Dawn Griffiths (Director), Peter Ch’ng (Director), Elizabeth Denman (Director) and Christopher Page(Counsel)
Conyers Dill & Pearman
Bermuda may not be the first place one thinks of for offshore investment funds, but it ought to be.
Bermuda’s global pre‐eminence in the reinsurance industry is undisputed ‐ it is currently home to 1,291 insurance companies which generated a gross premium of US$107.7 billion as at the end of 20101. Recent figures show that Bermuda is the pioneer offshore hedge funds jurisdiction. In fact, Bermuda’s registered funds have increased from US$159.51 billion of total net asset value2 in 2011 to US$185.39 billion in Q3 of 20123.
Bermuda’s funds industry is in the throes of an ILS revival. The phenomenon of insurance‐linked securities (ILS) as an ascendant alternative asset class4 in these uncertain economic times has taken special hold in the funds and reinsurance markets in Bermuda. Its historical ties to the US and to the UK, the depth of market service experience, a well ‐ respected regulatory regime and an internationally recognised stock exchange are creating a perfect triangulation of the reinsurance, funds and capital markets spaces with Bermuda in the centre of the vortex.
Here are 10 reasons why:
1. Location, industry depth and experience
Bermuda is the third largest offshore insurance and reinsurance centre in the world with global insurance giants having established physical operations on the ground in the last decades. According to the Economic Impact Study 20125, Bermuda is the most important foreign provider of insurance services to the US. PwC records Bermuda as holding 19% of ILS investors in the world, second to the US and tied with Switzerland ‐ an impressive feat, for a geographically small jurisdiction.
Bermuda’s sophisticated infrastructure is keeping in step with the development of the ILS market. Bermuda has an extraordinary concentration of professional funds and insurance talent operating in a regulatory environment already on track to service the world’s ILS market players.
2. Corporate governance: A race to the top
Even before the 2008 financial credit crisis, Bermuda embarked on a path of setting itself apart from the perceived offshore tax havens by pursuing a strategy of global co‐operation and transparency. Eschewing a short‐term ‘race to the bottom’ strategy of luring ‘all and sundry’ with lax regulation and supervision standards prevalent in other jurisdictions, Bermuda has chosen instead to ‘race to the top’. Bermuda has been on the OECD White List since June 2009 and was appointed Vice‐Chair of the OECD Global Forum on Transparency and Exchange of Information for Tax Purposes Steering Group. Bermuda’s strategies target top‐shelf industry players committed to the long‐game by choosing to domicile in an established jurisdiction capable of weathering any OECD challenges and shake‐ups, providing a respected regulatory environment in a post‐recessionary world.
Bermuda was set on pursuing a bifurcated approach to Solvency II – striving to achieve regulatory equivalency for commercial insurers through the adaption of enhanced capital requirement (ECR) whilst retaining its lighter, more flexible regime for those on the captive end of the spectrum.6 Bermuda is reportedly on track for equivalency for commercial insurers following an on‐site visit from the European Insurance & Occupational Pensions Authority and may be considered a step ahead in light of recent delays in implementation of Solvency II in Europe. In respect of its captive regime, Bermuda does not propose to seek Solvency II equivalency, but will adopt a proportionate risk‐based and pragmatic approach to enhancing Bermuda’s regulatory regime to relevant global standards. Fitch’s senior director of insurance is of the view that Bermuda will benefit from equivalency and continue to attract reinsurers. An offshore jurisdiction with a positively viewed regulatory environment
is projected to be attractive to companies, particularly those looking to go to market in the face of the global trend towards higher standards7.
3. Strong ratings
Bermuda continues enjoying strong IDR ratings (Fitch AA-; S&P AA‐; Moody’s Aa2). While there have been some blips in the ratings ride over the year, they are more a reflection of weaker macro economic performance and the build up of government debt. The rating agencies are broadly in agreement on Bermuda’s wealth (4th highest GDP per capita among Fitch’s surveyed peers) and its competitive advantage as a domicile of choice for insurance, reinsurance and financial services companies owing to its sophisticated legal system, strong regulatory framework, simple tax regime, proximity to the US market and highly-skilled business capital. The agencies believe that the Bermuda government will continue to renew its commitment to business‐friendly policies.
