Although the Cayman Islands tends to be the default option for most alternative fund managers, there is a good argument for saying that Bermuda is equally, if not more attractive; certainly from a cost perspective and a ‘substance’ perspective, with a well-established business district in Hamilton, the island’s capital.
Indeed, an estimated 400 international companies are physically based in Bermuda, with an increasing number of fund management entities either setting up, or thinking of doing so. After all, Bermuda is only a two-hour flight to the US east coast, making it an ideal location for hedge fund managers and PE managers looking for an alternative to Cayman and the BVI.
“What a lot of people tend to overlook is that the offshore fund market, as a concept, originally started in Bermuda back in the 1980s. Cayman replicated it in the 1990s when Bermuda re-positioned itself to cater for the insurance and reinsurance market, which is now three to four times bigger than the funds industry,” says Anthony D’Silva, Director of Incu Global, a fund platform operator which uses a Segregated Account Company umbrella fund structure to host investment advisors, to enable them to launch a fund quickly and cost effectively.
D’Silva points out that after factoring in the Registrar of Companies fees and the BMA government annual fee, the cost of operating a Bermuda fund comes to just under USD3K.
“In the Cayman Islands it is a little over USD10K a year,” he says. “The other advantage that Bermuda has over other jurisdictions is audit sign-off. In Cayman, you have to use a Cayman-based auditor to sign off the fund’s audit, which adds extra operating costs to the fund. In Bermuda you can appoint an auditor anywhere. We use Deloitte (Malta) for example.
“If you compare the cost of operations, and the regulatory regime, Bermuda is a solid option. In my view, Cayman is the offshore equivalent of Luxembourg, whereas Bermuda is the offshore equivalent of Ireland.”
For the many industry professionals who have lived and worked in Bermuda for years, if not all their lives, they have seen a lot of changes to the regulatory landscape and even though its funds industry may have tailed off in years past, there appears to be a renewed focus to foster growth. This, in part, has been helped by the success of Bermuda’s ILS fund space.
“Bermuda has upped its game by improving its funds regulation and its fund products, such that what you have now is a fairly even playing field. Cayman attracts a large volume of business but Bermuda still attracts a lot of high quality managers who like its reputation,” says Dawn Griffiths, Director and Head of Bermuda Funds Practice at Conyers Dill & Pearman.
Successive governments in Bermuda have realised how important the fund industry is to this jurisdiction and accordingly have been very receptive in bringing new legislation forward to not only enhance the industry but also allow market innovation.
“The Bermuda Business Development Agency has been very active in this space and provides a concierge service to those that want to launch funds in Bermuda,” notes Nitin Aggarwal, Chairman of Beacon.
At year-end 2016, the BMA reported total assets under administration and management of nearly USD200 billion.
“I personally think this is a good time for the fund industry in Bermuda and one which will show much positive growth in the future,” adds Aggarwal.
Scott Watson-Brown is Partner and asset management leader at PwC Bermuda. Discussing the funds landscape, he remarks that regulation on closed-end vehicles has always been very good. “We’ve seen other jurisdictions take on board some of the provisions that we’ve had in place for many years, in particular around the Partnership Acts. We have, in response to demand within the funds world, enacted the LLC legislation. Whether it is corporate structures, partnerships, LLCs, it is a matter of staying current and keeping on top of the expectations of those wishing to use these structures.
“In that respect, we see continuous improvement and enhancement of legislation as relates to those structures,” explains Watson-Brown. Rather than attempt to break Cayman’s stronghold on the hedge fund industry, Bermuda’s modus operandi is to provide an alternative option to fund managers.
“If someone wants something a bit different, we can provide it. Family offices are a good example. When people visit Bermuda, they see the infrastructure, they see just how many people are on the ground across different service providers. This leads some to establish an office and staff it with a handful of people so that they have a real, physical operation as opposed to just a letterbox entity.
“Bermuda offers that level of attractiveness, where you can easily put a fully functioning family office here and attract and retain talent to operate that entity. It’s also a very attractive place to live,” says Watson-Brown.
Bermuda has a different feel to other offshore financial centres. There is, says Griffiths, more of a sense of ‘permanence’ to it.
“The Bermuda Government is talking about raising height restrictions in the Hamilton Economic Empowerment Zone to encourage further residential and mixed-use development. We therefore anticipate the financial district changing and evolving over the next few years. The Government wants new business, it wants more managers to physically locate here,” she says.
The quality of service providers is a key factor to the success of any fund jurisdiction.
Service providers like Beacon have invested in technology and implemented complete end-to-end IT solutions on a single platform to help better support fund managers as the complexity of fund products continues to develop.
Beacon’s system is a multicurrency general ledger that is fully integrated within the partnership and portfolio accounting software.
