The British Virgin Islands has passed the Securities & Investment Business Act (SIBA). The law fine-tunes the framework for investment funds and could give the BVI an edge in offshore funds business.

2010 is shaping up to be a busy year for financial regulators.

Governments around the world have shaken off the shock of the financial crisis and moved to improve oversight and supervision of the financial industry.

In the US the Dodd-Frank Act has rewritten the rules for financial institutions, imposing tighter controls on banks and requiring hedge fund managers to register with the Securities & Exchange ­Commission (SEC).

The UK’s recently elected coalition government has bolstered the authority of the Bank of England to regulate financial business and stripped the Financial Services Authority of many of its powers.

The European Union (EU) continues to press ahead with its alternative investment fund managers (AIFM) directive, although it remains behind the curve in other areas.

The British Virgin Islands (BVI) is not to be left behind. The government there has recently enacted an ambitious and wide-ranging law governing the regulation of all forms of financial and investment business in the jurisdiction. Local practitioners believe the revamped regulations, while not revolutionary, could give the BVI an edge in the offshore funds business.

In the context of sweeping regulatory changes elsewhere, the long-awaited ­enactment of the Securities & Investment Business Act (SIBA) in the BVI may not have registered on the radar screens of many in the financial industry. The regulatory changes have potentially far-reaching consequences for hedge funds and ­service providers.

The BVI is the world’s largest offshore corporate domicile. There are close to 500,000 international companies registered in the jurisdiction. Of these around 3,000 are hedge funds, making the BVI the world’s second-largest offshore hedge fund domicile, behind only the Cayman Islands.

SIBA is an ambitious piece of legislation. It governs the regulation of all forms of securities and investment business in the BVI, including some activities which were ­previously unregulated.

The most significant change under SIBA is that it requires all persons and companies engaged in investment business to be licensed by the BVI Financial Services Commission (FSC). In the past only fund administrators and managers of open-ended investment funds were required to obtain a licence.

SIBA authorises the FSC to regulate the full gamut of financial service providers including investment advisers, custodians and brokers, among others. Fund managers of closed-ended vehicles will also be subject to licensing requirements for the first time.

The legislation also creates a framework for the public issue of securities and the operation of exchanges in the BVI which will come into force at a later date. Finally, SIBA ­introduces a regime for preventing market abuse including insider trading and market manipulation.

The good news for hedge funds is that SIBA does not make any significant changes to the way investment funds domiciled in the jurisdiction are regulated by the FSC.

“SIBA fine-tunes the regulatory framework for investment funds in the BVI and ­codifies existing policies and practices of the regulator which were previously enforced informally. It is not a major departure from what we had in the past,” says Ross Munro, a partner in the BVI office of the law firm Harneys.

BVI investment funds were previously governed by the Mutual Funds Act of 1996. SIBA repeals and replaces the Mutual Funds Act while retaining the overall structure of the previous regime.

“The Mutual Funds Act was an effective piece of legislation. SIBA revisits and updates the provisions of the Mutual Funds Act to take account of changes in the market since it was introduced, but there was no reason to make significant changes to the model. The fundamental approach to regulating investment funds in the BVI remains the same,” explains Simon Schilder, partner in the BVI office of the law firm Ogier.

SIBA provides for three categories of regulated funds in the BVI: private and professional funds for sophisticated investors and public funds suitable for retail investors. Public funds must be registered and licensed by the FSC while private and professional funds have to be recognised by the regulator before starting operations.

Professional funds are the most popular of the three categories, accounting for around 66% of regulated funds in the BVI. They may only be offered to professional investors or persons with a net worth of above $1 million and are subject to a minimum investment threshold of $100,000.

Private funds are not subject to any minimum investment or investor suitability requirements. However, in order to qualify for this category the fund must be limited to 50 investors and be offered purely on a private basis. There are around 800 private funds domiciled in the BVI.

The public funds category is designed for products aimed at retail investors. This category is considered unsuitable for hedge funds due to the tighter registration and licensing requirements.

SIBA will have a minimal impact on existing private and professional funds in the BVI. Investment vehicles established under the Mutual Funds Act are automatically registered or recognised under SIBA. The same applies to fund managers and administrators licensed by the FSC under the ­previous regime.

SIBA introduces a number of small changes which are relevant to hedge funds. Among them is a requirement for BVI funds to appoint an authorised representative in the jurisdiction. This is in addition to the existing requirement to have a registered agent in the BVI. The authorised representative is responsible for maintaining certain records on the fund and acts as a local point of contact for the FSC.