4. The Bermuda Stock Exchange
The Bermuda Stock Exchange (BSX), the largest offshore fully electronic securities market, has been attracting record cat bond listings in the last two years; its cat bond listing grew from US$0 to US$1.17bn in less than a year in 2010. Listing on the BSX transforms the securities into an acceptable mandate asset class for certain public institutional investors, such as public pension funds.
The BSX provides critical capital market support to the fast ‐ developing ILS market. As at the close of 20128 the BSX’s cat bond/ ILS listings was valued at over US$5.81 billion with 38 ILS issuers listed at the BSX with the momentum set to continue.9
Overall, the ILS market hit a record US$16.54 billion dollars in 201210. It is expected that there are many more listings in the pipeline making 2013 another active and positive year.11
5. Pension plan investors
Pension funds and retirement schemes have been leading the charge in pumping capital into ILS products in a bid to diversify their equity and stock market exposures into less volatile and non‐correlating risks and higher yields (between 5‐7% on average), spurring demand in the ILS space. Pension funds have amassed huge capital work with a longer investment time horizon and have traditionally been active in alternative investments with increasing allocations to alternative assets. Sluggishness in exchange traded securities is increasingly driving them to seek greater returns in the face of their rapidly aging baby‐boomer beneficiaries.
The dominance of pension fund investors is expected to escalate further over the next few years.
6. The legal framework
The typical ILS investment fund structure centres around the following corporate limited liability vehicles, frequently in combination:
(a) a mutual fund company authorised or exempted under the Investment Funds Act 2006 (ILS Fund); and
(b) an insurance company (likely a ‘special purpose insurer’ or ‘SPI’) registered under the Insurance Act 1978 (ILS Issuer).
An open‐ended investment fund company issuing participating shares to investors may be incorporated in Bermuda and required to be authorised under the Investment Funds Act 200612 as:
(a) an institutional fund if the shares are essentially offered to ‘qualified participants’ (i.e. sophisticated high ‐ net worth investors) or if the fund required a minimum investment of US$100,000 per participant and has an officer, trustee or representative present in Bermuda with access to its books and records;
(b) an administered fund if its administrator is licensed under the Investment Funds Act 2006 and requires a minimum participation of US$50,000 or is listed on a recognised stock exchange; or
(c) a standard fund if it does not qualify as under (a) or (b) above, unless exempted by the Bermuda Monetary Authority.
Regulated funds typically require the appointment of auditors in connection with the filing of financial statements, a fund administrator and an independent custodian to safeguard the fund’s assets, unless exempted by the Bermuda Monetary Authority.
Most significantly, there is scope for exemption from authorisation if the funds are (i) open only to ‘qualified participants’; (ii) is administrated by a licensed fund administrator; and (iii) has appointed an auditor and has an officer, trustee or registered representative in Bermuda with access to its books and records. Many private equity funds operate as exempted funds.
Total exclusion from regulation is available to (a) closed‐ended funds i.e. investors holding non‐redeemable securities or (b) when a fund has less than 20 investors and does not promote itself to the public generally.
Investment funds could also be organised as unit trusts or limited partnerships with unit trust structures being particularly favoured by Japanese and Asian fund managers and investors.
A master‐feeder structure with a Bermuda feeder unit trust targeting for example, Japanese investors, funnelling into a corporate Master Fund is a time‐tested structure. In December 2011, in recognising the importance of foreign financial markets, Bermuda created a further category of funds known as a ‘specified jurisdiction fund’ for authorisation if the jurisdiction in which it operates and the laws and regulation it is to operate under are recognised to apply to these funds. In June 2012, as a special nod to the Japanese funds market, the BMA issued the Investment Funds (Specified Jurisdiction Fund) (Japan) Order 2012 and the Investment Funds (Specified Jurisdiction Fund) (Japan) Rules 2012, to facilitate the marketing of Bermuda domiciled funds and unit retail funds to the Japanese investing public in compliance with Japan’s Fair Business Practice Rules #4 (Regulations Concerning Foreign Securities Jurisdiction) of the Japanese Securities Orders Associations (JSDA Regulations). The Bermuda Order envisions that the Bermuda funds and unit trusts targeted to Japanese investors will meet JSDA Regulations giving Japan dealers and distributors greater confidence to offer Bermuda funds and unit trusts in Japan in compliance with Japanese laws.
