Offshore: branching out

While fresh legislation is good news for the Cayman Islands’ insurance and reinsurance markets, BVI funds lawyers welcome a new regulatory regime. LB assesses the response from the Caribbean’s top law firms

Significant legislative changes have brought good news to the thriving Caribbean offshore market. After much anticipation, the Cayman Islands Insurance Law 2010 came into force in November, making significant amendments to the current insurance and reinsurance business regime in the islands. The law brings Cayman’s insurance sector in line with international standards and should attract more commercial reinsurers.

Improving the protection of policyholders in Cayman’s domestic insurance market, the legislation gives increased powers to the Cayman Islands Monetary Authority (CIMA) and facilitates the further development of Cayman’s insurance-linked securities (ILS) and reinsurance industries through the creation of new classes of licensee.

The updating of the islands’ insurance legislation is testament to Cayman’s position as a leading offshore financial centre, in that it enjoys political stability and a flexible regulator, and is able to address and fully engage in the market’s needs, and respond accordingly.

‘The insurance sector is all about quality and Bermuda continues to dominate the offshore insurance market for the same reasons it has for decades’

 Meanwhile, a new regulatory regime in the British Virgin Islands (BVI) has been designed to complement the existing licensing regime for investment managers under the Securities and Investment Business Act 2010 (SIBA). Offering alternatives that reflect different requirements based on the size and complexity of the proposed manager’s business, the new regime enhances the BVI’s attractiveness as a jurisdiction for smaller start-up managers as well as large market players.

But although Cayman seeks to increase its market share of insurance work, Bermuda’s dominant position remains unchallenged. Meanwhile the BVI’s latest regulatory developments showcase the responsive nature of its financial services industry and regulatory authorities in seeking appropriate regulation.

Class act

The new insurance legislation in the Cayman Islands is the result of significant input from the public and private sectors. Under the previous legislation, insurers were categorised as either Class A insurers – those insurers incorporated either locally or overseas, carrying on domestic insurance business in the Cayman Islands – or Class B insurers, typically insurers carrying on captive insurance business on a restricted or unrestricted, licensed basis.

The new law further defines the classes of insurer licences and there are two new categories. The Class C licence is directed at special purpose insurers that carry on insurance business through the provision of reinsurance arrangements and are financed through the issue of catastrophe (CAT) bonds or similar instruments. The Class D licence is designed specifically for commercial reinsurers.

Cayman is already one of the leading jurisdictions for ILS, particularly CAT bonds. However according to Philip Paschalides, a partner in Walkers’ Cayman Islands office, the creation of a specific licence for CAT bonds and ILS will consolidate Cayman’s pre-eminent position in this area. And because commercial reinsurance is one of the most lucrative sectors in the offshore world, the Cayman government has been overt about its objective of attracting more commercial reinsurers, says Wendy Lee, a senior associate in Harneys’ Cayman office.

Furthermore, the Class B licence, intended for captives, is no longer issued on a restricted or unrestricted basis. It is now divided into three sub-categories, depending on the percentage of net premiums written that originate from the captive insurance company’s related business. This is defined as business originating from the insurer’s members or the members of any group with which the insurer is related through common ownership or a common risk management plan, or as CIMA may determine.

The new insurance law also includes new provisions related to reporting and public disclosure requirements, and change of control. CIMA must now approve the issue of shares totalling more than 10% of the authorised share capital of a licensee and the transfer of more than 10% of the issued shares or total voting rights of a licensee. There are also increased duties for auditors and insurance managers, including whistleblowing obligations, and penalties for late filings and non-compliance.

The insurance sector is not a new one for Cayman. The islands have been involved in the formation and operation of captives for over 40 years. Cayman is the second largest captive domicile in the world and the leading jurisdiction for healthcare captives.

‘Cayman has grown and built a solid reputation for excellence in international insurance, evidenced by the most recent statistics from our regulator, showing a 57% increase in captive formations at the end of 31 October 2012 over the same period for the previous year,’ says Cayman-based James Bergstrom, a partner at Ogier.

According to Bergstrom, the aim of the recent insurance law was to differentiate clearly between the domestic and international insurance markets in Cayman and to regulate each in accordance with its requirements; to strengthen legislation to protect Cayman residents; to bring the law, formally, into line with international standards; and to open new markets for new business sectors.

