BVI Competing in the Global Funds Market with the Introduction of Innovative New Fund Products
By Philip Graham, Partner and Head of Investment Funds at Harneys
The British Virgin Islands, in continuing to distinguish itself as a premier offshore financial services jurisdiction, launched two new fund products on June 1, 2015, to complement its very popular existing funds offering with the bold intention of remaining on the cutting edge of the financial services market. The "incubator fund" and the "approved fund" are both lightly regulated fund products which are primarily aimed at start-up and emerging managers, as well as those managing funds for smaller groups of closely connected investors.
These types of managers face an increasingly hostile business environment as they try to get their fund vehicles to market; the regulatory outlook is ever–demanding, and this leads to an enormous amount of up-front cost before the manager can even begin to contemplate a marketing campaign. The new products, which have been brought in by the Securities and Investment Business (Incubator and Approved Funds) Regulations, 2015, aim to make the BVI a trusted and welcoming environment for small fund managers.
Why the BVI?
The BVI is recognised globally as one of the leading funds jurisdictions. Hedge funds domiciled in the BVI make up approximately one quarter of all offshore hedge funds established worldwide, ranking in second place behind the Cayman Islands. This popularity is due to the many advantages to establishing and running investment fund in the BVI including:
- A tax neutral environment.
- A stable political and economic jurisdiction committed to remaining fully compliant with all supra-governmental bodies.
- A competent regulator based on the ground in the BVI: the Financial Services Commission (FSC), committed to complying with the most rigorous international regulatory standards and ensuring that BVI funds continue to be marketable internationally.
- A recognized and respected legal system that boasts flexible and commercially driven corporate legislation supported by a framework of English common law and a sophisticated Commercial Court with a wealth of experience resolving complex matters and ultimate recourse to the Privy Council of the United Kingdom.
- Experienced service providers specialising in the funds industry.
- No regulatory restrictions on investment policies or strategies or on performance or other fee arrangements.
- No requirement to appoint local directors, local functionaries or local auditors.
What legal structures are available?
Most BVI investment funds are established as companies limited by shares under the BVI Business Companies Act 2004 (BCA). A BVI business company (BC) has legal personality, separate from its shareholders whose liability is limited under the BCA. The BCA is sophisticated legislation which is regularly reviewed and updated to keep up with international business and regulatory standards. As a consequence, it allows flexibility to funds structured as BCs. For example, provisions of the Memorandum and Articles of Association can be amended by the directors (provided the amendments do not affect the rights attaching to shares); there is no concept of share capital or authorised capital; shares do not need to have a par value and directors can issue shares in different series within each class without having to amend the constitutional documents.
BVI private, professional and public funds can also be structured as Segregated Portfolio Companies (SPC), and this is popular for multi–class and umbrella funds where there are two or more "segregated portfolios" that use different investment strategies. An SPC is a company limited by shares, just like a BC, but with the benefit of statutory segregation of assets and liabilities between segregated portfolios established within the company.
Limited partnerships can be used for BVI fund structures, although they are not as popular as the BC. A limited partnership does not have separate legal personality from its partners, and the General Partner is ultimately liable for the debts and obligations of the limited partnership. Under BVI law, limited partners are not liable for the debts and obligations of the limited partnership save for the amount contributed.
BVI law does also allow unit trusts to be used for fund structures, although they are much less common.
Prior to the introduction of the new fund products, what did the BVI have already?
Before the introduction of the new fund products, the BVI was already offering three respected and attractive fund products. These fund products continue to be available and have not lost any popularity since the introduction of the new products.
The Private Fund
Private funds do not have a minimum initial investment amount for each investor or any "professional" or "sophistication" test for investors. This has made them popular with start-up managers, allowing a friends-and-family offering.
A private fund is restricted to either:
- having no more than 50 investors
- only making an invitation to subscribe for or purchase fund interests on a private basis
The Professional Fund
Professional funds are the most popular category of regulated fund and make up approximately 70% of all regulated funds in the BVI. The interests in a professional fund may only be made available to "professional investors," and the minimum initial investment by each professional investor must not be less than US$100,000 (or other currency equivalent), unless the investor is an "exempted investor," in which case there is no minimum initial investment.