The ILS Fund typically invests in cat bonds, industry loss warranties (ILWs) and a variety of opportunistic reinsurance products ranging from mortality bonds, property and catastrophe reinsurance (though reinsurance must be conducted through a licensed insurer like a SPI).
The fundamental characteristics of the SPIs are that the insurance contracts must be fully‐funded and the parties to the transactions must be sophisticated. In return, the SPIs enjoy an expedited application process, overall lighter regulation and only nominal capital requirements. Further there is a vast array of transactions for which an SPI can be used. Provided those fundamental characteristics are in place, the BMA is predisposed to approve myriad investment and business models and strategies.13
The ILS Issuer may typically be owned and operated in tandem with the ILS Fund with the fund allocating capital to the ILS Issuer to fund specific ILS participations underwritten by the ILS Issuer. The ILS Issuer distributes earned premium and investment profits to the ILS Fund.
Yet a further refinement in the above structure is to give the ILS Fund and the ILS Issuer the power and ability to legally segregate and profile investor classes, or strategies and transactions by registering the entities as segregated accounts companies (SAC) under the Segregated Accounts Companies Act 2000. This would enable an SAC ILS Fund to issue multi‐class securities to investors tiered to individual risk profiles and investment appetites, mandates and strategies. Registering the ILS Issuer as a SAC also has the advantage of isolating and ring-fencing the legal and financial risks in respect of each cat bond or reinsurance program within separate cell structures achieving limited or non‐recourse to the other assets of the ILS Issuer, ensuring the continuity and integrity of the overall
structure as a legal bulwark against adverse results, claims or liabilities – essentially creating a bankruptcy‐proofed structure.
It should also be noted that ILS Funds may be formed with a minimum share capital of US$1 and the BMA has slashed the insurance licensing fee of SPIs by 50% to US$6,000 from April 2012.
The Companies Act 1981 of Bermuda was recently amended to allow companies to have a single director (previously two) and for such directors to be corporations as opposed to individuals, facilitating the management of Bermuda companies on a committee basis at the corporate director level and possibly providing an additional layer of insulation from personal liability.
Fund managers and asset management companies managing their own offshore ILS Funds are generally not required to be regulated by the BMA and are free to chart their own strategic course and operations on and off the island.
7. Cost advantages
Bermuda has not been idle in a time of competition from other offshore jurisdictions and is eager to debunk the myth that the fund formation and running cost in Bermuda is more expensive. A toe‐to‐toe breakdown of the average formation of Bermuda and Cayman Islands mutual fund companies shows that they are very close.
Bermuda mutual fund companies are not required to have a minimum share capital and can be incorporated in two business days.
8. Government support
The seeds for self‐examination were arguably sown in 2009 when Bermuda First was created as a non‐partisan, public‐private partnership, funded jointly by the Bermuda government led by the Progressive Labour Party and its leading businesses. Co-chaired by the then Premier, Opposition Leader and senior professionals, its purpose was to ‘better understand Bermuda’s overall economic position’.14 Its reported recommendations for ensuring Bermuda’s continued prosperity in light of the 2008 financial crisis included the deepening of Bermuda’s ILS market.
The Government commissioned the industry‐driven Bermuda Asset Management Task Force in January 2011 to lead an initiative to identify key development drivers in the financial services industry attractive to international business, enhance the Bermuda model and trouble‐shoot impediments to successfully marketing Bermuda to the world. The Task Force’s interim report presented in Parliament highlights two important points:
(a) Unlike the reinsurance market, Bermuda is not the leader in asset management sector. Nevertheless, Bermuda is regarded as the jurisdiction of choice for investment funds with an insurance focus.
