Monday, January 01, 2007Hedge Funds

Patrick JamesDomiciling your funds in the British Virgin Islands

According to the most recent figures released by the Financial Services Commission (FSC) in the British Virgin Islands, there are more than 2,400 active regulated funds and more than 470 active licensed fund managers and/or administrators domiciled or carrying on business in the BVI. This article looks at the background to the success of the BVI as a jurisdiction in which to domicile hedge funds, managers and administrators and the legal and regulatory regime in force in the BVI today.

The Mutual Funds Act is the key piece of investment funds legislation which establishes a straightforward legal and regulatory regime for the supervision and regulation of investment business in the BVI, and a simple system of licensing for entities wishing to provide management or administration services to investment funds.

The Mutual Funds Act establishes a two-tier regulatory environment for the supervision and regulation of investment funds. Managers and administrators who carry on business in or from within the BVI, by making a distinction between public funds and their services providers on the one hand, and non-public funds and their service providers on the other. The distinction provides for a different level of regulation to account for the different levels of risk involved in the different levels of funds and achieves appropriate protection, through regulation, for the different types of investors involved. The Government of the Virgin Islands recognises that public funds should be subject to a higher degree of regulation, both at inception and on an on-going basis, than non-public funds need to be. The two-tier system, which is now commonly used in other offshore jurisdictions, has certainly contributed to the success of the BVI to date and continues to be as important now as it was when the Mutual Funds Act first came into force.

The Mutual Funds Act defines a “mutual fund” for the purposes of BVI law as a company, a limited partnership or unit trust, or other similar body formed or organised under the laws of the BVI or of any other country or jurisdiction which collects and pools investor funds for the purpose of collective investment, and which issues interests which entitle the holder to redeem or withdraw on demand and to receive an amount computed by reference to the value of a proportionate interest in the whole or in a part of the net assets of the fund.

The Mutual Funds Act applies only to open-ended investment funds - in essence, funds whose equity interests are redeemable at the option of the investor. Closed-ended schemes, for example venture capital or private equity funds, are not regulated by the Mutual Funds Act or otherwise under BVI law.

It is worth noting that most funds which are recognised or registered in the BVI are in fact hedge funds, and there is nothing in the name or the substance of the Mutual Funds Act which limits the scope of the regulatory regime. There is nothing in the Mutual Funds Act which proscribes for the contents of a regulated fund’s offering document or the terms of its offering.

When considering setting up investment funds in the BVI, sponsors and fund managers may choose to establish the fund as a company, a limited partnership or a unit trust. The nature of the vehicle to be used may be of particular importance to certain investors, and the choice will often be driven by the nature and domicile of the fund’s investors, and a desire to accept investment from a number of different categories of investor whilst meeting each category’s particular fiscal demands and without allowing the presence of one category of investor to prejudice the fiscal status of others.

The Mutual Funds Act provides that no mutual fund shall carry on its business or manage or administer its affairs in or from within the BVI unless it is recognised or registered under the Mutual Funds Act. There is one exception to the rule, and that applies in the case of a professional fund, which is permitted to carry on business for a period of up to 14 days without being recognised. This 14-day grace period is often used in practice - it means that a professional fund can be established and legally carrying on business within a matter of days of first taking instructions, and it is part of the reason why the professional fund has consistently proved to be the most popular category of fund which the BVI has to offer.