Paschalides believes the law was also driven by the islands’ recognition of the opportunities presented by Bermuda’s embracing of Solvency II Directive equivalence – the EU Directive that codifies and harmonises EU insurance regulation, and that primarily concerns the amount of capital that EU insurance companies must hold to reduce the risk of insolvency. CIMA has indicated that the directive is a valid concept but that it has real concerns about its applicability and potential effect on Cayman’s captive insurance market.

Some competitor jurisdictions, such as Bermuda and Switzerland, argue that Cayman and other offshore jurisdictions, which have chosen not to adopt Solvency II equivalence, may not be able to grow their international commercial reinsurance business.

But while commercial reinsurers with a global presence and significant capital may choose to incorporate in or redomicile to those jurisdictions that have adopted the directive, Harneys’ Lee believes that Cayman could be a more attractive option for start-ups and those middle market reinsurers or reinsurers outside the EU, such as in Asia, Latin America or the Caribbean. This is because they may wish to carry a lighter capital burden and maintain their investment capabilities, especially in an unstable or recovering economy.

‘By not adopting Solvency II equivalence, Cayman could see an increase in captive insurance companies re-domesticating to Cayman or new Cayman captive formations’

 Captives also remain an attractive option for investors internationally. Jurisdictions like Asia, where holding company structures are popular, would be astute to look at the captive insurance company as an alternative structure. Captives not only act as a cost-effective hedge against risk but are also tools of investment. ‘By not adopting Solvency II equivalence, Cayman could see an increase in captive insurance companies re-domesticating to Cayman or new Cayman captive formations,’ says Lee.

The insurance law’s introduction is welcomed by Cayman’s insurance industry, as it underscores the pro-business nature of the jurisdiction for its historic captive insurance base and enhances its attractiveness for ILS vehicles and the reinsurance sector.

Furthermore, the law accommodates different types of insurance structures and products, thereby playing to the convergence of multiple sectors, which is the best way to characterise the insurance sector today. ‘Cayman is being viewed by many of the major players as an ideal platform for future activity,’ says Walkers’ Paschalides.

However, according to Appleby’s Cayman partner Simon Raftopoulos, the legislation’s actual impact on Cayman’s captive insurance market will not be significant. ‘This is because the legislation in the captive area largely enshrined what CIMA implemented in practice in any event,’ he says.

Nonetheless, Raftopoulos tells LB that the reception to the legislation from the firm’s clients has been definitively positive and encouraging. The firm has received an uptick in enquiries – looking to understand the new law’s significance – specifically from Latin America, but also from all over the world.

Walkers also reports a great deal of interest in the new legislation, both from insurers and hedge funds seeking to enter the reinsurance space. ‘This volume of interest is clearly a very strong endorsement of the new legislative and regulatory framework,’ says Walkers’ Cayman-based associate Derek Stenson. In response to the changes concerning commercial reinsurers, the firm has had significant interest from clients looking to make use of the unique environment that Cayman offers.

Walkers recently established a number of structures and is working on some significant transactions, which are currently in a holding pattern but are scheduled to close in early 2013. ‘For Walkers, 2012 was an extremely busy year,’ says Stenson, ‘and we expect 2013 to be a pivotal year in this sector.’

Although all major law firms with insurance practices will benefit from the new law in terms of significant mandates, many believe that the offshore firms most likely to gain from the new legislation are those with the deepest relationships with London and New York firms and with significant expertise in the capital markets and funds arenas. Walkers, for example, has a transatlantic insurance practice, with a
co-ordinated team working on Irish and Cayman structures, that has a full understanding of the Solvency II pressures. ‘This is essential to practice in this space,’ says Paschalides.

Leader of the pack

Notwithstanding the great strides being made by the Cayman Islands, Bermuda continues to lead the offshore world’s insurance market. With billions of insurance sector-related dollars in Bermuda, there is a certain momentum that is difficult to dislodge. ‘The insurance sector is all about quality and Bermuda continues to dominate the offshore insurance market for the same reasons it has for decades,’ says Appleby’s Bermuda-based partner Tim Faries.

In Bermuda’s favour is its accessible location – especially for the Eastern Seaboard; its well-regarded regulatory regime, which is at the vanguard of global insurance standards; and a healthy economy and stable political environment.

Bermuda is not complacent about its leading position and intends to ensure that its message continues getting across. ‘Cayman is a competitor to Bermuda and offers a very compelling and robust captive product to the international market,’ says Faries. Certain US states, such as Vermont and South Carolina, which are looking to build new markets and offer new products, are also serious competitors.

