Bermuda is the latest jurisdiction to update its regulation in response to the rising prominence of blockchain technology innovation and Initial Coin Offerings.
The Companies and Limited Liability Company (Initial Coin Offering) Amendment Act, 2018 (the “ICO Act”), came into force on 9th July last year, providing a framework for the regulation of ICOs in Bermuda. The ICO Act regulates offerings of ‘digital assets’, a term that applies to all categories of digital coins and tokens (whether they be utility, securitised, equity or otherwise) being issued as ICOs and via token sales.
Other jurisdictions, including the Cayman Islands, have taken steps to introduce sensible ICO regulation to attract entrepreneurs while providing a framework to regulate ICO activity; something that is likely to continue to grow as an alternative financing model to traditional capital markets.
The purpose of the ICO Act is to only regulate those ICOs and token sales which are public crowdfunding or similar type projects. According to Conyers Dill & Pearman, it does not regulate either private sales or those which are engaged in the business of pure virtual currency issuances. Such businesses, as well as those operating digital asset exchanges, e-wallets and similar structures, will be regulated by the Digital Asset Business Act 2018, which has also passed into law on the territory.
“The ICO Act is modelled on our Investment Companies Act and our Insurance Companies Act,” comments a spokesperson for the Bermuda Business Development Agency.
“They are very robust pieces of legislation and set a high standard on which to base the ICO Act. ICOs are a restricted business activity under the legislation so they require the consent of the Ministry of Finance before they are licensed to conduct business. Certain requirements have to be met that are of an institutional standard before one can launch an ICO – i.e. an annual audit, investor protection language, which needs to be incorporated into marketing materials. All of the features of that legislation, in my view, set a strong framework for attracting further ICO business.”
As Appleby Global explains, digital assets, as defined by DABA, means anything that exists in binary format and comes with the right to use it and includes a digital representation of value that:
• Is used as a medium of exchange, unit of account, or store of value and is not legal tender;
• Is intended to represent assets such as debt or equity in the promoter;
• Is otherwise intended to represent any assets or rights associated with such assets; or
• Is intended to provide access to an application or service or product by means of a distributed ledger technology.
Under DABA, there are two different licenses one can apply for. These are:
• Class F licence, under which the applicant shall be licensed to provide any or all of the digital asset business activities; or
• Class M licence, under which the applicant shall be licensed to provide any or all of the digital asset business activities for a defined period determined by the BMA which may be extended upon application to the BMA.
“A lot of thought and consultation went into the DABA and ICO bills last year, with international consulting partners involved in the process,” continues the BDA spokesperson. “We aren’t, however, focusing intently on digital assets to the exclusion of other industry sectors such as insurance/reinsurance, asset management and trust and private banking; technology will change how all of these sectors do business and we want to demonstrate that Bermuda is adapting in each of those sectors.”
Greg Wojciechowski is the President and Chief Executive Officer, Bermuda Stock Exchange. He notes that Bermuda has embarked on providing “a solid, certain and regulated platform for fintech businesses”.
“As always, Bermuda has approached this is in a thoughtful and cautious way by codifying through legislation and regulation those companies in the fintech space that can licence and operate here. Bermuda was a leader in promulgating ICO and digital asset exchange legislation and the global interest in using the Bermuda platform has been substantial.
“At the BSX, we understand that this is an evolving space that does have intersection points with the traditional capital market/exchange infrastructure providers, thus BSX participation will be predicated on our ability to add value to the ecosystem while ensuring user protection and security.”
The Bermuda Premier, David Burt, is especially excited by the opportunities that the digital asset revolution could bring to the jurisdiction, which has for decades embraced innovation in its insurance/reinsurance market; becoming the world’s leading centre for such activities in the process.
At a recent event hosted by the BDA in London, entitled “Innovation Island: Why Industry Pioneers Choose Bermuda,” Premier Burt remarked: “You can find accelerators and incubators anywhere in the world, from London to New York to Singapore, but there’s only one place where the entire place is itself an innovation hub— and that is Bermuda. Innovation is inside the collective DNA of all Bermudians.
