The regulatory framework for investment and securities business is undergoing major change, says Brodrick Penn, British Virgin Islands Financial Services Commission director of investment business.

The British Virgin Islands (BVI) Financial Services Commission (FSC) is at the centre of efforts to tighten and refine the regulatory framework for hedge funds and other forms of investment business in the jurisdiction.

The recently enacted Securities & Investment Business Act (SIBA) grants the FSC broad powers to supervise all forms of securities and investment business in the BVI, including some activities that were previously unregulated in the jurisdiction.

The job of implementing and enforcing the provisions of SIBA falls largely to FSC director of investment business Brodrick Penn (pictured) and his team.

The FSC is the sole and autonomous regulator of all financial services activity conducted in or from the BVI. The FSC was established in 2002 and is led by the BVI’s enigmatic financial services guru, Robert Mathavious. It is organised in a number of divisions which are responsible for the day-to-day regulation of all financial services business in the BVI, including banking, insurance activities and investment and securities business, among other areas.

The FSC’s investment business division over­sees close to 3,000 investment funds domiciled in the BVI and is responsible for licensing financial services providers operating in the jurisdiction.

Penn has been involved in regulating investment funds business in the BVI for over a decade. He is widely acknowledged as a strong regulator with a keen commercial sense. The FSC’s investment business division has developed a modern approach to regulation which has helped attract significant hedge fund business to the jurisdiction.

The FSC aims to promote a “prudent and sound” regulatory framework while also encouraging the conduct of legitimate financial business in the BVI, says Penn. “The FSC prides itself on robust regulation which is also flexible enough to meet the needs of business. We have worked closely with the private sector over the years to implement robust regulations that are also business friendly and we will continue to do so,” he notes.

Penn describes SIBA as a key piece of legislation which brings the BVI in line with international standards while retaining the flexibility that has come to characterise the jurisdiction.

SIBA does not introduce any major changes to how hedge funds are regulated in the BVI. Penn says this is testament to the strength of the previous regime, which continues to have resonance in the modern marketplace.

“The BVI is somewhat unique in that we have had a regime for regulating all types of funds business since 1997, unlike some other jurisdictions which provided exemptions for hedge funds or their managers or simply did not regulate them at all,” says Penn.

Hedge funds domiciled in the BVI must be registered or recognised by the FSC to conduct business, while fund managers and administrators require a licence to operate in or from the jurisdiction. That has not changed.

The main thrust of SIBA has been to grant the FSC the authority to regulate investment and securities activities beyond pure funds business. Its remit now includes the supervision of persons or entities engaged in the provision of investment advice, dealing in investments, arranging investment deals or maintaining custody of investments among other activities.

SIBA introduces a regime for preventing market manipulation and insider trading which the FSC is charged with enforcing.

“One of the primary aims of SIBA was to bring the regulatory regime in the BVI in line with international standards, such as the International Organization of Securities Commissions (Iosco) principles on regulation. In some cases, that meant expanding the remit of the FSC into areas that were previously unregulated in the BVI,” says Penn.

He believes that with the introduction of SIBA the BVI has a regulatory framework which meets international principles and standards.

SIBA is only one part of the BVI’s hierarchical system of regulation, whereby primary legislation is supplemented by regulations and codes, which are issued by the BVI government and the FSC.

“SIBA establishes the framework for conducting financial business in the BVI and sets the overall tone for the regulation of these activities. The regulations and codes outline the specific requirements for entities engaged in various forms of investment and securities business,” explains Penn. This model gives the FSC a degree of flexibility in terms of how the legislation is implemented and allows it to be responsive to changes in the market.

The requirements for establishing and operating investment funds in the BVI are contained in the Mutual Fund Regulations, which was published at the same time as SIBA.

The FSC is in the process of consolidating its expanded regulatory remit through a series of amendments to its regulatory code, which outlines the specific requirements for businesses which need a licence to operate in the BVI, including locally-based fund managers and administrators.

“The code will include some additional requirements for BVI-based fund managers and administrators that were absent from the previous mutual funds law,” says Penn.

The amendments are currently the subject of industry consultation and according to Penn “it is too early to say anything definite about the requirements that will ultimately be included in the code”.

Penn says any additional requirements in the code will be subject to a “nature, size and complexity” test which will allow the FSC to exercise some flexibility depending on the circumstances of the business being regulated.

“We do not want to import regulations that are too onerous to the business community. We are sensitive to the pressures on smaller businesses or those engaged in simple activities. Bigger and more complex business will be subject to tighter requirements,” he says.

The FSC also plans to issue a public funds code in the near future. This will contain additional requirements for investment products aimed at retail investors.

One of the investment business division’s core functions is assessing applications to establish investment funds in the jurisdiction. SIBA provides for three categories of regulated investment funds which can be established in the BVI: professional and private funds which are recognised by the FSC and public funds which must be registered with the regulator.

The FSC makes an important distinction between applications for the recognition of professional or private funds and the registration of public funds, which are aimed at the retail market.

