As closed-ended funds are not required to be registered with the Bermuda Monetary Authority (BMA), it is not possible to estimate with accuracy the number of such funds domiciled in Bermuda.The Bermuda fund industry sees investment predominantly from North America and Europe, and therefore trends in the Bermuda fund finance market track the major onshore markets. Although there is no overall data reporting service for the local fund finance market, anecdotal reports from many of the major facility lenders, as well as Appleby practitioners, anticipate that there will continue to be substantial growth in the fund finance market, with increasing numbers of funds seeking subscription line or capital call facilities.
Bermuda as a jurisdiction is highly responsive to evolving market demands and over the past two years key stakeholders, including the Bermuda government, the financial services regulator (the BMA) and investment industry professionals have collaborated to make legislative changes that serve to cement Bermuda’s position as one of the premier offshore jurisdictions for private equity funds. A review of the most significant changes from a private equity fund perspective is set out in the ‘Key developments’ section below.
Fund Formation and Finance
Investment funds – overview
The IFA governs the registration and authorisation of investment funds and contains certain requirements for the formation of investment funds, their operation and the offering of shares or interests of investment funds. An ‘investment fund’ is broadly defined under the IFA and means any arrangements with respect to property of any description, including money, the purpose or effect of which is to enable persons taking part in the arrangements to
participate in or receive profits or income arising from the acquisition, holding, management or disposal of the property or sums paid out of such profits and income.
Investment funds are prohibited from operating in or from Bermuda unless they are authorised or registered under the IFA. Funds that are private in nature, such as master funds, are required to be registered with the BMA as Private Funds. A fund is considered to be private in nature, and thus a Private Fund, if it is open to 20 participants or less and the promotion, communication and offer to participate in the investment fund is restricted and not made to the general public.
The formation of companies, partnerships and limited liability companies (LLCs) is subject to the approval of the Registrar of Companies (Registrar) and the BMA (the Registrar and BMA being the principal regulatory bodies). The BMA is the principal body responsible for the regulation of investment funds, including those listed on the Bermuda Stock Exchange (BSX). The Registrar is responsible for the registration of companies, partnerships and LLCs and has powers pursuant to, inter alia, the Companies Act 1981 (Companies Act), the Partnership Act 1902, the Limited Partnership Act 1883, the Exempted Partnerships Act 1992, the Segregated Accounts Companies Act 2000 and the Limited Liability Company Act 2016. While the Registrar and the BMA do not regulate the formation of unit trust
funds, a unit trust fund is required to apply to the BMA for authorisation or exemption under the IFA, and must also seek the permission of the BMA under the Exchange control regulations (Exchange Regulations) to issue units (as further defined and explained below).
Anti-money laundering (AML) and anti-terrorist financing (ATF)
The Bermuda AML and ATF framework requires that AML/ATF regulated financial institutions as well as independent professionals establish policies and procedures to forestall and prevent money laundering and terrorist financing. Such policies and procedures must cover:
(a) customer due diligence measures and ongoing monitoring;
(c) record keeping;
(d) internal control;
(e) risk assessment and management; and
(f) the monitoring and management of compliance with and the internal communication of such policies and procedures in order to prevent activities related to money laundering and terrorist financing.
The policies and procedures should be developed using a risk-based approach. The nature and extent of such policies and procedures will depend on a variety of factors, including the nature, scale and complexity of the business; the diversity of its operations, including geographical diversity; and its customer, product and activity profile.
Private equity funds
Closed-ended, private equity funds are typically formed as limited partnerships or companies incorporated with limited liability.
A Bermuda-exempted company (e.g. companies exempted from the provisions of Bermuda law that stipulate that at least 60% of the equity must be beneficially owned by Bermudians) incorporated with limited liability can be established with a single shareholder, any amount of authorised share capital, unrestricted objects, and the capacity and powers of a natural person.
