Bermuda: Investment Funds in the Cayman Islands , British Virgin Islands and Bermuda

The offshore funds market is growing rapidly and the Cayman Islands ("Cayman"), the British Virgin Islands ("BVI") and Bermuda have become the pre-eminent jurisdictions for the establishment of investment funds. Cayman alone boasts over 6,000 regulated funds, the greatest number of any offshore jurisdiction, and, although a late comer to the funds market with its mutual fund legislation coming into force in 1998, the BVI is rapidly gaining popularity and is currently estimated to have over 3,000 regulated funds. Recent data indicates there are also over 1600 collective investment schemes domiciled in Bermuda. There are also a significant number of unregulated funds in these jurisdictions which fall under available exemptions and therefore are not included in the above figures.

Although a direct comparison is difficult, this brief highlights the similarities and differences of the key features in each jurisdiction. The comparison table at the end ("Comparison Table") serves as a quick reference guide.

SIMILARITIES

Trustworthy and reliable legal systems

Each jurisdiction is a British Overseas Territory and has a stable government which is committed to promoting their financial services industry. The laws of each jurisdiction are derived from English common law and supplemented by local legislation. The laws of all three jurisdictions ensure that funds in these jurisdictions can be structured as internationally accepted vehicles. The court systems are also well developed with appeals ultimately going to the Privy Council in London.

Flexibility in fund structure

Funds in any of the jurisdictions may be formed as companies, partnerships or unit trusts according to investor requirements, which are often tax related in their home jurisdiction. For example, funds in which US taxable investors will invest directly tend to be formed as limited partnerships, funds that target European and South American investors tend to be formed as corporate funds and funds that target Japanese investors tend to be formed as unit trusts. There are many structures utilised in Cayman, BVI and Bermuda, including stand-alone, side-by-side, master/feeder, multi-class or series, umbrella and fund of funds.

No direct taxes

There are no capital gains, income, profit, corporation or withholding taxes or any legal restrictions on the investment policies and strategies of funds in any of the jurisdictions.

The definition of mutual fund

Each jurisdiction provides legislation to regulate investment vehicles that collect and pool investor funds for collective investment and issue equity interests that are redeemable at the option of the investor. Therefore, investment vehicles with just one investor and closed-ended investment vehicles are not regulated by the relevant legislation.

Segregated Portfolio Companies

Until recently, the BVI did not have segregated portfolio legislation, but this changed on 1 January 2005 when the new BVI Business Companies Act 2004 came into force. Now all three jurisdictions permit investment funds to take the form of segregated portfolio companies. In essence, the relevant legislation provides that, whilst retaining its corporate existence as a single legal entity, a corporate fund vehicle may be registered as having segregated portfolios of assets, which may be traded independently and which during the life of the company and on liquidation are protected from creditor claims arising with respect to liabilities of other segregated portfolios or the company generally. The use of segregated portfolio companies provides an attractive alternative to the traditional structures to address cross-class liability issues for multi-class corporate funds and provides corporate fund vehicles with the ability to operate in a way analogous to a corporate group despite utilising just a single legal entity.

DIFFERENCES

Categories of Mutual Funds:

• Cayman provides four types of mutual funds: Exempted, Registered, Administered and Licensed.

• BVI provides three types of mutual funds: Private, Professional and Public.

• Bermuda has three categories of funds: Standard Scheme, Institutional Scheme and Recognised Scheme.

Unless a mutual fund fits into one of these categories it is prohibited from carrying on (or attempting to carry on) business in or from Cayman, BVI, or Bermuda. The requirements for each category are briefly listed in the Comparison Table.

License Requirements:

• In Cayman, a license is required by Licensed Funds only. Registered and Administered Funds have to be registered with the Cayman regulatory authority. No registration or license is required for Exempted Funds.

• In the BVI, Private and Professional Funds are required to be recognised (and not registered) by the BVI regulatory authority. Public Funds are required to be registered.

• In Bermuda all schemes are classified under the Bermuda Monetary Authority (Collective Investment Scheme) Regulations 1998 (the "Regulations"). No licence is required although it is required for an investment manager with a physical presence in Bermuda.

Investor Restrictions:

• In Cayman, Registered Funds must have a minimum subscription of US$50,000 per investor or the equity interests of the fund have to be listed on an approved stock exchange. Exempted Funds can have no more than 15 investors as long as the majority in number are capable of appointing or removing the operator of the fund. Administered and Licensed Funds have no restrictions.

• In the BVI, Private Funds may be offered to the public but shall have no more than 50 investors or if offered on a private basis only (as defined by the relevant legislation - see Comparison Table for definition of "private basis"), the fund could have up to 300 investors. Each investor in a Professional Fund must be a Professional Investor and the minimum initial investment in respect of a majority of investors must be not less than US$100,000.00 (see Comparison Table for what constitutes a Professional Investor). There are no restrictions for Public Funds.

• In Bermuda, institutional funds must have an initial subscription of US$100,000 per investor or sophisticated or wealthy investors as described in the Regulations. Recognised Schemes are the most regulated type of fund and markets its shares in the United Kingdom, while standard schemes are for retail and institutional investors.

Service Providers:

• In Cayman, Registered, Licensed and Administered Funds must appoint Cayman auditors and audited accounts must be filed with the Cayman regulatory authority annually. Administered Funds, in addition to a Cayman auditor must also appoint a Cayman administrator.

