Global tax hikes strengthen the hand of stable jurisdiction

Date: Wednesday, May 20, 2009
Author: Hedgeweek.com

Never mind the noise in the U.S., U.K., and Europe about offshore jurisdictions and the economic turmoil, Bermuda continues to seek and unearth business opportunities.

The British territory, located in the North Atlantic Ocean, is looking to capture whatever it can of the slimmed-down ranks of fund-startups. Bermuda International Business Association, better known as BIBA, is campaigning actively on the global conference circuit, and, according to local market participants, the financial tsunami has not impacted the overall economy, although it has had an impact on locally-domiciled funds, similar to the experience in other funds jurisdictions.

The NAV of Bermuda-domiciled funds fell 31% from $249.17 billion at the beginning of last year to $171.19 billion at year-end. . The total number of funds fell by 12% during the year to 1,133 in the final quarter of 2008, compared with 1,286 funds at the end of third quarter. The first quarter of this year saw continued redemptions, the winding up of some funds and decreased fund portfolios, as a result of adverse global market conditions

Some Bermuda-registered funds have had to restructure due to the compounding impact of global market meltdown, fund-losses and investor-redemptions since last summer. A few even had their assets tied up in massive investment frauds. Fairfield Greenwich Group's embattled feeder fund, called Fairfield Sentry, invested USD6.9bn with Bernard Madoff's investment firm, Bernard L.Madoff Investment Securities, via multiple offshore affiliates including one in Bermuda.

Separately, Ark Royal Asset Management has decided to close down partially due to its exposure to Petters Group Worldwide of Minnetonka, Minnesota. Led by Steven Vestbirk, the asset-based lending manager ran some USD250m in its main fund. Federal authorities have accused Petters Group's founder, Thomas Petters, of orchestrating a massive ponzi scheme, a charge he denies. Petters is now behind bars.

Fund-related litigation has also surfaced. Packcentral Global Hub, the Bermuda hedge fund of billionaire Ross Perot's family, was named in a complaint concerning alleged portfolio mismanagement. Also, the Supreme Court of Bermuda oversaw proceedings of a petition to wind down Stewardship Investment's Stewardship Credit Arbitrage Fund partially due to its investment in Petters.

However, the above cases are exceptions and the ranks of funds shutting down altogether remain thin, say market participants. Thanks to the flexible framework provided by Bermuda fund legislation and the efficiency of the Bermuda Monetary Authority, Bermuda funds were able to act swiftly and effectively in response to unprecedented markets conditions of roughly the last six months, says Alex Erskine, the global head of law firm Appleby's funds and investment services practice. Some funds have been restructured with the goal of limiting or altogether suspending redemptions and segregating problematic assets.

Says Erskine: 'The BMA came out with tremendous willingness and speed to respond in instances where material amendments had to be made to a fund's documentation. It's been encouraging to note that we've withstood what has been a tumultuous environment for both investors and operators of funds.'

Indeed, it's difficult to ignore BMA's risk-based approach that comprises: An initial vetting of both the fund offering documentation and its key people; reporting requirements for all authorised funds, comprising consistent statistical reporting to the BMA; separation of fund administration, custody and auditing roles; and triggers that allow the BMA to step in quickly at the first signs of concern.

Funds do not require Bermuda-based directors or auditors, which some view as an added advantage in today's cost-conscious environment. Larger houses typically register their funds in multiple jurisdictions but have them audited in one location, thereby generating economies of scale.

Still, some changes may occur. The BMA says it is embarking on a 'fundamental analysis' of its funds regime following recent regulatory developments on the global front. It will conduct the review with other offshore centers under the auspices of the Offshore Group of Banking Supervisors, a 16-member body set up in 1980 at the suggestion of the Basel Committee. BMA's goal is that its work eventually ties in with the efforts of the International Organization of Securities Commissioners, the standard-setters for the global securities industry.

"In Bermuda, we have a risk-based approach to regulation which we feel is effective and appropriate.  Greater regulation, oversight and scrutiny will be part of the new global environment.  Bermuda has and will continue to enhance its regulatory regime in order to align with global standards as and when needed. It is important, however, that a balance is struck so that any proposed changes don't stifle the entrepreneurial spirit that helped grow the hedge fund industry,' says Chad Critchley, partner, Ernst & Young.

BMA chief executive Matthew Elderfield says, 'As with all enhancements to its regimes, any adjustments made to Bermuda's funds framework will be carefully implemented to ensure it remains consistent with international standards, and at the same time is appropriate to the nature of the Bermuda market.'   

However, the island came up short on the Organisation of Economic Cooperation and Development's view of offshore jurisdictions. The Paris group put Bermuda on its 'gray list,' a notch below its highest grade. It divides 84 countries into three categories based on their adherence to international tax reporting standards. Other popular offshore jurisdictions including Cayman Islands were also on this tally.