“If you’re looking for a jurisdiction with a forward-thinking government that welcomes entrepreneurs and you have an idea you’d like to demonstrate on a country-wide scale, then Bermuda can make your ideas reality.”
Back at the BDA, its spokesperson explains that the Government’s vision is to develop a financial technology industry with global reach, “just as our insurance and reinsurance industries have today”.
“That’s the long-term vision,” they remark. “The main priority of 2018 was to get the legal and regulatory foundation in place for digital asset businesses. The Digital Asset Business Act was a centrepiece of legislation passed into law last August.
“We have a bedrock on which fintech companies using blockchain or other DLT can set up businesses in Bermuda. There are other accompanying pieces of legislation such as the ICO Act, and also fintech banking legislation, which involved an amendment to our existing Banking Deposit Companies Act.
“All in all, this has helped create an environment that should be welcoming to digital asset businesses and service providers. We see fintech bleeding into InsurTech, as well as Regtech for traditional and alternative fund management activities.”
The potential of digital technology is still in its infancy. It started to be made manifest in the insurance industry a couple of years ago with smart contracts and other blockchain-enabled solutions. In the asset management space, it is now being seen in the tokenised offering of funds, where investors are offered blocks of a digitised fund structure, as opposed to traditional shares. This digital shift is now requiring different types of accounting services and other back-office related services.
For administrators and other service providers in Bermuda, these are exciting times to partner with fintech start-ups and explore new ways to service its insurance and fund management sectors.
There are now upwards of 60 fintech companies that have registered and been incorporated in Bermuda (at the time of writing). One example in the insurance space is a company called Envelop Risk, which underwrites cyber risk and other difficult to quantify risks using an underlying DLT.
In the asset management space, one of the first movers in the digital asset management space was a company called Alpha Innovation; an asset manager that offers a series of tokenised funds to investors. Their affiliate, Laureate Digital Securities offers that tokenised service on a third party basis to other fund managers.
Then there are broader technology solution companies like Uulala, that has a blockchain-enabled solution to do micro lending and financing; essentially to help bank the unbankable (people in developing countries without bank accounts) and empower them, financially.
The company raised money through a token sale and had the ICO approved by the BMA last year; making it the first ICO to be approved under Bermuda’s new ICO legislation.
Sherman Taylor is Associate Director, Estera, one of Bermuda’s leading independent providers of corporate, fiduciary, fund administration and trust services. He feels that Bermuda has taken an holistic approach to how it oversees the fintech industry. “Everything has been well thought out,” he says. “The proper amount of consideration has been given, in terms of how to best regulate this fledgling asset class and protect investors. Amendments to the Banking Act definitely are a part of that wider, considered approach taken by the Bermuda Monetary Authority.”
When asked what more he feels needs to be done to make Bermuda an even more attractive jurisdiction, Taylor says it just needs to stay the course. “It is already on a good path to attracting more fund managers and global investors. We’ve seen that growth and development in Bermuda’s ILS industry. We need to keep telling the story of how we have a gold standard when it comes to regulation and tax transparency, we have a pragmatic regulator, and over time that should lead to Bermuda’s continued growth across the board.”
With the two pieces of regulation now enacted to support all things fintech, Bermuda is aiming to position itself as a global leader and is very much ‘open for business’ in that regard. But there is also another piece of legislation, the Economic Substance Act 2018, which came into effect from 1 January, 2019, which could have some impact on how the island attracts talent.
According to James Dockeray, Tax Partner, Deloitte, “the fintech companies we’ve spoken to have always expressed an interest in being here, and while they have to consider economic substance, the reality is their business model aligns with it anyway.”
He adds: “When you have the C-suites of global publicly-listed insurance companies living here, it changes the conversation considerably. The service providers here have to be on their toes at all times; it raises the bar for everybody. Looking ahead, I think Bermuda will apply the public company standard to the fintech industry. We are unique in that no other offshore jurisdictions have an equivalent highly regulated insurance sector that Bermuda has leveraged over the years.”
Bermuda’s insurance sector and ILS sector have blossomed over the years, giving the island a solid footing on which to attract digital asset businesses.
James Ferris, Advisory, Director, PwC Bermuda, says that more fintech companies are setting up on the island and that he expects that to continue, given Bermuda’s business environment for facilitating start-up entities.