In general terms, the Companies Act restricts an exempted company from carrying on business in Bermuda except to the extent that it has been granted a licence by the Minister of Finance. There are certain activities that are expressly excluded from the requirements of a licence, including doing business with other exempted companies in furtherance of the business of the exempted company that is being conducted outside Bermuda, and dealing in securities of exempted companies or partnerships.
Approval is sought from the BMA for the intended beneficial ownership of those with voting rights in the company. Any information provided to the BMA is treated in the strictest confidence (pursuant to Section 31 of the Bermuda Monetary Authority Act, 1969).
Ordinarily, an incorporation can be accomplished within 24 to 48 hours. An exempted company can only commence business or issue shares after it has been organised and the requisite BMA consents have been obtained.
Historically, investment funds have typically been formed as mutual fund companies or limited partnerships, the optimal structure depending on a number of factors including where and to whom the investment opportunity is to be marketed, the nature of the investor base, and the identified portfolio of investment assets.
Mutual fund companies
A mutual fund company is a company incorporated with limited liability that is incorporated for the purpose of investing the monies of its members for their mutual benefit, having the power to redeem or purchase for cancellation its shares without reducing its authorised share capital, and stating in its memorandum of association that it is a mutual fund. In the case of a mutual fund company, the shares of which are to be sold in overseas markets, an exempted company is the appropriate vehicle. However, shares of a Bermuda mutual fund company, which is an exempted company, may also be offered inside Bermuda to both local and international investors.
Typically, a mutual fund company is incorporated with two share classes: ordinary voting shares (non-participating) held by the investment manager; and non-voting, participating, redeemable shares held by the investors.
The timeline for incorporation of a mutual fund company, after submission of the application to the BMA, is usually 24 to 48 hours. A mutual fund company may only commence business and issue shares after it has been organised and the consents under Bermuda’s Exchange Regulations, the IFA (if required) and the AML/ATF framework (if required) have been obtained.
Investment funds may also be formed as exempted limited partnerships. A limited partnership consists of one or more general partners (which may be bodies corporate, or general or limited partnerships, formed under the laws of Bermuda or another jurisdiction) and one or more limited partners (namely investors) whose relationship is governed by a partnership agreement.
In Bermuda, partnerships (both general and limited partnerships) are not legal entities separate from their partners unless a specific election has been made by the partnership to have legal personality. Nevertheless, a partnership may in any event function as an ‘entity’, and may sue and be sued and carry on business in its own name. If an election
is made by the partnership to have separate legal personality, such election is irrevocable and the partnership will continue regardless of whether all the partners die or are declared bankrupt or if there is a change in its constitution.
General partners are fully liable for partnership debts and obligations. In the case of limited partnerships, the general partners will have such general liability to third parties, while generally speaking, the liability of the limited partners is limited to the value of the money and any property that they contribute (or agree to contribute) to the limited
partnership . It should be noted that the limited partners may forfeit their limited liability status in certain circumstances if they participate in the management of the partnership.
Limited Liability Companies
Limited liability companies or “LLCs” were introduced to the Bermuda regulatory landscape in 2016 as a result of the Limited Liability Companies Act 2016, as amended (LLC Act). An LLC is a hybrid legal structure allowing the contractual and operational flexibility of a partnership to be housed within a corporate entity. Like a Bermuda exempted
company, an LLC has separate legal personality and the liability of its members is limited. Whilst members of a Bermuda company receive shares, members of a Bermuda LLC will each have an interest in a capital account in a similar way to partners in a partnership. Under the Bermuda LLC Act, parties can create bespoke vehicles, having the contractual freedom to set out in the LLC agreement the terms of operation and management of the LLC as well as expressly agreeing the allocation of profits and timing of distributions amongst its members. A Bermuda LLC may be managed by one or more members (a “managing member”), or a manager may be appointed who may or may not be entitled to share in the profits of the LLC.
