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Flexible rules attract funds

Flexible rules attract funds

Supervision tailored to level of risk earn The Bahamas a second look as offshore jurisdiction for investment funds

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The Bahamas Investor Magazine
January 1, 2006
January 1, 2006
Julie Charles

When a group of private investors recently sought an offshore location to launch a hedge fund, one thing convinced them to register an investment partnership in The Bahamas. Regulations here offered a light hand for them to easily incubate a start-up hedge fund, but could be ramped-up quickly to offer more supervision once outside investors join in.

These do-it-yourself hedge fund founders took advantage of a class of fund introduced within the country’s revamped regulatory regime, enacted in The Investment Funds Act, 2003. Their fund falls within a category Bahamians call a SMART fund–which stands for Specific Mandate Alternate Regulatory Test.

“Our client wishes to set up a hedge fund, but is not ready to solicit funds from the general public and incur the expense associated with setting up a professional fund,” says David Thain, general manager of Arner Bank & Trust (Bahamas) Ltd, a Nassau-based subsidiary of a Swiss-owned private bank. His client, a group of experienced investors, wanted a low-cost, hassle-free place to launch a fund and garner a performance record before opening it up to other investors in the future.

The “test” of a SMART fund determines the level of regulatory oversight imposed based on risk, the sophistication of a fund’s investors, the number of people investing and the participation of a licensed fund administrator. Four fund mandates have even been pre-approved by the Securities Commission of The Bahamas (SCB), so it can delegate licensing authority to local fund administrators–promising quick turnaround.

The hedge fund sponsors working with Arner adopted one such pre-approved mandate, for 10 or fewer investors, qualified as “sophisticated.” In this case, there’s no need for a detailed prospectus or annual audit requirement. When the fund upgrades its license to a professional fund, tougher rules will kick in, calling for more extensive documentation, reporting and the appointment of an auditor.

Since their introduction, some 114 funds have become licensed under the four pre-approved SMART fund mandates, according to data supplied by the SCB in mid-2005. Most are conversions of funds previously exempt from licensing (which are those with fewer than 15 investors), but some half-dozen funds have been set up in the same incubation model as Arner’s hedge fund client.

As securities regulators worldwide try to introduce more onerous disclosure rules on private investment partnerships, known as alternative or hedge funds, the Bahamian approach has been to craft its own legislation on a sliding scale, tailored to the investors who assume the risk.

“It looks at the true risks of the structure and responds to them with appropriate legislation,” says Wendy Warren, executive director of the Bahamas Financial Services Board, an industry association that promotes banking and financial services.

“Right now, all of the existing SMART funds [in The Bahamas] lean toward lighter touch regulation,” says Warren. “But you can actually use a SMART fund for a more regulated model, for example, to create an investor protection fund, which might require things such as a certain amount of insurance, a certain amount of capital required or more frequent reviews and reporting.”

The idea is to broaden supervision at either end of the risk scale, with more or less oversight as required. And it’s user-driven, so if a fund sponsor wants to create an entirely new type of investment partnership to suit a particular clientele, the idea can be proposed to the regulator. If approved, the regulator could add it to the list of pre-approved models which others could adopt in the future.

“I think the real benefit and attraction of a SMART fund is for financial institutions that want to attach some regulations [to their hedge funds] and be recognized as operating under a regulatory regime,” says Dirk Simmons, vice-president of operations with Citco Fund Services Bahamas. His Nassau-based office is a branch of the world’s largest hedge fund administrator, with some $250 billion in assets under administration through some 36 offices worldwide. He says Citco has not yet attracted new business to The Bahamas as a result of the new fund rules, but acknowledges the challenge is to pique the interest of more global fund players to include The Bahamas in their network. “If you are going to grow as an industry, you should do so from the top down,” he says.

The investment funds industry in The Bahamas has been left somewhat in the shadow of other offshore centres such as the Cayman Islands, where some 80 per cent of the world’s 8,000-plus hedge funds are domiciled. One deterrent here has been a second regulatory step required in The Bahamas: getting consent from the Central Bank to conduct operations in foreign currencies due to the country’s exchange controls. But, with recent changes, there’s optimism the financial services industry here is now better poised to attract a niche of new funds.

For instance, more than two dozen funds registered here have adopted a SMART fund mandate that covers private investment companies with five or fewer investors. This kind of licensed holding structure could be useful to a family office, for example, that wants the credibility of regulatory oversight yet can keep a level of privacy and flexibility over investment strategies.

For professional investors, flexible regulations and an income-tax-free jurisdiction make it easier to administer funds and keep costs down.

Probably the biggest draw to The Bahamas for a fund sponsor is the brand-name infrastructure of financial services support here, which includes global names in private banking and administration from Switzerland, North America and around the world. The Central Bank of The Bahamas counts more than 250 licensed banks and trust companies, all with a physical presence. Some 60 institutions are licensed to provide fund administration and 90 are licensed to provide broker-dealer and/or investment advisory services. The largest fund administrators with offices in Nassau include Templeton Global Advisors, which is part of Franklin Templeton Investments, Citco, Swiss Financial Services, Oceanic Fund Services, Cititrust (Bahamas) and SG Hambros Bank & Trust.

“If you look at all the major institutions that have a presence here, this provides the critical mass for people to consider The Bahamas as an alternative juris-diction,” says Gregory Cleare, chief financial officer of Templeton Capital Advisors Ltd. He heads the operations of the Nassau-based hedge fund advisory business for high-net-worth investors and institutions, along with veteran portfolio manager Mark Holowesko.

“You’ll find a maturity of the industry here, with tested laws and services,” he says.

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