Interestingly, he believes that there could be more activity among entrepreneurs launching stablecoins, rather than ICOs, whose numbers have fallen in lockstep with falling cryptocurrency prices, led by Bitcoin.
Stablecoins – such as centralised IOU stablecoins, which are the most straightforward type of stablecoin – are backed with fiat currency or precious metals, meaning the tokens have an intrinsic value.
“It come down to trust,” says Ferris. “If people want to use cryptocurrencies as a means of exchange, they are using physical assets on which the stablecoin they issue is based. That means investors know that something they are told is worth X dollars is backed by an asset that is worth XY dollars.
“In Bermuda you can build that trust very easily by having a tight knit ecosystem where people start to transact, build trust in that ecosystem and then think about rolling out the digital solution more globally.
“I think going forward, we will see more stablecoins being launched. If you’re interested in creating a product that works in financial services and is regulated appropriately, Bermuda is a great place to be.”
At Walkers, they are already seeing a lot of interest in the DABA regulation and working on numerous client applications for a business license. According to Sarah Demerling, a Partner in the Corporate, Finance & Funds Group at Walkers Bermuda, the certainty of the regulation and the fact the Premier David Burt is supportive, “will help attract more fintech business to the island.
“Also, the ILS market is very innovative and embraces technology. If you look at the underlying risk modelling used, and the underwriting tools used in ILS, this could be further enhanced by the fintech wave, and could help make the sector more nimble. I think the two go hand in hand and I expect we will see more innovation coming through, as a result.”
Scott Watson-Brown, Partner and asset management leader at PwC Bermuda, believes that entrepreneurs who do decide to come to Bermuda could help give credibility to their business ideas and leverage what is a well-established financial centre to do proofs of concept and properly test their ideas.
“Our role is to make sure we support and promote the territory and work with entities who want to develop their business here, and provide advice and assurances to both them and their shareholders,” says Watson-Brown.
He adds that PwC’s access to network expertise in key markets including the US, UK, Hong Kong and Switzerland “allows us to bring a global perspective to the advice we provide to clients in the Fintech space”.
Going back to the economic substance point referred to earlier, says that Bermuda has taken steps to further bolster its AML/KYC oversight requirements.
“We’ve always required some manner of local presence with respect to fund management, whether it be local directors or corporate service providers and I think those have held us in good stead; we will continue to push that high standard as it relates to AML/KYC and the Economic Substance Act.
“We are seeing signs of more service providers coming here. One law firm arrived last year and they have already surpassed where they thought they would be, in terms of employee numbers. The talent coming to Bermuda, alongside the talent that was already here, is further helping to set us apart. When people talk about economic substance, we already have the basic standards in place. To step and meet those new standards is a very easy step for us to take, compared to perhaps some of the other offshore jurisdictions,” comments the BDA spokesperson.
Putting the ESA in place was a process that involved the BMA as well as the Ministry of Finance and will be overseen primarily by a Registrar of Companies.
Alongside the growth of fintech, Bermuda continues to develop its insurance-linked securities (ILS) marketplace; one that has become a key part of Bermuda’s success story.
International debt listings grew to 201 securities in 2018; up 20 per cent from 167 the previous year with their nominal value growing USD4.6 billion to USD7.0 billion.
The BSX also supported and listed the Government of Bermuda’s new USD620 million issue of Senior Notes.
New ILS listings totalled 125 securities for the year with a nominal value of USD11.23 billion. This represents growth of 20 per cent in terms of the number of new securities listed in the year. At the year end, the total number of ILS securities listed stood at 302 securities with a total nominal value of USD30.92 billion.
The BSX also listed 31 new collective investment vehicles, one new equity and seven new derivatives.
The next few years could also see an interesting confluence of activity as ILS managers and fintech entrepreneurs converge on the island to develop new products and market solutions.
Bermuda has long been a home of innovation for the global insurance/reinsurance market and is also the jurisdiction of choice for a large number of ILS managers. With the expectation that Bermuda joins the whitelist of tax-compliant jurisdictions and the Economic Substance Act taking effect it is predicted that, with those increased economic substance requirements in place, a wider pool of talent will set up offices in Bermuda even if fund activities, by definition, will not require FCA or SEC-authorised fund managers to physically locate to Bermuda.
