As an emerging manager who has set up a BVI incubator fund with the backing of friends and family, the two to three-year incubation period is time to prove your credentials and build a solid track record with the ultimate aim of attracting sophisticated and institutional investors. However, there is so much more to do during that period than prove that your investment strategy stands up to scrutiny.
In an age of increasing transparency, it is vital that you use the incubation period to start preparing for a time when you will need to meet institutional-style demands in terms of your operations. It is still early days – and you may still fall below AUM thresholds for complying with extraterritorial regulation – but there is a level of infrastructure and reporting that sophisticated and institutional investors will expect before they are going to invest.
Reporting to investors
How much information you are going to need to provide to investors and how you will manage that demand will be key issues to consider. During the incubation period and, perhaps, for some time after that, your investor base is likely to be closely held by friends and family who may be willing to take a back seat and receive only periodic NAV statements. However, once you are looking to attract institutional investors, you are going to be dealing with demand for much greater transparency on such items as your trading strategy, fees and expenses, risk management and controls. Of course, providing this information is likely to mean improving infrastructure and, of course, an increase in related costs.
Keeping up with compliance
When attracting institutional investors, it is essential that you can demonstrate an unblemished record of compliance. You might want to start thinking about expanding your team to include compliance staff. In the meantime, to make sure you are familiar with your regulatory obligations, keep in touch with your legal advisers and diarise any deadlines. Downloading our continuing obligations guide is a good starting point.
Selecting service providers
Incubator funds can operate initially with no service providers. However, at the point of conversion to a fully-fledged offshore fund, you are going to need to appoint an administrator, auditor and prime brokers or a custodian. Appointing these third party service providers will be a regulatory requirement once the incubation period comes to an end. Additionally, selecting appropriate service providers will also be key to attracting institutional investors as it will provide the comfort that necessary external controls are in place. It is wise to start the hunt early, as some administrators and auditors are prepared to offer a supportive role to incubator funds in their initial incubation period at competitive rates, in order to foster a relationship that will last as the fund grows. This can give you a really good start and ensure that the transition from incubator to fully fledged fund goes smoothly.
Your administrator will be a key asset for upholding transparency and will support the fund, not only in making or verifying NAV calculations, but also in providing investors with information, and carrying out the fund's investor due diligence function both for Anti-money Laundering and Terrorist Financing (AML) and for tax transparency purposes, collecting the requisite information on investors and, where applicable, carrying out reporting on the fund's accounts under FATCA, CRS and UK CDOT.
Your auditor will provide verification of your annual financial statements and also offer comfort to investors by giving opinions on reporting and reviewing the fund's compliance. In the BVI, funds can appoint any auditor in any jurisdiction approved by the Financial Services Commission under the Securities and Investment Business Division (Recognised Jurisdiction). This can be helpful if you have an existing relationship with an auditor in a Recognised Jurisdiction. However, appointing a BVI-based auditor can be an advantage as they can provide an extra layer of checks and balances to ensure that you are keeping up with BVI-specific regulatory requirements.
Although you have probably been using a prime broker or custodian during the incubation period, you will need to think about diversifying by using multiple prime brokers in order to manage risk, and you should demand assurances and transparency from your brokers on the segregation of client's assets.
IT and data security
In order to manage data security risks and deal with demands from investors and compliance obligations, it is likely that you will need to start investing in your IT functions and specialist staff to service it. Cybersecurity will also become a key focus and you will need to have a robust disaster management plan in place. Our guest blog from Erik Kellogg gave some useful tips on cybersecurity which are worth reading.
The BVI is aiming to give emerging managers a step-up in an area that is increasingly difficult to penetrate without deep pockets. Whilst this gives a short window to get going without feeling the full burden of increasingly substantial set-up costs, it is vital that the incubation period is used wisely and that funds and their managers prepare early for the demands of the sophisticated and institutional investors they will need to attract to take their strategy to the next level.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.