Whilst the LLC vehicle may be utilised by clients in a broad range of sectors, the Bermuda LLC is an attractive structuring option for operators of investment funds and, in particular, closed-ended private equity funds, as the flexible corporate governance structure allows “managing members” to manage the fund (in a similar way to a general partner) but without unlimited liability for such members in respect of the fund’s losses. At the moment, it is not yet clear what the lender collateral package will look like in respect of LLC funds, although arguably the use of LLCs, as opposed to partnerships, may serve to simplify the security package, as security would only have to be granted by the LLC itself and not its manager.
Security package in fund financings
A key consideration in any fund financing transaction (whether it be a capital call facility, subscription facility or equity bridge facility) is the collateral package which the lender can secure. Typically, security will be granted over the rights to call for contributions from investors, with the security interest in uncalled capital commitments perfected by
the delivery of a notice of the assignment of such capital commitments to the investors, where the document granting the security is governed by Bermuda law. Where the security document is not governed by Bermuda law, local counsel should be engaged to determine any perfection requirements. Additionally, the lender will want security over the account into which investors’ capital contributions are funded.
There is no Bermuda law requirement that the collateral account be a local one (although of course, the local banks are very familiar with such requirements, should it be preferable to secure a local account).
Bermuda law does not stipulate that the security package must be governed by Bermuda law, and most often we see the security agreements mirroring the governing law of the applicable credit facility. Bermuda as a jurisdiction is very familiar with New York law as the preferred governing law for US facilities, and English law for European facilities.
Of primary concern therefore, from an offshore perspective, is to review the validity and priority of the offshore-based security.
Bermuda recognises the concept of a security agent and there are no restrictions under Bermuda law on the enforcement of rights or security interests solely because those rights or security interests are held by an agent. An agent is treated in the same way as any other secured party and is subject to any applicable Bermuda law. It should also be noted that there are no Bermuda law restrictions on granting security to foreign lenders and that
it is not necessary under Bermuda law for a security agent to be registered, licensed or otherwise qualified in Bermuda in order to enforce any of its rights.
There are no restrictions under Bermuda law on a company or partnership making payments to a foreign lender under a security document, guarantee or loan agreement, and exempted companies and partnerships are designated by the BMA as “non-resident” for exchange control purposes, which means that they are free to deal in any currency of their choosing, other than “resident” Bermuda dollars.
The Stamp Duties (International Businesses Relief) Act 1990 abolished stamp duty on most documents executed by exempted undertakings (including exempted companies and partnerships, and this also applies to LLCs).
Following execution of the security document, lenders will want to ensure that their security package is appropriately registered. Charges over the assets of Bermuda companies in Bermuda (except charges over real property in Bermuda or ships or aircraft registered in Bermuda) which are granted by or to companies incorporated outside of Bermuda,
are capable of being registered in Bermuda in the office of the Registrar, pursuant to the provisions of Part V of the Companies Act. Registration under the Companies Act is not compulsory and does not affect the validity or enforceability of a charge, and there is no time limit within which registration of a charge must be effected. However, in the event that questions of priority fall to be determined by reference to Bermuda law, any charge registered pursuant to the Companies Act will take priority over any other charge which is registered subsequently in regard to the same assets, and over all other charges created over such assets after 1 July 1983, which are not registered.
Partnerships which have elected to have separate legal personality can also register with the Registrar and thereby ensure priority in a similar way to the regime for companies. In the event that a Bermuda partnership has not elected to have separate legal personality but has a Bermuda company as its general partner, the charge can be registered against the general partner acting in its capacity as general partner of the partnership.
The Economic Substance Amendment Act 2019 (Amendment Act) became operative on 28 June 2019. The Amendment Act creates an exemption for entities that are resident for tax purposes in a jurisdiction outside of Bermuda (provided such jurisdiction is not on the EU’s list of non-cooperative jurisdictions for tax purposes). This important development
will place Bermuda on a level playing field with other jurisdictions that are subject to the EU’s economic substance requirements.
Information received by the Registrar from an entity to support its non-resident status will be provided to the foreign competent authority of the jurisdiction where the holding entity, the ultimate parent entity, the owner or the beneficial owner of the non-resident entity is incorporated, formed and registered or resident.