(b) The nexus between the need and ability to attract international investors and professional experts to the island and Bermuda’s GDP was acknowledged.
In November 2012, the Government endorsed the Bermuda Business Development Corporation (BBDC), an independent body created to systemise the island’s business development, sustain existing business and actively develop new business. It also pledged to increase the grant available to the new body. In April 2013, the BBDC merged with Business Bermuda and the Insurance Development Council, resulting in all organisations mandated to support growth of international business which receive funding from the Government forming the new BBDC. To boost the financial sector, Bermuda, facilitated by the BBDC, aims to lay out the red carpet for key hedge fund managers and ancillary professionals from portfolio managers, investment researchers, IT, compliance and marketing and investor communications. Bermuda Inc. is open for business.
As a further example of the public/private initiative, the Bermuda Monetary Authority announced in April 2013 that Bermuda is able to satisfy the conditions for becoming a so called “Third County” under the Alternative Investment Fund Managers Directive (AIFMD) and that as such Bermuda investment funds or investment funds managed by Bermuda investment managers are able to be marketed in Europe under the private placement regimes of EU member states and the anticipated extension of the passporting regime to Third Countries in 2015.
9. Tax Information and Exchange Agreements (TIEAs) and Double Tax Agreements (DTAs) Network
Bermuda has signed 35 TIEAs and 3 DTAs as of 6 December 2012.15 The TIEAs aim to establish clear and specific diplomatic rules and protocols on the circumstances by which foreign tax authorities may legitimately request information from the Minister of Finance as part of ongoing criminal or civil investigations or proceedings in the foreign jurisdiction. Essentially, they promote international cooperation in tax matters through the exchange of information between countries party to the agreement. The TIEAs may not be utilised for ‘fishing interrogations’ and confidentiality is to be maintained by the relevant handling authorities. TIEAs are significant and are acknowledgments of Bermuda’s sovereign standing and acceptance by each country paving the way for foreign investment in Bermuda. Notably TIEAs have been signed with all G7 countries.
Bermuda’s growing network of TIEAs and DTAs do in some instances allow for Bermudian incorporated companies to enjoy special tax‐free treatment of repatriated income received by a resident of a treaty country.
Certain TIEAs are elevated to the same status as DTAs. Whilst Bermuda does not tax income earned by Bermuda companies, these agreements do have the effect of exempting taxes on repatriated income that a business or a subsidiary of a business in the other jurisdiction earns in Bermuda. An example of a past TIEA elevated to the status of a DTA is Bermuda’s Canada‐TIEA which came into force on 1 July 2011. The Canada‐TIEA not only facilitates the exchange of specific tax information in tax investigations, it affords favourable tax treatment for business income repatriated by a Bermuda subsidiary of a Canadian corporation operating in Bermuda by exempting it from Canadian tax. This has energised the establishment of Bermuda insurance captives by Canadian corporations, encouraged boutique Canadian hedge fund managers to set up headquarter operations in Bermuda and spurred the movement into ILS space by Canadian institutional investors such as pension funds.
10. Work permit and immigration
Expatriates must have a valid work permit from the Bermuda Immigration. As part of specific Task Force initiatives to boost Bermuda’s fund industry by welcoming hedge fund managers to set up shop in Bermuda, work permit applications may often be expedited for Chief Executive Officers and senior management by granting exemptions from advertisement in local newspapers to offer the job to Bermudians. The rationale is that fund managers operating on the island will spur local employment and economic activity.
A concrete example of Bermuda’s resolve is the enactment of the Incentives for Job Makers Act 2012 in January 2012 whereby qualifying companies may pave the way for their key personnel to obtain permanent residency status free from work permit restrictions. As a signal to all that Bermuda Inc. is open for business, the present Bermuda Government now led by the One Bermuda Alliance abolished work permit term limits for expatriate employees in January 2013 reversing a more than decade-long immigration policy. This gave companies and its key personnel the needed security to make long‐term strategic plans concerning their business future in Bermuda.