'It's disappointing that the OECD has apparently not taken into account Bermuda's long-standing commitment to OECD information sharing standards on tax matters, and its cooperative participation in relation to establishing tax information exchange agreements with key jurisdictions,' says Elderfield.

It is understood that the Bermuda government is attempting to obtain the additional bilateral agreements it requires to advance. Notes Elderfield: 'Such agreements support Bermuda's position as a leading financial jurisdiction and the overall stability of our markets, complementing the effective regulatory environment that exists here.' Locals say shortage of staff at Bermuda's Treasury unit may have been mainly responsible for the agreement-shortfall.

In contrast, the U.S. Department of State's International Narcotic Control Strategy Report ranked Bermuda in the lowest risk category for money laundering and terrorist financing in its latest survey. Industry participants view this as a validation of their robust policies.

'Bermuda, which over time has established a reputation for being a quality jurisdiction, has been focused on regulations and money laundering long before it became critical,' says Cheryl Packwood, chief executive of BIBA. BIBA is slated to attend events scheduled in New York, London, Singapore, Monaco, Hong Kong and Toronto to educate prospective clients about Bermuda's financial services sector, the largest sector of its economy (followed by tourism). Additionally, the group, which interfaces with the government and has over 120 members, is revamping its website to make information more accessible. 

Leaders of the G20 industrialised and developing nations, meanwhile, took a hard line last month against offshore jurisdictions. That has irked Bermudans. Separately, the European Commission called for tighter oversight of offshore centers used by European managers to register their funds. Says one market participant: 'The islands in general have become an easy football for authorities to kick around. It's politically convenient to say offshore jurisdictions are bad whereas it's the big financial onshore centers that have faced problems in the latest crisis.'

The words emerged from the G20 summit were unsettling for the asset management business in Bermuda, says Bob Richards of Bermuda Asset Management, a 21-year-old equities outfit. 'It remains to be seen whether anything will come out of this or this was merely a case of empty words being bandied around by politicians,' adds Richards.

In terms of the overall market sentiment, things have stabilised considerably since last year, when following the collapse of Lehman Brothers, the credit crisis and redemption frenzy obliterated performance and valuation of hedge funds around the globe. Notes Appleby's Erskine: 'We're seeing a perceptible decline in the level of panic in the marketplace. Funds that have survived have seen the worst. Those hedge funds that have managed to retain their capital base will see pragmatic expansion.'

Erskine expects the availability of fresh capital to eventually drive the creation of new products and services. For instance, the market for distressed assets is buoyant and already a number of fund managers and service providers have made enquiries. Proposed tax hikes in the U.K. and U.S., coupled with increased importance of offshore-based 'mind and management,' could drive more investment management firms to Bermuda.

Bermuda offers 'benign but credible regulations,' pragmatic capital requirements resulting in lower operational costs, depth of professional funds-related services, and convenience resulting from its geographic proximity with the U.S., says Erskine. 

Some London managers are already threatening to exit from the city to avoid its proposed tax hikes. The U.S., meanwhile, is also looking to more than double its tax rate for hedge funds and private equity.

Scott Watson-Brown, a partner at PricewaterhouseCoopers's Bermuda-based investment management practice, says the alternatives industry will have to adapt quickly to future changes in order to retain their efficiency and effectiveness. Managers have begun addressing changes by adjusting their fees, fund structure and key operating terms in an effort to both retain and attract new assets. 'We expect the traditional 2 and 20 fee arrangement will move to a place where lower fixed fee levels may be offered for longer lock-up periods and on the flip side, investors who demand liquidity will have to pay for it,' he says.

He says there's great concern that some of the talked about regulatory reform is being pushed forward to appease political needs, versus assessing and identifying the risks within the financial markets that truly need to be regulated. Notes Watson-Brown: 'As we've seen in recent times, heavily regulated industries haven't escaped problems in the current economic crisis.'
   
In addition to hedge funds and related service providers, Bermuda has seen business develop around reinsurance for hedge funds. Japan's Tokio Millennium is one such player. Its four-member markets solutions group in Bermuda underwrites insurance paper for hedge funds and banks that are looking to take risks, says Tokio Millenium vice president Kathleen Faries in Hamilton. 'For our market, Bermuda is where we need to be. Sure, the hedge fund market has gone soft but there're still funds out there that continue to do well and are experiencing growth.' 

The Bermuda Stock Exchange (BSX), a cornerstone of Bermuda's financial system, is an accurate bellweather of market trends. The condition of the global capital markets has had an impact locally, says chief executive Greg Wojciechowski. 'Domestic stock trading volume has dropped, as have share prices. This trend tracks the performance of other international stock exchanges.'

Of the scores of international vehicles that are listed on the BSX, some are being restructured or wound down, says Wojciechowski, adding: 'But we've also been fielding many inquiries from new business prospects. I'm cautiously optimistic this trend will continue.'

Even in these times of economic turmoil, opportunities abound and for those with a solid and tested infrastructure and an innovative spirit, the future will be exciting, notes Wojciechowski.