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SMART – ICONIC: How The Bahamas continues to evolve its funds industry

The Bahamas is taking steps in the right direction to raise its profile as an attractive funds centre. To succeed as an international funds centre requires not just a proactive regulator but a willingness to respond to the changing needs of the market and develop new products accordingly. 

In that regard, The Bahamas ticks many boxes. It is the first independent country in the region with IOSCO “A” Status, which it received on December 27, 2012. It continues to build out the SMART Fund model template to provide a range of solutions for investment managers. This flexible product range, whose numbers have doubled in the last five years, benefits from sensible supervision and oversight that avoids the heavy-handed approach to regulation taken in other jurisdictions. 

And on the legal structuring side, last November saw the introduction of the ICON – the Investment Condominium that has been designed to appeal, specifically, to Brazilian investment managers and advisers, as well as Latin American managers more generally. 

The ICON is designed to be fully compliant with Brazilian laws and operate like one of the nation’s products. It is intended to target fund-familiar investors looking to diversify away from their domestic market. 

“We now have 830 funds licensed and registered in The Bahamas, 502 of which are SMART funds, representing roughly 60% and underscoring the attractiveness of that product. We’ve been a financial centre for over 80 years focusing on wealth management and a key component of that has been the development of a fund regime that is supportive of our private investor client base but which can also be utilised by institutional investors. 

“We have the Professional fund, which is for qualified investors and more of an institutional offering. We have the Standard fund, which is aimed at retail investors, and then SMART funds, which offer risk-based regulatory oversight within a flexible structure,” explains Aliya Allen, CEO of the Bahamas Financial Services Board whose task it is to raise the profile of The Bahamas internationally and foster development of its funds industry. 

Companies, segregated accounts companies, partnerships and unit trusts, until recently, have been the legal structures available to investment managers. Now, with ICON, they have an additional choice to avail of. 

Ivan Hooper is CEO of Winterbotham Trust Company, which has grown to become the largest fund administrator (by number of funds) in The Bahamas. It services over 50 per cent of the SMART Fund market. 

“We still see a lot of growth on the fund side, particularly with respect to the Brazilian market. In the last 12 months, Bahamian fund vehicles have started to be viewed by managers in other Latin American countries as a benefit to pooling assets; managers in countries including Peru, Colombia and Mexico have found it useful, because of changes in legislation, to establish a regulated entity, even a listed entity, in The Bahamas. 

“Two years we would have focused only on Brazil and institutional clients. Now, we see that the market has started to grow across other Latin American countries,” says Hooper.

Main attractions of The Bahamas

Aside from securing the “A” Standard with IOSCO, The Bahamas’ financial regulator, the Securities Commission of The Bahamas (SCB), takes innovation seriously when it comes to furthering the evolution of its funds industry. For example, an unrestricted fund administrator in The Bahamas has authorisation capabilities that administrators in other jurisdictions simply do not have. They have the SCB’s imprimatur to register Professional and SMART Funds (not Standard Funds), which brings clear speed-to-market benefits to the manager and streamlines the whole process. Ongoing supervision is then conducted by the SCB in line with international standards. 

Christina Rolle is Executive Director, SCB. She explains that for Professional and SMART funds, aspects of the supervisory regime allow for oversight commensurate with the risks involved, “as the investors in these funds are accredited and knowledgeable and are capable of conducting their own due diligence.” There’s more oversight with respect to Standard funds, which are marketed to retail investors.

“Our goal is to ensure the integrity of the industry and ensure that investors are protected. In the case of Professional and SMART funds, we know that investors have a sophisticated level of knowledge so these funds require less intervention, from an oversight perspective. We try to give managers sufficient room to operate,” says Rolle. 

Fostering innovation and allowing new SMART fund templates to be created is another key attraction of The Bahamas. “We have working groups that engage with law firms and other service providers to draft proposals, shape the discussion and so on. We see ourselves as a part of the innovation and development process. It’s important to ensure that the environment is right for any new development to grow. That then helps us on the profile raising side. Year after year The Bahamas continues to see growth in fund numbers. We think the ICON structure will enable us to become even more competitive in terms of our fund offering,” states Allen.

For sophisticated investors who may wish to invest in illiquid asset classes such as Private Equity, Real Estate, Commodities, they can avail of various SMART fund structures. Currently, there are seven templates.

SMART funds have more regulatory flexibility. “The investment manager only needs a simple term sheet as opposed to a full-blown Offering Memorandum. There are three advantages to this: it is cost effective because it saves on legal fees; it makes it easier for investors to digest fund information in a more concise way; and, it reduces time to market”, explains Brian Jones, Managing Director at Deltec Fund Services. 