A "professional investor" is a person:
- whose ordinary business involves, whether for that person’s own account or for the account of others, the acquisition or disposal of assets of the same kind as a substantial part of the assets of the relevant fund
- who, whether individually or jointly with his or her spouse, has a net worth in excess of US$1,000,000 (or other currency equivalent)
An "exempted investor" means:
- the manager, administrator, promoter or underwriter of the fund
- any employee of the manager of the fund
The Public Fund
A public fund has no restrictions on the type or number of investors and is viewed as a retail product. This means that the regulatory burden on a public fund is greater than for other types of BVI funds.
Registered public funds may not make an invitation to the public or any section of the public to purchase shares unless prior to such invitation they publish a prospectus which complies with statutory requirements, is approved by and signed on behalf of the fund’s directors, and which is registered by the FSC.
Each of the three traditional fund products offered by the BVI is subject to various statutory requirements, with those applying to public funds being the most onerous. The requirements include:
- Various reporting obligations (or prior notice in the case of public funds) on the happening of certain events such as changes to offering terms and appointments and removals of directors.
- Obligations to prepare and submit audited financial statements and annual returns to the FSC.
- A requirement to appoint and have at all times various functionaries, which at a minimum, must include:
- an administrator
- an investment manager
- a custodian
- Prior notice requirements (and prior approval in the case of public funds) on the appointment of any functionary and notice requirements following the appointment or termination of any functionary.
- The obligation to have at least two directors, one of whom (and both of whom, in the case of a public fund) must be an individual and, in the case of the public fund, the directors must be approved by the FSC.
The New Products
The new products have been designed to be subject to lighter regulatory requirements in order to enable emerging start-up and smaller managers to set up funds with fewer ongoing obligations and a lower cost base.
The Incubator Fund
The incubator fund is aimed at managers who do not necessarily have the benefit of seed investor capital, but who wish to set up quickly and establish a track record with minimal set-up costs and without having to comply with onerous regulatory obligations. The incubator fund is permitted to operate for two years (with the possibility of an additional one-year extension), which is described as the "validity period," without a mandatory requirement to appoint the typical functionaries (i.e., administrator, custodian or manager), and there is equally no requirement to appoint an auditor. The only mandatory appointments, therefore, are the registered agent and authorised representative in the BVI.
This level of flexibility is contingent upon the fund remaining within the relevant thresholds applicable to the fund during its validity period. These thresholds are:
- A maximum of 20 "sophisticated private investors".
- A minimum initial investment of US$20,000 by each investor.
- A cap of US$20 million on the value of the net assets of the fund.
Prior to the end of the two- or three-year term (as applicable) or upon exceeding any of the specified thresholds, the fund must elect one of the following options:
- apply for recognition of the fund as a private fund or professional fund by preparing, among other items, an audit demonstrating its current financial position and compliance with its regulatory obligations and submitting the application to the FSC
- apply to the FSC for approval as an approved fund
- winding up its operations as a regulated fund.
This incubator fund product allows a smaller manager to dip its toe in the investment funds water and either decide at the end of the validity period to completely submerge in the straight-forward transition to a more regulated fund vehicle, or instead, easily and cost-effectively remove that toe, windup that particular fund and come up with a new plan.
The Approved Fund
The approved fund is aimed at managers who wish to establish a fund for a longer and unencumbered term, but on the basis of a more private investor offering, which may appeal to family offices or an investor base of close connections.
It also has relevant thresholds:
- A maximum of 20 investors at any one time
- A cap of US$100 million on the value of the net assets of the fund
It has similar characteristics to the private fund, including no minimum initial investment for the investors; but unlike the private fund, the approved
fund is not required to appoint an auditor, a manager or a custodian. However, to ensure there is some suitable oversight of the operations of the
fund throughout its much longer lifetime, it is required to appoint an administrator (along with the registered agent and authorised representative),
which will be reassuring to potential investors.
