Opportunity knocks as market comes back to life

Date: Wednesday, February 23, 2011
Author: Simon Gray

By Simon Gray - The outlook for the fund industry in the British Virgin Islands continues to brighten thanks to increasing investor confidence and reassurance that offshore funds are now unlikely to be shut out of European markets, as once seemed possible. However, BVI-based professionals believe that longer-term prospects might be improved by attracting a broader base of service providers to Tortola.

Once the world’s largest domicile of offshore hedge funds, the BVI has trailed the Cayman Islands for around a decade, but today industry members are relaxed about the jurisdiction’s ability to thrive in the shadow of its Caribbean neighbour, especially given the territory’s smaller population and the difficulty in building up a larger-scale fund administration industry without straining local resources.

Still, there is regret about the withdrawal more than a year ago of Fortis Prime Fund Solutions, at the time the jurisdiction’s largest administration firm, even though the decision appears to have had more to do with the problems then facing the Fortis group than the merits of the BVI as a fund services centre (today the remnants of Fortis are owned by the Dutch state, trading under the name of ABN Amro, and the Prime Fund Solutions business is in the process of being sold to Credit Suisse).

The BVI fund industry does benefit from the presence of a large legal sector featuring home-grown giant Harney, Westwood & Riegels and the rest of the ‘offshore magic circle’ of law firms, Walkers, Maples and Calder, Ogier, Conyers and Appleby, as well as the more recent arrival of Withers. And the Big Four audit and accounting firms are back in the BVI after for the most part diverting their businesses a decade ago, although PricewaterhouseCoopers’ operation is for the moment limited to an insolvency practice.

And while the biggest names of the administration industry have mostly set up operations in Cayman rather than the BVI, other players have taken the opportunity to develop activities in the jurisdiction. For example, Conifer Fund Services, which is affiliated with San Francisco-based Conifer Securities, has grown steadily since its establishment in the BVI at the beginning of 2007.

“The firm has grown fairly steadily over the past couple of years,” says managing director Peter O’Connell (pictured), who was previously with Fortis and its predecessor firm, Hedge Fund Services. “The business environment was tough in 2009, but we saw a return to growth in 2010. Last year we reorganised the firm within the Conifer group, managing Conifer Fund Services as one business line incorporating the two offices, in order to provide the same client experience whether they are serviced out of San Francisco or the BVI.”

According to O’Connell, incremental business over the past year has been dominated by new clients. “We’ve seen continuous new business development,” he says. “The funds that are launching with us tend to be larger than they might have been two or three years ago, when it was common for managers to set up a fund with just USD5m in capital. Today they need to have more like USD25m or USD30m, and a reputation as a high-quality manager.”

The bar has been raised for managers seeking to gain traction with investors, he believes. “Operational due diligence will be more demanding going forward, and managers that are successful mostly have found a strategic partner or seed investor,” he says. “The funds need to be bigger.”

Ross Munro, a partner and head of investment funds and regulatory at Harneys, also reports satisfactory business flows. “Over the past couple of years things have been slow, with what new business there was tending to be new products from existing clients, although there was also an enormous amount of restructuring work. However, the past six to nine months have seen a good flow of new business from all around the world.”

Munro says the BVI’s combination of a competitive cost base with a good reputation and high-quality service providers is particularly compelling when many managers, especially start-ups, are having to work hard to woo investors. “Finding capital is still the hardest thing that the manager has to do,” he says.

“Some managers are looking to start off in a small way, perhaps a closed-ended fund with friends and family money. They may not be regulated on day one and they may be carrying out their own administration. Once they have built up a track record they can have audited, they may then expand with a regulated product. For managers in that position, the BVI’s cost level is particularly attractive.”

Derek Adler, whose fund administration business, Ifina, has offices in both the BVI and Cayman, believes that the BVI would benefit from copying its rival’s exempt manager status – something that is already under consideration by the authorities – in order to make the jurisdiction more attractive to start-up managers that are under pressure to control costs but want to demonstrate regulatory compliance to their investors.

Ifina recently launched the Primary Development Fund, a Cayman-based umbrella structure offering new managers an affordable package of services including administration, custody, banking and legal counsel, and Adler would like to offer the same product for BVI funds. “In today’s market there are a lot of managers who would love to have the opportunity to be regulated in some form,” he says.

As it is, the rebound from the industry’s darkest hours in 2008 and 2009 has been satisfactory, according to Sherri Ortiz, executive director of the BVI International Financial Centre, a government-sponsored promotional body. “The recovery has been quite encouraging,” she says. “We are seeing more appetite for funds as markets strengthen, although there’s still a lot of caution among investors, while managers remain wary about the threat of increased regulation and how it could impact their business.”

Simon Schilder, a partner with law firm Ogier, is confident that the BVI will remain the main alternative to Cayman as a domicile for hedge funds and other alternative investment vehicles. “Start-up managers have traditionally liked the BVI because the cost of establishing a fund here and its ongoing costs are lower than for a Cayman fund,” he says.

“One reason for optimism is that we are seeing existing managers continue to use the BVI as a domicile for their new fund products, and when market conditions make it easier for new start-up managers to raise money, this new manager business will come back to the BVI due to the lower running costs.”

In fact there’s not much distinction between professional fees in BVI and Cayman, Schilder argues, but regulatory fees are significantly higher in Cayman. “Another thing that makes a difference for many start-up managers is the absence of an local audit sign-off requirement in the BVI, unlike in Cayman,” he says.