The Registrar released Draft Economic Substance Requirements – General Principles (Draft Guidance Notes) on 26 June 2019 for industry consultation. The Draft Guidance Notes will assist entities in determining whether they are within scope of the economic substance requirements and, where entities are in scope, provide guidance on how to satisfy these requirements. Additional sector-specific guidance notes will be released by the Registrar in due course. The Draft Guidance Notes state that the Registrar is in the process of building an e-registration system to accept and manage the economic substance declarations, and it is anticipated that the e-registration system will launch in the second quarter of 2020.
The legislative framework in Bermuda in respect of economic substance is likely to continue to evolve in the near to medium future and this evolution is likely to continue to affect Bermuda funds.
Beneficial Ownership Regime
Bermuda has recently adopted legislation to implement international standards in order to enhance transparency while combating money laundering and terrorist financing. The standards which the legislation implements were initially adopted by the Financial Action Task Force (FATF), with the Organisation for Economic Co-operation and Development
incorporating key FATF requirements into their proposals. The Bermuda beneficial ownership regime has built in key exemptions for open-ended investment funds and for closed-ended investment vehicles managed or administered by a person licensed under the Investment Business Act, 2003 or the Investment Funds Act, 2006 or registered, authorised
or licensed by a foreign regulator recognised by the BMA.
Register of Directors
In keeping with the global trend towards increased transparency, it is now a requirement under the Companies Act that the Register of Directors of every Bermuda company be lodged with the Registrar, where it will be publicly available for inspection. The Register of Directors must contain the following information with respect to each director of a Bermuda company: (i) if an individual, his/her present first name, surname and address; or (ii) if a company, its name and the address of its registered office. Whilst there is a requirement to disclose the identity of the directors, there is no requirement for such directors to be registered or licensed with a governing body or to satisfy any additional
disclosure or regulatory requirements.
Anti-money laundering and anti-terrorist financing
The Bermuda Government and BMA are committed to ensuring that Bermuda’s anti-money laundering and anti-terrorist financing (AML/ATF) requirements are aligned with the highest international standards, and legislative amendments have recently been implemented to further strengthen the regulatory regime in Bermuda. These include
extending the scope of those entities which fall within the definition of an “AML/ATF Regulated Financial Institution”, and enhancing the registration requirements for such entities where such entities are not otherwise licensed, registered or authorised by the BMA.
The year ahead
We are seeing an increase in the number of tailored investment structures and single investor vehicles being utilised in Bermuda. These “fund of one” structures are especially popular with funds of funds (FoF), in which the investor, in this case the FoF, is the sole investor in a specific vehicle or fund. These structures allow the FoF to create a bespoke investment rather than investing in a target fund as an ordinary limited partner. As “fund of one” structures continue to grow in popularity, we anticipate that the subscription credit market will also look to expand its offering to facilitate lending to these types of structures.
Another innovative legal structure which Bermuda offers, and where there is increasing interest, is the segregated accounts company. Under the provisions of the Segregated Accounts Companies Act 2000, a mutual fund company may be registered as a segregated accounts company, enabling it to create different share classes, each representing a
segregated portfolio of assets. Accordingly, where a multi-class structure is desired with a separation of liability between classes, it is not necessary to incorporate multiple companies in an umbrella form. Instead, a single segregated accounts company may be incorporated, with segregated accounts representing each share class. Such accounts enjoy a statutory division of liability, effectively ring-fencing each segregated account from the general
liabilities of the company, and from other segregated accounts. Bermuda segregated accounts can invest in other segregated accounts in the same company, creating a master/feeder structure, making it possible to invest and redeem without the capital leaving the company and creating a capital transfer.
Bermuda will continue its commitment to developing new and innovative products, and we will continue to see a ‘collaborative effort’ by regulators, government and industry professionals to ensure Bermuda continues to provide innovative fund products and maintains its position as a leader in the offshore funds world.