Jonathan Culshaw, Asia Managing Partner, and Raymond Ng, Counsel, Harney Westwood & Riegels
The British Virgin Islands (the “BVI”) has recently passed the Securities and Investment Business (Incubator and Approved Funds) Regulations 2015 (the “Regulations”) to create two new fund products: the “incubator fund” and the “approved fund”.
A common problem encountered by start-up managers looking to establish small hedge funds issuing redeemable shares to investors is the high barrier to interest entry represented by the costs of full audits and the appointment of numerous independent functionaries (such as administrator, custodian and manager) required by offshore regulators. It is hoped that the two new fund products, which are not as heavily regulated as the traditional fund products, will lower the hurdle for emerging managers to set up new funds in the BVI.
The incubator fund is aimed at managers who do not necessarily have the benefit of substantial seed investor capital, but who wish to set up quickly and establish a track record with minimal set-up costs and without having to comply with onerous regulatory obligations. The product is expected to appeal to start-up managers who are seeking the best environment to grow their assets under management in the most cost-efficient manner.
An incubator fund is permitted to operate for two years (with a possible extension of one additional year) with no functionaries and no requirement to appoint an auditor. The thresholds which apply to an incubator fund are:
- a maximum of 20 investors;
- a minimum initial investment of US$20,000 by each investor; and
- a cap of US$20 million on the value of investments of the fund.
Prior to the end of the term or upon exceeding any of the above thresholds, the fund must opt for one of the following options:
- apply to the Financial Services Commission of the BVI (the “Commission”) for recognition as a private fund or professional fund – this would include preparing an audit demonstrating its current financial position and compliance with the Regulations;
- apply to the Commission for approval as an approved fund; or
- wind up its operations.
The approved fund is aimed at managers who wish to establish a fund for a limited number of investors for a longer term, which may appeal to funds servicing family offices or an investor base of close connections.
The thresholds which apply to an approved fund are:
- a maximum of 20 investors; and
- a cap of US$100 million on the value of investments of the fund.
It has similar characteristics to a BVI regulated private fund but, unlike a private fund, an approved fund is not required to appoint an auditor, a manager or a custodian. However, to ensure there is some independent oversight of the fund operations, an approved fund is required to appoint an administrator. Other service providers may be appointed at the discretion of the manager.
Unlike an incubator fund, an approved fund does not have a restricted validity period and can continue to operate as an approved fund for the full duration of its lifetime, unless:
- a decision is made to voluntarily apply to the Commission to recognise the fund as a private or professional fund;
- it is required to convert into a private or professional fund upon exceeding one of the above thresholds; or
- it elects to wind up its operations.
The new fund products are able to commence trading within two business days of lodging the application for approval with the Commission. In addition to the reduced ongoing costs, legal costs on establishment will be lower than those associated with setting up a typical offshore hedge fund, since the mandatory information to be contained in the offering documents is greatly reduced.