“This affects managers seeking to have their funds’ accounts audited elsewhere, for instance in their home jurisdiction. Choosing the BVI over Cayman avoids the need for a local audit firm to sign off accounts that have already been prepared by auditors elsewhere. Again, this is a saving more significant to start-up managers than those with billions under management.”

However, Schilder applauds the BVI’s decision to join Cayman in requiring funds’ accounts to be audited. “It reflects the needs of investors in the current environment and reflects the way the whole financial world has changed in response to the crisis,” he says. “Even in the past it would have been unusual for a fund not to be audited, but it’s now a requirement unless the regulator gives them an exemption.

The only circumstances in which the commission is likely to grant such an exemption are for very small funds with friends and family-type money where the investors all agree that they would rather save the cost of the audit. But funds being marketed to third-party investors base have generally always been audited.”

Ortiz says there was particular concern among New York lawyers, gatekeepers for much of the territory’s fund business, about the impact of the European Union’s Directive on Alternative Investment Fund Managers. “They were asking whether the BVI would be able to qualify under the directive because they did not want to lose the possibility to do business in the jurisdiction and to tie in fund investment with the BVI Business Company structure,” she says.

Last November, however, the European Parliament adopted a compromise version of the directive that promises offshore funds access from 2015 to a single European market for funds aimed at sophisticated investors, as long as managers comply with the legislation and domicile jurisdictions adhere to international standards on tax information exchange, measures to counter money laundering and terrorist financing, and regulatory co-operation. In the meantime offshore funds should be able to continue to access European investors through national private placement regimes.

The expectation is that the BVI should be able to meet the conditions of the directive comfortably, although they are as yet not fully defined. “The work we’ve done to improve our regulation and our membership of Iosco, as well as the signing of tax information exchange agreements, all contributes to what we hope will be the basis on which they consider the private placement and then the passporting requirements,” says KPMG director Tanis McDonald.

“We are confident we have done everything we can at this point, but we need to move forward with reaching agreements with EU member states while we wait to see how they define the details of the new regime. However, overall we are very positive about the outcome and confident that we can meet the requirements. We have done all we can from the point of view of legislation and tax agreements.”

The main area where offshore centres are waiting for greater clarity is the kind of regulatory co-operation with EU member states they will be required to undertake in order for their funds to be accepted into the EU market. Says Munro: “Our position is that being a member of Iosco, the organisation’s multilateral memorandum of understanding offers a framework that is already available.

“What we are anxious to avoid is some kind of subjective co-operation requirement that could represent a back-door method of restricting offshore funds’ access to the EU. However, overall the directive seems to be workable for offshore jurisdictions, and it could bring us some advantages as well. The depositary requirements that will be imposed on European but not offshore funds might represent an opportunity.”

Indeed, there is speculation that some managers may prefer to avoid having to comply with the directive unless they are specifically targeting European investors. Says O’Connell: “If your fund is not really marketing in the EU but you have European service providers, you might fall within the terms of the directive when there is no need to be. There are probably a few managers with administrators in Europe that will consider shopping around, perhaps for a Caribbean-based administrator.”

The jury is out on whether the uncertainty over the directive, which took more than a year and a half to finalise, has affected business flows to offshore jurisdictions such as the BVI. “It’s difficult to say whether during this time new funds actually went to Ireland or Luxembourg rather than the BVI or Cayman because of the uncertainty,” Schilder says. “We were asked by our existing manager clients whether it was something they should be considering, but we certainly did not see a mass migration of existing funds to the EU.”

However, he and other BVI professionals believe that now the outline of the EU regulations has been confirmed, confidence in offshore funds has been restored. “It’s come out in a way that will keep the offshore centres in the game as legitimate jurisdictions that managers will want to use in order to structure their funds,” he says. “I have every confidence that the BVI industry will be unaffected and that we will be able to comply with all the conditions when the time comes. Touch wood, I don’t think we will see a material impact on our business.”

A perennial question for the BVI fund industry is whether the jurisdiction would be more attractive if it could offer a broader range of local service providers, including administrators but especially banks. Munro says expansion would be beneficial simply because it would increase the circle of businesses with a vested interest in marketing the territory’s services around the world.

“One of our weaknesses is the fact that we don’t have enough people telling the BVI story,” he says. “We don’t have as many administrators, custodians and banks as certain other fund centres. It would certainly be beneficial to have a global bank with a strong commitment to the jurisdiction.”

Munro is less certain how much of a difference it would make to investors and managers. “BVI companies and funds are accepted around the world without any problem, and many people want to have an administrator in their own time zone. However, it would help us if we had some big players singing from the same song-sheet – something that certainly does play to Cayman’s interests. Because Goldman and UBS have offices there, they have an interest in pushing business toward Cayman.”

Adler believes that increasing the currently restricted number of banks authorised in the jurisdiction – something that reflects to a degree the regulator’s concern about the reputational risks inherent in offshore banking – could help the jurisdiction’s profile, especially if they included global household names. “Undoubtedly some top-notch banks would give the BVI a much more solid image as a financial centre,” he says, noting that Chase Manhattan used to have a presence but sold its operations in the territory. “Many people in the BVI would like to see some big players joining the ranks of the financial industry.”

Click here [1] to download a copy of the Hedgeweek Special Report: BVI Hedge Fund Services 2011