year). This period allows for the establishment of a track record without onerous regulatory obligations. Before the end of the two or three-year period (as applicable) or upon exceeding any of the specified thresholds, the fund can be converted into an approved, private, or professional fund or it may choose to wind up its operations.
The approved fund is ideal for closely connected investors and family offices. It has no minimum initial investment requirement, but it is required to appoint an administrator to provide proper oversight of its operations. Similar to the incubator fund, an offering memorandum is not required, but the fund must file a description of its investment strategy and give appropriate investment warnings to investors. Unlike the incubator fund, the approved fund can continue to operate as an approved fund for an indefinite period or be converted into a professional or private fund or wind up its operations at any time.
Approved manager regime maintains appeal
Various law firms interviewed for this report all confirmed that the vast majority of manager applications this year have been to become an approved manager. It has proven to be a real boost to the island, and shows no sign abating.
“When it was first introduced we had to steer clients away from what they knew in the past, in terms of what the new offering was. Now, clients straight away ask us how to set up as an approved manager; it is the default option clients are asking for,” says one law firm partner.
The AUM limit to be an approved manager is USD400 million for open-ended funds and USD1 billion for closed-ended funds. Start-up managers are typically the main ones using this regime, which is less onerous compared to becoming a fully licensed BVI investment manager under the Category 3 investment business regime.
“Previously, those looking to set up as an offshore investment manager chose to use Cayman to become a Cayman exempted manager. The effect of this was for a lot of people to also set up a Cayman fund alongside the manager. The reason why the FSC asked us, and other industry practitioners, to develop what is now the approved manager regime, was because the number of new investment managers was falling. The approved manager product is now a well known and trusted regulatory option, which has helped stem the flow, as we frequently see people opting again to set up both the manager entity and their funds in the BVI,” comments Schilder.
What the approved manager has over the Cayman exempted manager product is that with an exempted manager one pays a fee each year but does not have a license to wave at prospective investors. With the approved manager product, one can tell investors that you are licensed and regulated by the FSC, providing an additional layer of reassurance to investors.
Such has been the success of the approved product suite that managers beyond the US and Europe, long the traditional strongholds of hedge fund management, are showing growing interest. Payne points to Asia and Latin America as key growth markets and states that “some people are setting up approved managers even though they are using managed accounts. It’s a flexible structure and I’m glad the BVI went ahead with it.”
Simpson concurs: “The approved manager regime has been good for the jurisdiction especially since it was broadened to allow such managers to manage foreign funds.
“With the regime’s quick turn around time, clients can maximise opportunities as they arise. In general, this regime has allowed the BVI to feature in more fund structures around the world.
“Clients are attracted to the highly regarded international reputation of the BVI and so including a BVI fund manager in a fund structure adds more than just a vehicle for management of the fund.”
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