“We have a number of ILS managers physically located and operating here on the island. Nephila Capital is the largest with approximately USD11.5 billion in AUM and there are a number of others with USD5 billion or more in AUM,” explains Demerling.
“We would like to see more intellectual capital and other ILS managers come here, which will be beneficial both for the island and for those wanting to operate in the ILS space.
“Growing the pie in traditional and alternative re/insurance is the key priority. We don’t want to favour one model or asset class over another or see risk-cannabalising in the industry; we would like to see growth across all areas.”
Commenting on international debt listings, Estera’s Taylor that this is becoming increasingly popular and “speaks to the confidence that the global financial community has for the BSX”.
“We worked on the Baltic PCC Limited cat bond, the first ever terrorism-risk related ILS, which was listed on the BSX by Pool Re in the UK and which provides reinsurance coverage for Pool Re in the UK.
“In the ILS sector, we are seeing a slightly slower start than usual in 2019 but we nevertheless think this is going to be another growth year for the sector,” comments Taylor.
He believes there are various reasons to explain continued investor interest but cites a maturing of the asset class as one of the key drivers.
“As time goes by, ILS is becoming more and more of a trusted asset class,” opines Taylor. “Some of the inherent concerns that investors may have had years ago are starting to disappear. There is a discussion as to whether ILS should even still be considered an ‘alternative’ asset or whether it should be viewed as more mainstream. That is a big driver behind continued investor interest.
“The Baltic PCC vehicle was the first time a cat bond has taken on terrorism-related risk, and yet the market reacted very positively to it.”
As service providers on the island gear themselves to further support fund managers with next generation technology solutions, either developed in-house or externally with fintech groups, one other area of growth is the rise in popularity of ‘hybrid funds’, as both private equity and hedge fund managers converge to meet institutional investor demand for long-term investment strategies.
Global private equity inflows have reached nearly USD1 trillion over the past couple of years. Such has been the demand that investors can’t allocate quick enough. With PE funds attracting oversubscriptions, investors are looking for alternative ways to put their money, and with hedge funds having struggled to shine, performance-wise, some are moving quickly to develop more illiquid, closed-ended products to meet that demand.
Horseshoe Group is one of Bermuda’s best-known independent fund administrators and has seen clear traction in terms of fund managers launching PE and hybrid fund vehicles.
“We are in discussion with a hedge fund manager who launched their first two funds in an open-ended structure and as we speak they are in the process of launching their third fund as a hybrid private equity structure to meet investor demand. It’s driven by where the money is. Larger investors have much stronger appetite for PE-like structures, and hedge fund managers are following suit.
“The top quartile PE funds are almost impossible to get in to. I think that opens up the door for good fund managers with track records to compete for dollars from those investors who can’t access those top-tier PE funds. It is very much a demand-driven market right now,” explains Scott Burns, Senior Vice President at Horseshoe Group.
As hedge fund managers move into the closed-ended space, they quickly realise what a different world it is. Operationally, it requires a completely different mindset.
One of the issues is around the investment valuation process. While private equity funds often report quarterly, the valuation process of illiquid investments is often very different from the typical hedge fund manager that holds liquid securities.
“This valuation process of private investments requires a well documented process that can produce sufficient valuation support each quarter and satisfy the increasing demands of the fund auditors,” comments Burns.
“The second issue we see is around the funding model. The capital call and distribution model in the private equity space requires a platform that houses ever changing investor details, an efficient process for performing fund level calculations, investor calls and distributions, and an efficient and professional delivery method.
“This is another area where the leading private equity systems used by top firms and administrators can really add a lot of value and save a lot of time.”
Burns advises those managers who are thinking about going down the hybrid fund route, which have both open-ended and closed-ended features, to either make the investment in building an experienced back-office team, or outsource the reporting to a fund administrator.
“Ideally, one like Horseshoe that specialises in both private equity and hedge fund administration, has very experienced qualified staff, has implemented a top-tier private equity system and, most importantly, has long-term clients,” he says.