• The BVI Policy Guidelines issued by the BVI regulatory authority require that, for all BVI funds, the manager, administrator, investment advisor and custodian must be incorporated under BVI law or under the laws of a "recognised jurisdiction (see Comparison Table for list of recognised jurisdictions). The Policy Guidelines indicate that service providers incorporated in other jurisdictions may be acceptable if the jurisdiction in which they are incorporated is regarded as having a prudent system of regulation and supervision of mutual funds business. There is no requirement for the appointment of an auditor by a Private or a Professional Fund. Public Funds must appoint an auditor who must be approved by the BVI regulatory authority. A Public Fund must maintain adequate accounting records and prepare audited financial statements for each financial year.

• In Bermuda Standard and Recognised Schemes are required to appoint a financial institution in Bermuda. Institutional Schemes do not have to appoint a local custodian. All three schemes are required to appoint administrators, auditors and publish an offering document.

The Retail Mutual Funds (Japan) Regulations 2003 ("Regulations"):

• The Regulations were brought into effect in Cayman in November 2003 and apply to Cayman funds sold to the Japanese public as they aim to comply with the requirements of the Japan Securities Dealers Association, the provisions of the Business Practice Rule, Number 4, Articles 26-27, the Japanese Income Tax Law and the Securities Exchange Law. The Regulations provide for certain disclosure requirements by the Cayman funds, regulatory reporting obligations of the fund and various service providers, and stipulate the approvals required from the Cayman regulatory authority and consequently make Cayman a more attractive jurisdiction for Japanese investors.

• The BVI and Bermuda do not have equivalent legislation.

EU Savings Tax Directive ("Directive")

The BVI and Cayman are not members of the EU but have agreed to implement measures to comply with the substance of the Directive which was due to come into force in July 2005. In essence the Directive affects payments of interest (e.g. income from debt claims of any kind and distributions from and proceeds of sales or redemptions of funds that hold interest-bearing assets) by paying agents (e.g. banks, funds and debt issuers) located in the EU (and dependant and third countries) to tax resident individual investors in an EU state other than where the paying agent is located.

• The BVI provides for EU resident individuals to have the choice between (i) application of a withholding tax and (ii) the automatic exchange of information. All Private and Professional Funds fall outside the scope of the Directive. Certain types of Public Funds (i.e. a Public Fund which has certain express statements in its prospectus relating to the key characteristics of a UCITS will be treated as being UCITS equivalents and therefore will be caught by the Directive.

• Cayman will not impose any withholding tax under any circumstances. Cayman will require payments of interest or dividends to be reported in certain circumstances. Exempted, Registered and Administered Funds will fall outside the scope of the Directive. A Licensed Fund may be treated as a UCITS equivalent and consequently fall within the scope of the Directive.

• Bermuda is currently looking into the European Unions tax policies.

Stock Exchange:

• Cayman and Bermuda have their own stock exchanges.

• The BVI does not have a stock exchange.

Government Fees:

The government fees involved in establishing a fund are much lower in the BVI and Cayman than Bermuda (see Comparison Table).

The similarities and differences are better visualised in the Comparison Table.

SO WHICH IS THE BETTER JURISDICTION?

There is no definite answer to this question. Funds vary widely, and therefore, the best way to approach this question is to examine what each jurisdiction has to offer and see how this compares to what the client needs.

Some Examples:

1. Cayman offers an exemption for funds with less than 15 investors, as long as the

majority in number are capable of appointing or removing the operators of the fund. If the client has this type of fund structure in mind then Cayman may be the better option, as it will completely avoid registration with a regulatory authority. Such a structure in the BVI will fall under the Private Fund category requiring an application for recognition to the BVI regulatory authority. 2. The Registered Fund category is the most popular category in Cayman. However, it requires the minimum subscription per investor to be at least US$50,000 or the equity interests of the fund have to be listed on an approved stock exchange. Such restrictions are not always desirable or achievable by the promoter or investor. So, in the event that the fund will have in excess of 15 investors, will not meet the minimum subscription of US$50,000 and will not list the equity interests, then, the BVI Private Fund category may be the best option as long as the fund will have less than 50 investors or if the equity interests are to be offered on a private basis (but to no more than 300).

3. For some promoters, the location of certain service providers, such as investment managers or administrators, is very important. In Cayman, with the exception of Administered Funds, which require a local administrator, there are no specific requirements with regard to the location of investment managers, advisers, administrators and custodians. In the BVI, fund managers, advisers, administrators and custodians of all BVI funds must be domiciled in the BVI or in a recognised jurisdiction.

So, in the event that a fund is to have, for example, an investment manager domiciled in China (or in any other country not regarded as a recognised jurisdiction by the BVI), Cayman may be the more suitable jurisdiction.

4. Bermuda is a well controlled base for funds continuing to rely on principles of self regulation, rather than bureaucratic intervention, to regulate the commercial affairs of its business clients. In addition, Bermuda is well recognised for having a sophisticated infrastructure, and this coupled with its close proximity to the United States makes it a more convenient destination for holding meetings in the jurisdiction, which is becoming more prevalent.

5. Industry perception may also be a factor for the client in deciding where to domicile a fund. Cayman is currently the most popular jurisdiction for offshore funds and sophisticated investors may be more comfortable with Cayman rather than the BVI.

6. If the client is cost conscious then the BVI may be the preferred jurisdiction as it is much cheaper.

Contact us to be sent the Comparison Table referred to in this Brief

If you require any advice or further information on the subject matter of this publication, please contact the partner/attorney in the firm who normally advises you, or alternatively contact one us directly:

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.