The FSC’s licensing supervisory committee (LSC) is ultimately responsible for approving all applications to conduct investment business in the BVI. In the case of professional and private funds, the LSC has delegated this authority to Penn and his team at the investment business division.

“Having the authority to approve professional and private funds within the investment business division means we can facilitate much faster turnarounds for these applications. We understand the importance of getting these funds up and running quickly and the implications for finalising seed investments and service provider arrangements,” says Penn.

The investment business division routinely communicates its decisions to applicants within 24-72 hours, although the process can take longer if the proposed fund is unusual or complex, says Penn.

The first step in assessing an application is determining whether or not the proposed fund meets the requirements under SIBA for professional and private funds, such as the minimum investment threshold and ­marketing restrictions.

The investment business division then assesses the fitness and propriety of the main functionaries of the fund, including the ­investment manager, administrator, auditor ­and custodians.

The process involves regulatory due diligence on the people and organisations behind the fund. Penn and his team also aim to determine whether the manager and other service providers have the requisite experience, expertise and resources to operate it.

“We have to be comfortable with the manager and the service providers before recognising a fund. We will look through the principals and beneficial owners and the resources of the manager and other functionaries to assess their suitability for running the fund,” Penn explains.

Penn would like to see greater international co-operation on hedge fund regulation. “Hedge funds, more so than many other investment products, are truly borderless,” he notes.

“This is an industry where the corporate structure of the fund can be in the BVI while the manager could be in the US, the administrator in Dublin and the custodian is in Hong Kong. The global nature of the business demands a globally consistent approach to regulation,” says Penn.

“The various regulatory agencies around the world need to be on the same page because to a great extent we are relying on each other to effectively regulate the different aspects of the industry,” he adds.

In his view Iosco is best placed to forge a global consensus on the regulation of hedge funds. The BVI is a full member of Iosco and participates in its regional bodies, such as the Inter-America Regional Committee (IARC).

Penn says the BVI is fully behind Iosco’s high level principles on hedge fund regulation published in 2009. “Iosco is leading the way towards the adoption of global standards for hedge fund regulation,” he says. However, he believes there is still more work to be done on the international stage.

“There has been a lot of progress in defining how financial services ought to be regulated over the past year, but the overall picture is still far from clear. The US has enacted a significant overhaul of its regulations but the EU’s proposals on regulating hedge funds have still not crystallised,” says Penn.

He notes the Dodd-Frank financial reform legislation which will require US hedge fund managers to register with the Securities & Exchange Commission (SEC) and says this could help the FSC to regulate BVI funds.

“There is a degree of comfort that comes from knowing a manager seeking to establish a BVI fund is regulated by the SEC as opposed to running its business through a shell company that is not subject to regulation,” says Penn.

He is somewhat guarded when talking about the EU’s alternative investment fund managers (AIFM) directive which has been roundly criticised in the hedge fund industry. In its current form the directive could have a harmful impact on the offshore hedge fund business.

Penn says he is reserving judgment on the directive until it is finalised and ratified by the EU.

Penn is a strong believer in the need to balance prescriptive rules with a principles-based approach to regulation. The financial crisis has prompted many regulators around the world to be more prescriptive but Penn says a one-size-fits-all model of regulation is inappropriate for a jurisdiction like the BVI which caters to financial companies from every corner of the globe that offer a myriad of products and services to their clients.

“Our preferred model is to combine certain prescriptive rules with a principles-based approach to how these rules are enforced and applied. That gives us the flexibility to meet the needs of business,” says Penn.

For instance, SIBA requires all BVI funds to have an independent administrator, custodian and auditors. However, the FSC has the power to grant exemptions on a case-by-case basis.

“There may be certain circumstances in which it does not make sense to have a traditional custodian, for instance, if the fund is investing in esoteric assets. In those cases we will look at the safeguards and controls around client monies and the assets of the fund and provide an exemption if we are comfortable with those arrangements,” says Penn.

Exemptions are not granted lightly, he stresses. “We will look at all the risks and whether a legitimate commercial goal is being pursued before granting exemptions,” he explains.

This balance between prescriptive rules and the flexibility to provide certain exemptions on a case-by-case basis is at the heart of the BVI’s success as a hedge fund domicile and international financial centre.

“The mandate of the FSC is to create a sound and prudent environment in which funds business can thrive. This involves setting certain basic standards for doing business in or from the BVI, including safeguards to prevent fraud and other such abuses. However, the requirements must not be so onerous as to discourage legitimate business from being conducted here,” says Penn.

The FSC has a broad investor protection mandate. This is somewhat tempered in the case of private and professional funds which are subject to restrictions on marketing and distribution.

“Professional funds come with a significant ‘buyer beware’ sticker,” says Penn. “These funds may only be marketed to professional investors who are required to acknowledge that they understand the risks before investing. Investors in these funds have a responsibility to be vigilant.”

In the case of public funds, the FSC is more proactive about invoking its investigatory and enforcement powers to protect investors, says Penn.

The FSC will emphasise the application of appropriate standards for different types of investment products as it continues to refine and develop the regulatory framework in the BVI, he concludes.