There are four categories of regulated fund under BVI law, although in practical terms, only three categories are commonly used and therefore referred to in this article. They are the private, the professional and the public fund, each of which are defined in the Mutual Funds Act in essence as follows: private fund means a mutual fund where the constitutional documents specify that it will have no more than 50 investors or that the making of an invitation to subscribe for or purchase shares is made on a private basis;professional fund means a mutual fund in respect of which interests are only made available to professional investors and where the initial investment by a majority of the investors is not less than US$100,000 (or equivalent); and
public fund means a mutual fund that is neither private nor professional

In order to be recognised or registered by the FSC, a private or professional fund will simply need to demonstrate that it complies with the various elements of the statutory definition, as summarised above, and the functionaries would need to be identified – i.e. the manager, the adviser, the administrator and the custodian. Usually nothing further is required and, assuming that all is in order with the application, recognition is usually achieved in a matter of a few days. Public funds are subject to a higher level of regulation and may not make an invitation to purchase their shares unless they first publish a prospectus, which is required by the terms of the Mutual Funds Act to provide full and accurate disclosure of all information as investors would reasonably require and expect to find for the purpose of making an informed investment decision. An investor in a public fund has a statutory right of action for rescission or damages in respect of any misrepresentation (which includes an omission to disclose required information) contained in the fund’s prospectus. A copy of the prospectus, and any material changes made from time to time, has to be filed with the FSC. In addition, each of the directors (or similar officers) of the public fund will be required to provide a résumé. The application for registration of a public fund is considerably more involved than that for a private or a professional fund, and typically therefore the process can be expected to take longer.

The BVIBCA introduced the ability for a BVI regulated fund to apply for registration as a Segregated Portfolio Companies (SPC). An SPC enjoys statutory segregation of assets and liabilities attributable to a particular segregated portfolio from the assets and liabilities attributable to other segregated portfolios, within a single legal entity.

BVI corporate and investment funds law is flexible, and enables the use of a number of alternative structures for investment funds, including the following common structures: Single class funds which are set up with a single class of shares giving investors the opportunity to participate in a single investment portfolio. Multi-class funds (sometimes referred to as umbrella funds) which issue equity interests in classes to enable investors to participate in a range of investment portfolios. Multi-class funds which are registered as Segregated Portfolio Companies under which the assets attributable to a particular portfolio are segregated by statute and not available to meet the liabilities of creditors attributable to any other portfolio.

Master/feeder funds which are structured to enable subscriptions made in separate feeder vehicles to be pooled into and managed as a single master fund portfolio. The principal objective is to enable investors that are subject to differing tax or other regulations or with distinct requirements to participate together in the same investment portfolio having common investment objectives.

The Mutual Funds Act also regulates fund managers and administrators, and provides that a fund manager or administrator may not, in or from within the BVI, carry on or hold itself out as carrying on business as a manager or administrator of a mutual fund unless licensed to do so by the FSC.

Applicants for an administrator’s or a manager’s licence must demonstrate that they are and remain “fit and proper persons” to be engaged in the business proposed and that they have available adequate knowledge, expertise, resources and facilities necessary for the nature and scope of the business proposed. The “fit and proper” test is a fundamental benchmark of the regulatory regime in the BVI, and it establishes a basic standard for all persons who carry on the business of providing management or administrative services to investment funds.

The overall purpose of the “fit and proper” standard is to ensure, as far as possible, that the dishonest, the incompetent and the inexperienced cannot easily take up positions of trust and responsibility to the detriment of investors in investment funds. The test serves to provide a level of confidence for those who use the services of BVI investment fund firms by seeking to ensure that such business is conducted in accordance with high standards of market practice and integrity.

The regulatory regime in the BVI achieves a balance between over-regulation and under-regulation and the pressing need for preserving transparency in the investment funds industry. Regulation is critically important for the protection and benefit of investors, but it should also facilitate capital formation and economic growth of the industry and in that context, it is recognized that regulation is also for the benefit of competition in the market place.

In creating and in the practical implementation of the regulatory regime in the BVI, the Government of the Virgin Islands and the FSC have consistently shown that an even-handed, pragmatic approach best protects investors without placing an unjustified burden on the market and thus inhibiting market growth and development. This is often an extremely complex task, and one which requires a complete and thorough understanding of the industry both within the BVI and on a global basis - there is often no single correct approach to any particular regulatory issue, and there are always a number of different considerations often with conflicting, or at least different, requirements to be met or addressed.

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