SIBA also tightens the minimum investment threshold for professional funds by requiring all investors to commit at least $100,000, not just a majority as in the past.

Another change under SIBA permits professional funds to start business up to 21 days before receiving formal recognition from the FSC, an advance from 14 days under the Mutual Funds Act.

The specific regulatory requirements for BVI funds are outlined in the Mutual Fund Regulations which came into force at the same time as SIBA.

The BVI has what is best described as a hierarchical system of regulation under which primary legislation is supplemented by regulations and codes issued by the BVI government and the FSC. This model gives the authorities a degree of flexibility in implementing legislation and enables them to be responsive to changes in the market. Regulations can be issued or amended through an act of cabinet while the FSC has the power to prescribe codes.

In many cases the Mutual Fund Regulations simply codify the existing policies and practices of the FSC which were previously enforced informally. For instance, the regulations require every private and professional fund in the BVI to appoint independent functionaries, including a fund manager, administrator and custodian bank.

BVI funds must prepare audited financial statements and file them with the regulator on an annual basis, although a local audit sign off is not necessary. There is also a requirement to have a minimum of two directors, one of whom must be an individual.

The FSC has the power to grant exemptions from the requirement to appoint a manager and custodian bank although there are no exemptions from the requirement to appoint an administrator.

Private and professional funds must also include a prescribed investment warning in their offering memorandums. The regulations prohibit a hedge fund from accepting a subscription from an investor until they provide written acknowledgement that they have received and understood the warning.

“Private and professional funds will have to update their offering memorandum to include the prescribed warning. Subscription agreements will also have to be revised to include the necessary acknowledgement from investors,” says Catherine Ross, a partner in the BVI office of Walkers.

The regulations specify various ongoing notification and reporting requirements for BVI funds. For example the FSC must be informed of material amendments to the legal documents of the fund and any change to the functionaries or ­authorised representatives.

The FSC plans to issue a Public Funds Code which will define the regulatory requirements for BVI investment funds aimed at retail investors. The regulator is currently seeking industry feedback on a draft version of the code which covers areas such as corporate governance, the segregation of assets and the implementation of valuation and pricing policies. A final version of the code is expected to be in place by the end of the year.

There are no plans to issue a similar code for private and professional funds, according to Brodrick Penn, director of investment business at the FSC.

The Regulatory Code, which applies to companies that require a license to operate in the BVI, is also in the process of being updated by the FSC. This includes BVI-domiciled fund managers, investment advisers and administrators.

The updated Regulatory Code is widely expected to include formal requirements for these entities to appoint compliance officers, file business plans with the FSC, purchase professional indemnity insurance and meet certain capital requirements. The industry is also being consulted over amendments to the code.

BVI lawyers have welcomed SIBA as a positive for the jurisdiction. “It brings greater certainty and stability to the jurisdiction. The requirements for investment funds are set out in black and white in one comprehensive piece of legislation. It is very clear exactly what is expected of funds based in the jurisdiction,” says Richard May, a partner and head of the investment funds practice in the BVI office of Walkers.

The move to codify the rules and requirements for investment funds is a response to the changing business environment, notes Kieran Walsh, a partner and head of the BVI funds group at Maples and Calder.

“The financial crisis has changed the regulatory landscape,” says Walsh. “The international community expects to see more visible regulation of investment and financial business. SIBA brings the BVI in line with international best practices and puts the jurisdiction in a stronger position to attract business over the coming years,” Walsh says.

“SIBA seems positive,” agrees Daniel Cann, a director at Folio Administrators. He describes the provisions of the legislation as “sensible”. However, he has some concerns about the wisdom of introducing potential costly regulatory requirements at a time when the funds industry continues to face ­business challenges.

“Regulation always leads to additional costs. Funds will have to take legal advice on how SIBA impacts them and some may have to appoint additional functionaries and directors. The cost may be hard to swallow in this environment,” notes Cann. “However, the BVI remains a more cost effective jurisdiction for hedge funds than Cayman even with these changes,” he adds.

The global recession has prompted many offshore jurisdictions to increase their regulatory fees to counterbalance declining business activity. The BVI is no exception. The annual regulatory fees for professional and private funds are set to rise to $1,000 in 2011, up from $350 currently. This is the first time regulatory fees have been increased for BVI funds since the Mutual Funds Act came into force in 1996. However, the BVI remains less expensive than Cayman, which raised its annual fee for funds registered under the Mutual Funds Law to $3,658 at the beginning of 2010.