Furthermore, there is always the risk that policy decisions could be taken in the US at federal level to the detriment of Bermuda’s insurance market, such as tax initiatives that would reduce the amount a domestic insurer could deduct for reinsurance ceded to an affiliated reinsurer outside of the US. ‘But we have a robust strategy in place to deal with such an eventuality and ensure that we stay at the top of our game,’ says Faries.

Moreover, Bermuda’s insurance market continues to grow, with significant developments including the growth of hedge fund ownership of insurance company start-ups.

Hedge funds have invested in Bermuda’s insurance sector since the 1990s. They were frequently involved in sidecar and other special purpose entities but they tended to look to liquidate those positions after around 18-24 months. From 2001 and 2005 onwards, following 9/11 and the Katrina-Rita-Wilma hurricanes, hedge fund ownership of insurance company start-ups developed significantly. Hedge funds now feel more comfortable than ever with the insurance industry generally and regard it as an excellent investment, uncorrelated to the financial investments in their portfolio. They were a driving force behind insurance start-ups in 2011-12.

The ILS sector in Bermuda saw its first CAT bond in 1999 but the ILS market, as a means of financing risk in Bermuda, has grown exponentially since that time. ‘The ILS and hedge fund developments are reflective of how appealing and adaptable Bermuda is as a jurisdiction,’ says Faries.

The types of products have also changed, with the name of the game being to create products that appeal to capital markets investors. The insurance market always needs to access capital markets to a greater or lesser degree but it is crisis events that trigger an increased demand for capital market investment to support reinsurance, in addition to the traditional sources. The current environment – with soft prices on the one hand and less than attractive rates for traditional investment products on the other – stimulates the demand from reinsurers for access to non-traditional sources of capital and from capital markets investors for alternative investment products that offer a greater rate of return. This has driven the demand for ILS products over the last few years.

However, Walkers’ Stenson believes that Cayman is already challenging Bermuda’s insurance market leader status, while Ogier’s Bergstrom says that diversification of Cayman’s insurance sector is a logical next step in the lifecycle of its financial sector and is not based on challenging Bermuda for market share. Rather, it is dictated by having invested in the right legal and regulatory framework, as reflected by changes to its insurance legislation, leveraging Cayman’s resident world-class expertise in insurance and taking advantage of the market demand for choice in the highly competitive global insurance market.

While Cayman’s new legislation and its emphasis on proportionality may provide the ideal environment for captive insurance companies, it is at the innovative and cutting-edge of the market that Cayman excels. With Cayman a top jurisdiction for hedge funds and enjoying a big captive insurance industry, this is where reinsurance firms and hedge funds are now converging, believes Walkers’ Paschalides. He believes this is why Greenlight Re, a specialist property and casualty reinsurer formed out of Greenlight Capital, a leading hedge fund manager, chose Cayman. ‘This is a powerful advertisement for Cayman’s capability and the potential in this space,’ he says.

Regime change

The BVI is also in a state of transition. In December 2012, a new regulatory regime for the approval of eligible investment business managers came into effect, marking the result of extensive consultation with the private sector.

‘The BVI has always led the way in offering well-balanced and effective regulation for hedge funds and the approved manager regime now offers an equivalent regime for investment managers and advisers,’ says Anton Goldstein, a BVI-based associate at Conyers Dill & Pearman.

Harneys’ BVI partner Philip Graham says the driver for the legislation was the desire to make the jurisdiction as flexible and effective as possible for fund managers of all sizes, while ensuring that they are properly regulated at all times.

‘The BVI has always led the way in offering well-balanced and effective regulation for hedge funds’

 With over 2,400 registered funds, the BVI is one of the leading offshore domiciles for hedge funds. According to Goldstein, the popularity of BVI funds is testament to both the ease and cost-effectiveness of establishing funds in the jurisdiction, as well as the quality and sophistication of the BVI’s legislative, regulatory and judicial framework.

Historically, however, the number of investment managers and advisers established in the jurisdiction has not matched the number of hedge funds established in the BVI. One reason for this discrepancy is that investment managers and advisers established in the BVI require an investment business licence under SIBA.

Obtaining such a licence can be cumbersome and typically takes longer and is more expensive than the regulatory process for establishing a fund. Accordingly, there is a discrepancy between the ease with which a fund can be established in the BVI when compared to setting up an investment manager or adviser.