“The enhancements in our technology provide a single dependable hub for accounting data, which facilitates reconciliation and streamlines operations,” explains Graham MacDonald, Director of Operations at Beacon. “The portfolio accounting software tracks, analyses and accurately reports the value of complex investments across numerous portfolios. Built-in flexibilities organise data to efficiently account for all assets and the system is designed to meet the needs of diverse investment managers.
“Not only do our enhanced automated workflow tools streamline back-office operations to a higher level of efficiency, we also provide the best level of service due to our investment in qualified and professional talent. Our client servicing team are orientated according to each client’s needs where they can expect a personalised touch.”
Another factor is offering managers fund products that meet their needs and are appropriately regulated.
Managers that are either FCA or SEC regulated or have more than USD100 million in AUM and marketing to sophisticated investors can, for example, qualify for Class A exemption. Managers who don’t meet that threshold have the option to use a Class B Exempt Fund, in which case they must make a filing to the BMA. The regulator then has two weeks to come back to the manager with questions or to request further information. If they don’t, the manager is deemed to have approval.
“In the hedge fund space, a lot of our clients really appreciated the ability to use registered but not regulated fund products,” comments Griffiths. “With respect to closed-ended funds, they are not currently subject to regulation under the Investment Funds Act. They operate entirely outside of regulation, which is a very flexible option for private equity managers, although they are subject to AML requirements.”
There may be some consultation by the BMA with industry in the coming months on potentially bringing these funds under the IFA regime but in that case, says Griffiths, “it is anticipated that they would be able to take advantage of the same flexible approach available for open-ended funds, that is, the ability to seek classification as regulated funds or exempted funds.
“With alternative fund managers thinking about substance and establishing a nexus more to where their funds are located, which is something we’ve already seen in the ILS funds space, I think it is a trend that will continue and benefit Bermuda as a result.”
A third factor is the ability to support start-up managers who need a cost-effective, quick route to market without having to worry about heavy handed regulation or delays in getting their funds approved.
Bermuda is beginning to see more platforms emerging, to cater to this demographic. SAC structures such as Incu Global are an important feature of the landscape. D’Silva confirms that the platform has onboarded two new funds so far in 2018, with another two funds expected to launch in the next six months.
“We are very selective about the managers we choose to work with,” says D’Silva. “I try to meet the managers on the platform at least twice a year but typically it ends up being once a quarter.
“I’m not there to raise capital for any of the managers on the platform but I am willing to introduce them to potential investors, if they are performing well. If they raise additional capital, we don’t charge additional fees. It’s a partnership. We charge a basis point fee for operating on the platform – so if the fund grows in AUM, overall, then we too grow as a platform.
“There are platforms that engage in what I call ‘double dipping’ – that is, they charge a fee for being on the platform and then charge a fee for helping the manager raise capital. That’s one of my bugbears. It can lead to a break down in relationship with the manager, which we do not want.”
Corporate governance & best practices
With offshore jurisdictions coming under greater media scrutiny, helped in part by high-profile cyber attacks, regulatory authorities cannot afford to be blasé about their oversight roles. Turning a blind eye to things is anathema in the eyes of global regulators such as the SEC and political bodies in the form of the European Commission.
Bermuda has actually long been committed to transparency in relation to corporate activity, having maintained a beneficial ownership register for some 70 years. It was an early adopter of Common Reporting Standards and FATCA and has more than 40 tax information exchange agreements (TIEAs) in place as well as memoranda of understanding in place with 27 countries. It is also a Solvency II equivalent jurisdiction, having been granted equivalence back in November 2015 by the EU.
“There is a wide array of examples to demonstrate Bermuda’s commitment to global best practices,” says Ariane West, partner in the corporate and finance practice at Taylors, a full service law firm which works in exclusive association with Walkers.
“It is a long-standing and constant commitment to uphold best practices as they apply to regulation and transparency. The Bermuda Government and the BMA have always paid close attention and cared to know who is doing business in Bermuda and made it a priority to ensure that Bermuda is not a jurisdiction that would be attractive to parties who perhaps are looking to evade regulation or tax compliance in their home jurisdictions.
“That has been the standard operating procedure for Bermuda throughout its history as an international financial centre.
“Bermuda’s regulatory regime is seen as being user-friendly; for example there’s no local audit requirement, you don’t have to use a Bermuda administrator or have Bermuda-based directors sitting on the board. There is a lot of flexibility and optionality that managers can avail themselves of.”
Decades ago one might have regarded Bermuda as a bit of an outlier but the way the world has changed, other jurisdictions have been forced to play catch up.
In Bermuda, therefore, it is very much a case of business as usual to uphold the standards of regulatory compliance and transparency.
