By: Sarah Demerling
Fund structures that combine a hedge fund approach to investing in liquid assets with private equity style features are growing increasingly attractive to fund managers.
The “hybrid fund” combines a traditional hedge fund investment mandate with the characteristics of a private equity fund (such as being closed-ended, a waterfall distribution of profits and a specified investment period).
In its 2013 report, J.P. Morgan identified the key drivers for this upswing in hybrid hedge fund vehicles as being major changes to the global credit market aligned with the growing regulatory pressures (not least the pressure on European banks following Basel III). This finding is echoed in the February 2014 report by New York-based law firm Seward & Kissel, which points to an increasing convergence between hedge funds and private equity funds, with hard lock-up periods as well as tougher redemption terms.
Forming and operating a hybrid fund, or a private equity structure, which can successfully combine a mix of asset classes and investment strategies, needs the right legal framework and knowledgeable and experienced professionals to implement it.
Bermuda’s strength and breadth of private equity service providers, together with its robust yet responsive legal and regulatory environment, make it a strong choice of jurisdiction for both private equity fund formations and for the selection of service providers required to service such funds.
EXPERIENCE IS THE DIFFERENCE
Bermuda’s history with private equity dates back to the early 1980s and 1990s. Over the past 30 years, Bermuda has developed a network of knowledgeable service providers and advisers to the private equity industry who work closely with regulators to create a world class jurisdiction for the private equity industry.
The Bermuda Monetary Authority (BMA) – the industry regulator – takes a risk-based approach to financial services regulation and has continually demonstrated a dedication to collaboration and consultation with the private equity industry, as well as with the financial services industry more broadly.
The continually changing regulatory landscape, and variety and complexity of fund structures (such as the hybrid fund vehicle), has increased the value of access to highly qualified and skilled private equity professionals. The resources required to attract, train and retain highly qualified industry professionals have increased as the value associated with this expertise has intensified. The outsourcing of private equity services is not only a benefit from a cost perspective, but also provides the private equity managers with access to staff with wide-ranging experience across multiple clients and fund structures. Bermuda has spent 30 years developing a unique network of skilled private equity professionals and is in position to fully leverage that talent.
Having a service professional that has extensive expertise in private equity funds provides the general partner with a great source of guidance on industry best practices. This expertise can be leveraged by the general partner, beginning with the fund formation stages to determine reporting formats and managing subsequent close calculations, and then continually through the life of the fund to assist with distribution waterfall calculations, portfolio valuations, best practices and limited partnership agreement provision calculations, and interpretations.
Scott Burns, head of private equity services for ISIS Fund Services in Bermuda, has been servicing private equity clients from the country for close to 20 years.
He says: “One big advantage Bermuda has over other jurisdictions, is the depth of private equity experience in all areas of the service provider landscape. One reason our clients continue to choose our administration services in Bermuda is the incredible depth of experience in the law firms, accounting firms, directors and consultants. Our relationship with the staff in these other firms goes way back. For some of our clients, I worked as the fund accountant when they were formed in the late 1990s and the current audit partner was a senior on those early audits. This close proximity of such depth of private equity experience gives Bermuda a strong advantage in the selection of a private equity fund formation domicile and service provider selection.”
INDUSTRY DRIVEN STRUCTURING OPTIONS
Bermuda has a history of a collaborative relationship between investment industry professionals and regulatory stakeholders.
A recent example of this successful collaboration is demonstrated in Bermuda’s dominance in the insurance-linked securities (ILS) space, with close to half of all ILS stock now issued in Bermuda. Bermuda has also leveraged this alignment of a world class financial regulator and deep industry knowledge to create a very favourable structuring environment for private equity and hybrid funds.
For these closed-ended structures formed as limited partnerships, the benefits of forming it in Bermuda include less regulatory scrutiny as the partnership legislation does not look to regulate the affairs of limited partners; the general partner can be based outside of Bermuda; and a Bermuda limited partnership can elect (in a similar way to Delaware limited partnerships) to have separate legal personality.
A hybrid fund may also be formed as a Bermuda mutual fund company. Bermuda offers key advantages as a jurisdiction for establishing a fund company as the legislation (including segregated accounts legislation) allows for the creation of bespoke governance and economic arrangements within a single entity. Options exist to ‘opt in’ to the amount of regulation a fund requires based on its investor base. Closed-ended structures fall outside of the Investment Funds Act and therefore there are no filings, no approvals and no restrictions on the use of chosen service providers. In addition, there is no requirement under Bermuda law for local auditor sign-off.
These factors, coupled with low fees and same day incorporations, make Bermuda a superior choice as a jurisdiction for forming private equity as well as hybrid fund entities.
Sarah Demerling, partner of Appleby (Bermuda) Limited and member of the asset management committee of the Bermuda Business Development Agency, has been working closely with the asset management industry, the BMA and the Bermuda Government to reinvigorate the industry in Bermuda.
“Bermuda is listening to the needs of the industry and responding accordingly. Bermuda’s reputation and sensible balance of regulation provides investors with confidence and our current environment is very supportive of the industry as it continues to expand and evolve,” she says.
Another key incentive to forming a hybrid investment vehicle in Bermuda is the tax neutrality of the jurisdiction. There is no Bermuda income, capital gains or withholding tax, corporation or profits tax applicable to a fund or to its shareholders.
BERMUDA, A COMPLETE JURISDICTION FOR HYBRID FUND/ PRIVATE EQUITY VEHICLES
As the private equity industry continues to evolve due to changes driven by regulators, investors and general partners themselves, Bermuda is well positioned to be a leading choice as both a location to domicile hybrid funds, traditional private equity entities, as well as general partners and also as a leading choice for private equity professional service firms.
Bermuda has spent three decades creating a landscape tailor-made for private equity, and continues to be a responsive and innovative jurisdiction, which strives to implement new structures and products to provide solutions to the challenges which arise in the private equity arena.
Article first published in HFM Week Bermuda Report, August 2014
This article was published in Opalesque's Private Equity Strategies our monthly research update on the global private equity landscape including all sectors and market caps.