The SMART fund model

So what exactly is this SMART fund model template that The Bahamas has created? 

The specific mandate alternative regulatory test (SMART) fund model was first introduced to The Bahamas in 2003 under the Investment Funds Act. Since then, it has grown to include seven templates, presenting a range of options for fund sponsors. 

As Allen explains, each of the templates has been developed to meet the particular needs of investors. SMART Fund 002, for example, is limited to 10 investors, SMART Fund 004 can have a maximum of five investors operating as a private investment company, whilst SMART Fund 007 may be offered to up to fifty “super-qualified investors” who must each make a minimum initial subscription of USD500k. 

“Let’s say you’re a sponsor with a particular business case and none of the templates match that business case. You can apply to the SCB for the approval of a new SMART fund template. It’s a process that allows the SMART fund range to grow organically and be very adaptive to market needs. After the financial crisis, when there was a requirement for managers to have side pockets in place for illiquid assets we came up with SMART Fund 006. So each template has arisen out of a specific business case or market requirement. 

“It’s an innovative concept. SMART Fund 007 found a market for large family offices, and more institutional investors, and is now the fastest growing template in terms of registration,” says Allen.

The main difference between a SMART Fund and a Professional Fund is that the latter can be offered to an unlimited number of investors provided they are qualified. 

“When one is choosing the best fund to use, it really depends on who it is that the fund will be marketed to. In my experience, family offices tend to choose SMART Fund 002 or 004. It allows them to save on the associated costs, for example, of creating the Offering Memorandum, doing the annual audit at the end of the year; that’s what makes the SMART fund product so attractive,” states Hooper. 

Indeed, the ability to waive the annual audit, provided there is unanimous investor consent, is another key difference between Professional Funds and SMART Funds. If a manager does decide to waive, they will be required to file semi-annual performance reports to the SCB. 

“There tend to be valuation issues with some of the alternative fund strategies that use the SMART fund so the ability to defer the audit until there is a liquidity event within the fund structure is a big advantage,” says Jones.

Rolle confirms that the SCB is very encouraged by the growth of SMART funds which illustrates the progressive nature of the Bahamas’ funds framework. 

“The SMART fund legislation on the whole was a significant development for The Bahamas. It took a number of years before we started seeing real growth in fund numbers as investors learnt about the product and became more familiar with it but that’s no longer the case. The statistics speak for themselves – over the last year we’ve seen almost an 18% growth in SMART funds,” confirms Rolle.

Jones says that one attractive feature of SMART Fund 007, in particular, is that the rules allow for a single investor. This means that the integrity of funds-of-one can be preserved; something that institutions are beginning to favour more today as they look to protect themselves from commingled risk. The model is also used to establish feeder funds.

Jones was instrumental in drafting the legislative rules for SMART Fund 007 and developing the template. His vision was to create a fund model that would have the appeal of a “quasi-institutional” fund for HNW investors and institutions, and for use as a Special Purpose Fund (SPF). One feature that makes SMART Fund 007 unique is the relatively high statutory initial minimum investment per investor: USD500k.

“We are offering a premium fund model for “super qualified investors”. The fund can only be privately placed and is limited to no more than 50 investors. Consequently, it has a reduced risk profile compared to a Professional fund, which can have an unlimited number of investors,” explains Jones.

As of December approximately 65 SMART funds using the 007 model were in operation within the jurisdiction, says Jones. “Since the start of the year, several more have been licensed so there are probably in excess of 70 such funds today. This is evidence of the fund’s broad appeal, and it certainly fills a niche for private investors.” 

Another scenario where an investment manager might look to the SMART Fund template is if they wish to incubate a strategy, test it in the market to see if it works, and if it does whether it has the potential to gain traction with investors. 

“The manager can then convert that SMART fund into a Professional fund, once it reaches a critical mass in terms of track record. At that point, all of the investors must be qualified and the fund must file an annual audit,” explains Allen.

An ICONIC opportunity

The SMART Fund evolution clearly has been important to The Bahamas but an even clearer illustration of the commitment it has to embracing new ideas, in response to market opportunities, is the creation of the Investment Condominium legal structure. It emerged out of a desire to tap into the Brazilian domestic funds market, thanks to constant dialogue that The Bahamas, through organisations like the BFSB, has with investment advisers in Latin America. 

“This constant dialogue enables us to devise solutions that raise the value proposition of The Bahamas. ICON was a product of that engagement, specifically with managers and advisers in Brazil,” confirms Allen. 