Unlike the incubator fund, the approved fund does not have a restricted validity period and can continue to operate as an approved fund indefinitely, unless:
- a decision is made to voluntarily apply to the Commission to recognise the fund as a private or professional fund
- it is required to convert to a private or professional fund upon exceeding one of the relevant thresholds
- it elects to wind up its operations
We are seeing an enormous amount of interest in this product from a number of the emerging markets where high net worth individuals are often looking for a lightly regulated, low-cost fund vehicle incorporated in a well-respected funds domicile which will provide them with a number of distinct benefits within their home jurisdiction.
Lighter Continuing Obligations, Fast Time to Market and Associated Cost Savings
While the incubator and approved funds are subject to some of the same obligations as the traditional BVI products, for example, they are required to appoint two directors (one of which must be an individual) and are required to submit returns (which must detail, among other items, the number of investors and the AUM of the fund) semi-annually (for the incubator) and annually (for the approved fund), there are fewer notification obligations which relate mainly to changes to the information provided with the application for approval.
The most significant regulatory concessions and cost savings are afforded to the new products by the lifting of the absolute requirements for them to appoint various functionaries. This flexibility allows managers to start out only with the service providers that they consider necessary for the size and nature of their operations and investor base, but of course the appointment of an auditor is strongly recommended, largely because it is now fundamentally expected by outside investors.
In addition, the mandatory information which must be contained in the offering documents to these funds is greatly reduced and is limited to a proscribed investment warning and information setting out the fund’s investment strategy. This means that funds can launch with short-form term sheets and that the legal costs of getting started are significantly reduced.
In recognition of the importance of time to market, both of these new fund products have also been provided the flexibility of being able to commence trading within two business days of lodging a completed application for approval with the Commission. This, combined with the cost savings, has made it much easier for small managers to get their funds off the ground in the BVI.
What are the weaknesses of the BVI as a funds jurisdiction?
The BVI now has a full suite of products available to meet the requirements of a start-up manager all the way through to a firm with US$50 billion under management. However, there is no doubting that the Cayman Islands remains the market leader in the offshore funds world, and that raises the question of why someone should not follow the pack and simply use a Cayman-equivalent product. For some managers, the significant cost saving and added regulatory flexibility is enough of a reason, but it is certainly not for all, and on that basis Cayman continues to be the choice jurisdiction for those that want to continue down the well-trodden path. But given the ever-increasing fees in Cayman and aspects like local auditor sign-off which the BVI has not adopted, the BVI’s market share will continue to grow as an attractive alternative.
The other issue that BVI funds face (along with the Cayman Islands) is the ever-increasing number of hurdles placed in front of funds incorporated in offshore jurisdictions when opening bank accounts. While there are certain providers who will fast track these applications, there is no doubt that the global banking system has slowed down the speed at which a fund can launch, simply because the fund does not have an account to accept subscription monies.
The new products and the Regulations are a welcome addition to the BVI investment funds landscape and will further refine the BVI’s reputation as a flexible, innovative, attractive and cost-effective jurisdiction for new fund launches. Coupled with the highly regarded approved manager, a lightly regulated management product which is now truly blossoming since its introduction in 2012, the BVI is very much part of the next frontier in the global investment funds market.
About Harneys and Phil Graham
Harneys is a leading offshore legal and fiduciary services firm with more than 12 offices spanning the world. We are trusted legal advisors to an international client base including all of the world’s top 30 international law firms and 18 of the world’s 20 largest banks and financial institutions. We regularly work alongside professional advisors from around the world providing legal, corporate and fiduciary services relating to BVI, Bermuda, Cayman Islands, Anguilla, Cyprus and Mauritius law.
Phil Graham heads up the investment funds and regulatory team in the BVI and advises on all aspects of the formation and restructuring of investment fund vehicles. His team specialises in all aspects of contentious and non-contentious financial services law and regulation, including advice on obtaining or transferring investment management, administration or banking licenses and guidance on the anti-money laundering regime, anti-bribery legislation, information exchange in tax matters and economic sanctions. Phil is a senior editor of Harneys blog http://offshorefundsblog.com which is dedicated to demystifying offshore investment funds.