Moreover, once established, a BVI investment manager or adviser is subject to a relatively high degree of ongoing regulation under SIBA and the BVI Regulatory Code 2009, which can be burdensome for smaller investment managers and advisers.

‘Since the introduction of SIBA local practitioners and the BVI Financial Services Commission (FSC) felt that the existing licensed manager regime, while absolutely relevant and appropriately detailed for particular managers, was potentially unwieldy for others,’ says Harneys’ Graham.

According to Bedell Cristin’s Singapore-based partner Stephen Adams, who is an experienced BVI lawyer, practitioners and industry stakeholders have been calling for a fund manager exemption regime similar to other jurisdictions, or a streamlined licensing regime similar to what existed under the old Mutual Funds Act. Within the BVI funds industry, it was even thought that the SIBA licensing regime may have given Cayman a comparative advantage, Conyers’ Goldstein tells LB.

Consequently, the FSC looked to work with the private sector to bring about a product that could address these issues. The new regime will apply to BVI companies and limited partnerships that wish to act as investment manager to a BVI private, professional fund, closed-end fund or affiliated entities, or non-BVI funds with characteristics equivalent to a BVI private, professional or closed-end fund.

While the new regime will not create an outright exemption from regulation for approved managers, they will enable any proposed investment manager or adviser that meets the qualifying criteria, to apply to the FSC for approval as an approved investment manager through a simplified process.

Hedge fund managers and advisers may only qualify as approved managers if the
assets under management are under $400m. The threshold for managers and advisers of closed-ended funds is $1bn.

If approved, the regulations exempt the approved manager from having to obtain an investment business licence under SIBA, comply with SIBA and the Regulatory Code’s continuing obligations, and appoint a compliance officer and maintain a compliance manual.

The regulations intend to strike a balance by providing managers with an attractive, timely and cost-effective alternative to the full licence regime under SIBA, while still providing an appropriate level of regulatory supervision by the FSC. The new regime should improve the attractiveness of the BVI to the managers where the risk and complexity does not demand full compliance with SIBA and enhance structuring options that were frustrated by SIBA’s introduction.

In particular, the fact that the BVI has opted for an approval regime rather than an exemption regime is more in keeping with the demands of the marketplace and international clients. ‘Our impression is that there is a genuine desire and need for managers to be regulated – as opposed to being exempt from regulation – and the new regime provides an excellent alternative for those managers without increasing any risk to investors,’ says Bedell’s Adams.

Many market observers expect to see an increase in the number of managers using the BVI and that the BVI’s global funds industry will benefit from the new regime, as it will ensure that the BVI has a product that can be appropriately used for the right type of manager. It will be especially useful for small and medium-sized managers who wish to minimise set-up costs.

The speed at which the management vehicle can commence business will also ensure that managers, looking to place money via hungry investors quickly, will be able to do so. ‘Hopefully the resulting increase in managers using BVI vehicles to manage their funds will ensure that all BVI service providers should see a general increase in new enquiries,’ says Harneys’ Graham. They will also be able to offer their existing clients an alternative to the current status quo, potentially ensuring that existing business also remains in the BVI.

Consequently, the BVI now offers a competitive one-stop shop for hedge fund groups wishing to establish both funds and investment managers and advisers in the BVI. When considered in tandem with the flexibility of the BVI’s corporate legislation, the strength of the commercial court and competitive incorporation fees, some commentators expect that the new regime will consolidate the BVI’s position as one of the leading domiciles for offshore hedge funds.

The changes also give BVI law firms an opportunity to market a new, competitive product, believes Conyers’ Goldstein. Previously, it was difficult to market investment management and advisory vehicles in the BVI because of the perception that Cayman had a more competitive and appropriate regulatory regime.

The response from clients has been positive. Many of Bedell’s clients are glad that the BVI took the route of lighter touch regulation in specified circumstances, while Conyers’ fund group clients, which are below the assets under management thresholds, have expressed strong interest in the new regime.

It is early days for Harneys, but the interest seems high. New clients are responding positively and the firm’s existing clients are considering whether to move from the licensed manager regime under SIBA.

Looking ahead, Appleby’s Faries believes that the challenge going forward for the international financial centres will be staying aligned with international regulatory developments. With the BVI’s dynamic financial services industry, Bermuda’s leading offshore insurance market and growth in Cayman’s insurance sector, the Caribbean legal market expects bright times ahead. LB

julian.matteucci@legalease.co.uk