Lawyers and fund services providers in the BVI believe the jurisdiction is a strong alternative to Cayman for hedge funds seeking an offshore domicile. Following the enactment of SIBA, the BVI is thought to be fully compliant with the best practice standards of international watchdogs such as the International Monetary Fund (IMF) and the International Organization of Securities ­Commissions (Iosco).

The jurisdiction will soon find out exactly where it stands with regard to international requirements. In April the BVI hosted a delegation from the IMF conducting an exhaustive review of the rules and regulations governing its banking and asset management industries, among other things. The IMF is expected to issue its report before the end of the year. Local practitioners are confident the BVI will receive a clean bill of health.

The BVI government has also made a big effort to comply with the Organisation for Economic Co-operation and Development’s (OECD) standards of tax transparency and information exchange. In April 2009 the BVI found itself on the grey list of 38 jurisdictions accused by the OECD of failing to implement fully international standards on tax transparency. The BVI and other jurisdictions on the grey list were given six months to sign a minimum12 tax information exchange agreements (TIEAs) or face possible sanctions.

The BVI government moved quickly to agree the requisite TIEAs and currently has 17 such agreements in place, including TIEAs with the US, the UK and China.

The enactment of SIBA and the drive to sign TIEAs mean the BVI is well positioned to meet the equivalency criteria under the EU’s AIFM directive, according to lawyers in the BVI.

The AIFM directive remains clouded in uncertainty and there is a real question mark over how the law will impact BVI-domiciled hedge funds, admits Valerie Georges-Thomas, a partner in the BVI office of law firm Appleby. “It is hard to advise clients on this issue until the directive is finalised. However, we are in a strong position relative to other offshore centres,” she says.

“The BVI is fully compliant with all relevant international standards on financial regulation, tax transparency and anti-money laundering. We are in a strong position to meet the equivalency criteria of the EU, provided they are reasonable,” adds Georges-Thomas.

Robert Briant, a partner in the BVI office of Conyers Dill & Pearman, agrees the BVI has the framework in place to meet any requirements outlined by the EU. “The BVI is well regulated and transparent and meets all international standards on regulation. I don’t anticipate any major problems. At the moment it’s all smoke and no fire,” he says.

Conyers has advised its clients to “continue doing business as usual” at least until the directive is finalised and enacted by the EU. “We have not had any clients redomicile funds in either the BVI or Cayman to onshore jurisdictions in Europe,” says Briant.

The BVI is gearing up for a major promotional effort to increase its profile as an offshore funds domicile. The BVI International Financial Centre (IFC), the marketing arm of the local financial services industry, is planning a series of conferences and road shows in the US, Europe, Latin America and Asia over the next 12 months.

The idea is to place the BVI on the same footing as the Cayman Islands for alternative funds business, explains Sherri Ortiz, executive director of the IFC. “Cayman has over the years established itself as the leading offshore funds domicile. We need to ensure that everyone understands the BVI is on a par with Cayman in terms of its regulations and service capabilities,” she notes.

Ortiz highlights the BVI’s position as the world’s largest offshore corporate domicile and says fund managers can leverage the regulations, infrastructure and service providers that have emerged in the jurisdiction to support this business.

“The BVI has been in the financial services business since the 1970s. The corporate world has shown great confidence in the BVI over the years. We would like to see more fund managers take advantage of the expertise and experience that we have to offer as an international financial centre,” says Ortiz.

The BVI is already seen as a blue-chip jurisdiction in developing markets. It has consistently been the second largest source of foreign direct investment (FDI) into China, surpassed only by Hong Kong. It is also one of the major channels of investment into India. The level of outward FDI by Indian companies being channelled through the BVI is also growing.

The BVI has also established strong links with Latin American companies. The IFC hosted a conference in Brazil earlier this year, following a successful mission to the country in 2009. Ortiz reports business flows from Latin America are on the rise.

The bulk of the work from developing countries continues to be company incorporations, says Ortiz, but the amount of investment funds business is increasing.

The IFC is also redoubling its promotional efforts in the US and Europe. “Our biggest push is going to be in New York,” says Ortiz. In September the IFC will host its first major conference in New York for over five years. The FSC and representatives from BVI law firms will be there to discuss the jurisdiction’s regulatory framework and its strengths as an offshore funds domicile.

“We genuinely believe we have all the pieces in place to be a leading offshore jurisdiction for hedge funds. The challenge is to get the message out to fund managers and service providers in the major onshore financial centres and ensure they appreciate what we have to offer,” Ortiz concludes.