In Brazil, domestic funds are organised as condominiums. What The Bahamas has done with ICON is effectively transplant a civil law contract into a common law jurisdiction. 

“We found it to be attractive for a number of reasons:

• It’s a familiar structure 

• Latin Americans like to use a structure that is not corporate in nature

• ICON is a more robust vehicle from a governance perspective – regulated governance is built within the structure

• It’s an alternative to existing structures that might not fit the particular case for whatever jurisdiction a manager is looking to market their fund in to. 

“We have a lot of work to do educating the adviser community, explaining what ICON is and why it is advantageous, but we are very excited,” says Allen.

To briefly explain, a Condominium is a form of joint ownership of property under Brazilian civil law. This was transposed into the Brazilian investment funds regime as the structure under which managers would register their funds. It is a contractual agreement where investors agree to invest jointly and is similar, in principle, to collective investment schemes in Europe. 

“As a regulator we are called upon to be involved in the development of legislation. We have been involved in the development of very progressive fund legislation, in particular ICON legislation. The SCB’s legal counsel was a part of the ICON development committee that drafted the legislation,” confirms Rolle.

In Ivan Hooper’s opinion, The Bahamas has demonstrated a high degree of insight in modelling and creating a concept that has been demonstrably successful onshore in Brazil for use locally, to see what the appetite might be for a similar product internationally.

“People argue that the ICON only works for Brazil but that’s not true. It’s a special vehicle, a hybrid of a partnership and a unit trust, and has potential appeal beyond Brazil. Being a pioneer in using a structure that has been successful in a domestic market and applying it to common law is very creative in my opinion. At the moment it is targeting Brazil simply because people are familiar with the structure but I think as time goes by other jurisdictions and advisers might start using the concept for other purposes. The speed of passing legislation and getting government approval for innovative and compliant products is hugely positive for The Bahamas,” states Hooper.

Clearly, the ICON structure has the potential to take The Bahamas fund industry to the next level if Brazilian managers – and the Latin American advisor community at large – start to avail of it to roll out offshore investment strategies as they bid to attract global, as opposed to merely regional, assets. 

By using an appointed unrestricted fund administrator to set up a SMART Fund, for example, within the ICON structure, managers will also benefit from speed to market: the licensing process for a SMART Fund typically only takes 72 hours. That said, there is a much greater regulatory and compliance burden on the appointed Bahamian fund administrator, compared to using other fund structures. 

The lack of legal personality is addressed by the appointment of an administrator that is empowered to transact in its name, and represent and bind the ICON.

Allen confirms that interest is already building across Latin America as investment managers seek to learn more about it. 

“We are cautiously optimistic. We want to grow ICON in a measured way. It’s an interesting alternative to other structures not a magic pill. Other managers might want to set up a corporate structure, of course,” Allen says.

Three routes to licensing funds

Today, managers have a wider range of legal structures and funds to choose from in The Bahamas. But what are the different routes to getting that fund licensed and out to market?

The first option is to get the fund licensed directly by the SCB. Typically, a fund administrator would apply for the license on behalf of the manager. This is the only route available to those managers wishing to establish a Standard Fund; there is no fast track option available. 

The second route falls under the delegated licensing regime, whereby an unrestricted fund administrator is used to license a Professional Fund or SMART Fund. 

“As the unrestricted fund administrator, we are the licensor; thus we have a vested interest in the launch of each new fund. We walk the fund sponsor through the entire process and ensure everything is in place before issuing the license. There’s a 30-day window within which we must submit copies of the license and all due diligence documents to the SCB. We certainly take this role seriously, given that we’ve been delegated licensing authority for the fund. This ensures a smoother launch experience for fund initiators and sponsors,” says Jones.

Rolle notes that if the fund is coming from a jurisdiction where it is not already licensed the unrestricted fund administrator would require the manager to submit due diligence documentation to the administrator, who in turn would license the fund and file that documentation with the SCB.

“The third option is where a fund sponsor appoints a restricted fund administrator; regardless of the fund category that restricted administrator would have to apply to the SCB for a license. For a Professional or SMART fund, the SCB provides a fast-track route. If the application is accurate and complete, the license will be granted within 72 hours,” outlines Jones.

Usually with SMART and Professional funds members of the board of directors may have connections to the fund or to the investors. “We do not stipulate that the directors have to be independent. What we do stipulate is that due diligence is undertaken on each appointed director,” confirms Rolle.

Looking at the year ahead, Allen says that the focus will be on going to Brazil and Latin America to talk about ICON with advisers, ensuring market access of Bahamian funds into Europe “and ensuring we have the best environment possible for the regulation of investment funds”.

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