Beacon’s Aggarwal believes that with the introduction of enhanced new regulations, corporate governance standards have been strengthened over the last few years “and that companies doing business in Bermuda are much more aware of their requirements with the recognition that they must ensure appropriate mechanisms and controls are in place”.
The BMA remains committed to maintaining the international integrity of the jurisdiction and will be subject to a Mutual Evaluation by the regional body of the Financial Action Task Force (‘FATF’) in 2018. Ahead of this, it has strengthened the AML/ATF regulatory environment in Bermuda and introduced updated Proceeds of Crime (Anti-Money Laundering (AML) and Anti- Terrorist Financing (ATF)) Regulations 2008, effective January 1, 2016.
“Bermuda has a strong and robust sanctions regime, where screening needs to take place to ensure that companies know their business and aren’t unknowingly breaching sanctions,” explains Ian Mutch, Consultant, Oyster Consulting. “It is a challenge for companies to perform regular sanctions screening and client due diligence themselves because they don’t necessarily have the people or the skill set, or indeed the systems in place, to perform that ongoing monitoring. For that reason one of our most popular services is performing customer due diligence, enhanced due diligence and sanctions screening for our clients.
“Being a compliance specialist, even though we aren’t involved in the initial fund set-up with managers we have decided to put together a new start-up service proposition: we can help connect them with legal support, with accounting support while we can provide all of the ongoing regulatory and compliance support. We are seeing an uptick in interest in this new service proposition.
“We are all from Bermuda at Oyster Consulting so we have a vested interest in helping and supporting new clients who come to the island.”
For platforms like Incu Global, it is vital to have effective oversight of, and transparency on, each sub-fund investment advisor. Not only to protect end investors by ensuring that each manager is operating their investment strategy in full compliance with the PPM, but also to protect Incu’s own reputation.
D’Silva presently acts as director to nine funds. He is careful to control the number as his main priority is running the platform.
“I’m not a paper pusher. I get actively involved with the manager, giving them recommendations on best practices, how to market their fund, how to deal with due diligence, etc. I’ll offer advice on hedging strategies in their portfolio as well, on occasion.
“I have my own board of directors at Incu; one of them is a funds lawyer, one has worked for UBS and Deutsche Bank in custody and fund administration and I have an investment adviser who also offers perspectives,” says D’Silva.
Independent, split boards such as these are fast becoming the preferred option for institutional investors, particularly when investing directly with managers. Gone are the days of appointing members of the investment team, or even family members, as directors to the fund. That no longer cuts the mustard.
Unlike other jurisdictions, where jumbo directorships have been the source of media interest, Bermuda’s more modest funds universe allows people like D’Silva to train their sights on a limited number of funds.
“I have seen a lot of changes in terms of governance, compliance and AML. There are still plenty of managers who take money from small family offices, for example, who may not mind if the manager sits on the board of directors of the fund. I think where the main push (for independent directors) is coming from is from larger institutional investors including endowments and pensions who want boards of directors to be 100 per cent independent, composed of a mix of complimentary skill sets and more importantly, to protect and focus on the interest of the investors,” adds D’Silva.
Mutch says that one of the raisons d’etre at Oyster Consulting is to make things as simple as possible for clients.
“It’s compliance without the complexity,” he states. “We’re here to help and provide guidance to new start-ups right the way through to mature organisations.
“Every jurisdiction is different but Bermuda has all of the necessary regulations in place to help support organisations and ensure that they meet global standards. That is important because it means that clients, or investors, will be happy doing business with Bermuda-based entities. Bermuda recognises it needs a strong regulatory compliance framework to uphold its world-class reputation.”
ILS market evolution
Aside from regulatory and compliance developments, one area of continued evolution and growth is Bermuda’s ILS fund market, with 2017 proving to be another record year for the Bermuda Stock Exchange, in respect of ILS listings (see Q&A article with BSX in this report).
Bermuda’s ILS story is one that underscores Bermuda’s entrepreneurial and innovative spirit.
As it became evident that a shift began to occur in the manner in which the reinsurance industry sought/received capital, it was clear that an opportunity existed for Bermuda to leverage its depth of experience in the market and provide a commercial solution that met international standards.
“Bermuda’s success in this space is a testament to the hard-work and dedication of many people from many different organisations (some of which are competitors) to quickly build a solid platform upon which this asset class got traction and momentum,” comments Greg Wojciechowski, President and Chief Executive Officer of BSX.
Sherman Taylor is Associate Director at Estera, which over the years has become Bermuda’s leading administrator to ILS vehicles. He notes that the types of risk that underlie ILS products have shifted away from relating purely to catastrophe events.
“We’ve started to see more discussion about things such as cyber risk and operational risk in the ILS market; indeed, there was a CHF220 million Cat Bond deal in 2016 with operational risk featuring as the underlying risk and this year, a new ILS product has come to market where financial guarantee risks are being transferred to the capital markets. I expect to see more of these new types of ILS products emerge as the ILS market continues to develop.