The Bermuda Government, the BMA and industry stakeholders have rallied around the ILS business with one voice and have laid the necessary infrastructural ground work to secure Bermuda’s lead position in this fast growing sector.
With many competitive advantages in stellar alignment and the predicted hardening in reinsurance premium rates from the soaking up of global capacity from the recent property catastrophes in the USA, Japan and elsewhere, Bermuda’s reinsurance and investment funds market is poised for another renaissance.
2This does not include the much greater number of close‐ended funds or excluded private funds not required to be regulated by the Bermuda Monetary Authority.
3Regulatory Update February 2013, Bermuda Monetary Authority
4Reported $44 bn in cat bonds have been placed in the market since 1996 according to AON Beneficial Securities Inc.
5Bermuda in the World Economy: Economical Relations with Asia, Europe and the United States – 2012 prepared
by Transnational Analytics LLC, Washington D.C.
6“No Solvency II – type regulation for Captives”, The Royal Gazette, 30 January 2013
7“Fitch director” – Bermuda stand to gain from having greater regulation” – The Royal Gazette. 11 September 2012
82012 Year End Review Report, Bermuda Stock Exchange
9Cat bond issues in 2012 alone utilizing Bermuda vehicles include Lakeside Re III ($225m); Skyline Re ($50m);
Residential Reinsurance 2012 ($400m); Queen Street VII Re ($75m); Atlas Reinsurance VII (228m); Mythen Re
($200m); MultiCat Mexico ($315m); Eurus III (€100m); Embarcadero Re ($300m); Vita Capital V ($275m); Queen
Street VI Re ($100m); Oak Leaf Re ($22.78m); Long Point Re III ($250m); Residential Reinsurance 2012 ($200m);
Mythen ($400m); Everglades Re ($750m); Pelican Re ($125m); Akibare II ($130m); Blue Danube ($240m); Combine
Re ($200m); East Lane Re V ($150m); Mystic Re III ($275m); Queen Street V Re ($75m); Embarcadero Re ($150m);
Kibou ($300m); Ibis Re II ($130m); Successor X ($63m); Vitality Re III ($150m).
10“Insurance-Linked Securities: Fourth Quarter 2012 Update” – AON Benfield
11“Insurance-Linked Securities: First Quarter 2013 Update” – AON Benfield
12If non-redeemable participating shares are issued to investors (i.e. close ended funds), the investment fund may
be excluded from regulation under the Investment Funds Act 2006 altogether.
13“Bermuda Emerging as Centre of Global ILS Business”, 11 October 2012, BMA Press Release.
14“Bermuda First group unveils its vision for Bermuda” – The Bermuda Sun. 3 November 2009
15For full list visit the OECD website: http://www.eoi-tax.org/jurisdictions/BM#agreements
Dawn Griffiths, Peter Ch’ng, Elizabeth Denman and Christopher Page are leading lawyers in the Insurance Linked Securities (ILS) space. Based in Bermuda, they service key ILS clients and are involved from the initial planning stage for new fund products to launch and beyond. Regularly acting for both established and new fund managers and investors, they advise on all legal aspects of ILS investment fund structures, including those with specialised investment in cat-bonds, mortality bonds, industry loss warranties, swaps and opportunistic reinsurance products. The team also has extensive experience advising pension plans and institutional investors with respect to configuring offshore investment vehicles and has played a key role in accessing private and listed ILS funds and products for their clients.
Founded in 1928, Conyers Dill & Pearman is an international law firm advising on the laws of Bermuda, the British Virgin Islands, the Cayman Islands and Mauritius. With a global network that includes 140 lawyers spanning eight offices worldwide, Conyers provides responsive, sophisticated, solution-driven legal advice to clients seeking specialised expertise on corporate and commercial, litigation, restructuring and insolvency, and trust and private client matters. Conyers is affiliated with the Codan group of companies, which provide a range of trust, corporate secretarial, accounting and management services. For more information please visit www.conyersdill.com