“Looking at the trends in own book of business, we’ve already got a sense that 2018 will match, and very likely exceed 2017,” remarks Taylor.
At Conyers Dill, Griffiths believes that many of the changes made to Bermuda’s funds regulation in 2008 were “well overdue” and in need of an overhaul to improve things such as speed to market. She says that introducing the category of registered but not regulated fund products (Exempted Funds) was a positive development given that most ILS funds fall into that category.
In regards to fund NAV calculations for ILS funds, there any nuances that investors should be aware of compared to traditional hedge funds. ILS funds, in many cases, are investing in private transactions, which means administrators are dealing with level 3 assets in terms of valuation. As Brian Desmond, CSO and EVP Head of Fund Services at Horseshoe Group, comments: “The importance of administrator oversight when funds own hard to value assets cannot be overstated. Investors gain a lot of comfort when they know the fund they are investing substantial money in, is administrated by specialists in the valuation of those hard to value assets.
“In terms of valuation, Horseshoe are well equipped to verify that our clients’ premium earnings are consistent with their portfolio’s underlying, potentially seasonal, exposure and are also well qualified to test the assumptions our clients use in determining a loss estimate and building a buffer around that estimate for additional uncertainty.”
Another difference from traditional hedge funds relates to side pocketing. When investors in traditional hedge funds hear about side pocketing, they generally associate the concept with poor performance and some of the emergency measures that funds had to take in dealing with the market meltdown in 2008/2009. However, in the ILS market, due to the uncertainly around the magnitude of losses and a potentially protracted settlement period associated with a catastrophic event, the creation of side pockets can be a regular occurrence. The creation of the side pocket allows for continued fair and orderly subscriptions and redemptions after a significant event.
“A third area where ILS funds can be different is in their liquidity/redemption provisions,” adds Desmond. “Due to the hybrid mix of liquid and illiquid securities that ILS funds may own, ILS funds have come up with some innovative ways to deal with redemptions such as using the concept of slow pay shares. In the process, a slow pay series or class is created for the relevant investor, and the investor’s share of the in-force contracts as of the redemption date are transferred to the slow pay share class and the investor is paid funds as the portfolio contracts reach maturity.”
Blockchain in ILS market
One catalyst that could lead to further growth in Bermuda’s ILS market is the role of technology, in particular blockchain technology, as the markets focus on building as much efficiency into the process as possible. “We recognise that this is likely to be achieved by automation in some form or another,” explains Sarah Demerling, Client Director, Estera.
“The Bermuda Government is exploring ways of introducing blockchain technology into the jurisdiction in such a way that will capitalise on transactional efficiencies without sacrificing the integrity and security of the Bermuda marketplace. For example, a digital ledger could be used for record keeping and AML purposes, and to create more transparency relevant parties could easily see the entire history of an ILS instrument.
“We would certainly embrace the new technology once the proper controls and regulations are in place.”
The road ahead
As alluded to earlier, Bermuda is already an attractive jurisdiction with a blue-chip reputation. This is in part because of a well-respected regulator, a fully electronic offshore Securities Exchange, a wealth of talent and a leader on tax transparency and cooperation with the OECD, Financial Action Task Force, and G20.
Asked what further developments need to be made, Beacon’s Aggarwal opines: “We believe that with a more collaborative approach, where government and regulators work closely with fund administrators, we can achieve greater speed to market and better marketing initiatives to convince the promoters of business to offshore jurisdictions that Bermuda is, indeed, a world class jurisdiction to do business in.”
Certainly addressing some of the shortfalls, in terms of creating a product that has good speed to market for established and emerging managers, was a positive step forward for the island, in terms of giving it more credibility. The new exempted funds class requires filing with the BMA rather than having to go through an approval process.
“Covering that off, I think, met an important need for managers,” says West. In her view, one of the issues that has yet to be fully addressed is simply for Bermuda to do a better job of getting its message out to the market. Having people think of Bermuda as a viable choice and having the investor community recognise the quality of the jurisdiction.
“Overcoming the prevailing trends and what has become ‘conventional wisdom’ in terms of jurisdictional choice is probably the biggest challenge right now. I do think there’s a bit of a stumbling block in the sense that, with so much compliance and so much being asked of managers by investors in the ODD process, if they can avoid having to answer those additional questions then they will.
“But we are also confident that managers who are open to what Bermuda has to offer may find that the choice pays off. We have a real market on the ground here and we are easily accessible from major onshore financial centres of New York and London.
“Bermuda is on the right path. We continue to do the right things and my expectation is that more managers, over time, will pay closer attention to the advantages of Bermuda and the stability it can offer, as they look to establish funds,” concludes West.