Bermuda Partners Sarah Demerling and Natalie Neto outline the process of enacting and maintaining a tokenised fund in Bermuda.
Imagine a world where asset management transactions and contracts are maintained in a decentralised form across different locations using distributed ledger technology (blockchain), all information securely and accurately stored using cryptography and accessed using keys and cryptographic signatures. This would allow subscriptions and redemptions to be processed by way of smart contracts and investor reporting being available in real time leading to greater transparency, better efficiencies and lower fees. These days, it feels that such a transformation is not so far away.
The Bermuda Government understands the power and disruptive potential of this technology and has identified an opportunity to be a pioneer in this space. Bermuda has leveraged its significant expertise in regulatory management under the supervisory oversight of the Bermuda Monetary Authority (BMA), Bermuda's sole financial services regulator and during 2018 introduced cutting edge digital asset business legislation 2018 (known as DABA) together with amendments to the Companies Act, 1981 and related token offering regulations to create a statutory framework for the regulation of token offerings and digital assets business activities in Bermuda.
This framework provides a unique environment that prioritises regulatory certainty, investor confidence and compliance with internal know your customer and anti-money laundering and anti-terrorist financing and sanctions compliance (AML/ATF) regulations. These benefits of certainty and stability are attracting the best structured fintech companies and funds which are becoming part of the Bermuda fintech ecosystem.
This article will consider the use of a Bermuda fund structure to enable investors to acquire tokenised interests in a fund which represent the underlying assets, versus more traditional interests such as shares, units or partnership interests. Bermuda does not regulate funds which simply hold digital assets within their portfolio, although depending on the nature and level of the digital assets business activity conducted by the fund or the fund manager, consideration should also be given to whether a licence for such activity is required under DABA.
Tokenised funds may be caught by the Token Offering Legislation if the fund is considered to be offering digital assets for purchase or acquisition by the public. The term digital asset is very broadly defined and covers anything that exists in binary format and comes with the right to use it and includes a digital representation of value that is:
- used as a medium of exchange, unit of account or store of value (other than fiat currency)
- intended to represent assets such as debt or equity in the promoter
- otherwise intended to represent any assets or rights associated with such assets
- intended to provide access to an application, service or product by means of blockchain.
This would therefore capture most forms of issue or offering by a fund of interests in the fund that are intended to be represented in tokenised or digital asset form.
The Token Offering Legislation applies to token offerings that are made available to more than 35 investors but exempts private token offerings with fewer investors. Offers which are of a private character or which are restricted to persons whose ordinary business involves the acquisition, disposal or holding of digital assets are also out of scope.
Do I need to establish a Bermuda company to issue tokenised fund interests?
No person is allowed to issue an initial token offering in or from within Bermuda unless that person is a Bermuda company or LLC that is registered with the Registrar of Companies (ROC) in Bermuda. Before a company or LLC can commence a token offering, the consent of the Bermuda Minister of Finance (Minister) is required.
Process of conducting a token offering
A tokenised fund that proposes to launch a token offering in Bermuda must publish and file an offer document (often based on the White Paper). The offer document does not need to be filed where the digital assets are listed on an appointed stock or digital asset exchange if the rules of the relevant exchange do not require it to be filed or, generally, where the company or LLC is subject to the rules of a competent regulatory which does not require filing.
The contents of the offer document must include the following:
- the registered or principal office of the promoter
- the officers of the promoter
- the proposed business of the entity
- a description of the project and proposed timelines
- the amount of money equivalent the token offering intends to raise
- the allocation of the amounts intended to be raised amongst the classes of issuance
- any rights or restrictions on the digital assets being offered
- timings of opening and closing of the offering of the digital assets
- a general prescribed token offering risk warning
- a statement as to how personal information will be used.
The Token Offering Legislation requires that the company or LLC has in place appropriate measures to comply with applicable AML/ATF requirements. The Token Offering Legislation sets out those actions that would be deemed to be 'appropriate measures' for these purposes, the required timing for identification and verification of participants, record keeping and requirements concerning an internal compliance audit.
Tokenised and conventional fiat hedge funds similarities
There are many similarities when setting up any fund. Be it tokenised or traditional, service provider diligence is key. You need to work with knowledgeable partners (auditor, attorney and administrator).
As with any investment fund, structuring your fund in the most favourable manner is of utmost importance. If any of the investors are located outside of the US and/or are US tax exempt, offshore jurisdictions, such as Bermuda, often form part of the fund structure. Carefully describing the fund's strategy and paying close attention to disclosures, making sure they are drafted broadly enough to evolve with the asset class is key. Consideration needs to be given to the liquidity of the fund and side pockets for illiquid investments serve as well in the digital asset universe as they do in the fiat world.
Differences include the challenge of finding a suitable custodian to hold any digital assets securely and in compliance with Bermuda DABA requirements (if applicable) and getting auditors comfortable to verify the existence and valuation of digital assets.
Tokenised fund structures
A tokenised fund can be established as an open-ended or closed-ended Bermuda exempted company or LLC.
- Open-ended: This structure is more common for those managers looking to pursue an investment strategy which focuses on trading in cryptocurrencies or other forms of digital assets. These strategies tend to be more liquid in nature and investors are able to redeem their investment at their own initiative. These structures are therefore open-ended and similar to a traditional hedge fund. As a result, pursuant to the Investment Funds Act need to be registered or authorised with the BMA as either a private fund (less than 20 investors) or a professional fund (open to qualified participants and having prescribed service providers) or authorised, most commonly, as an institutional fund (qualified participants and prescribed service providers).
- Closed-ended: This structure is more common for those managers looking to pursue an investment strategy which focuses on long-term investments in digital asset start-ups or projects. These strategies tend to be illiquid in nature and investors are unable to redeem their investment without the manager's consent. Closed-ended funds do not currently need to be registered with the BMA.
In general, a Bermuda fund will need an investment manager, a fund administrator, a registrar, an auditor and a custodian or prime broker, unless an exemption is available and approved by the BMA. It is not necessary to appoint a local director but the fund will need to have at least one local service provider, which can be the corporate service provider that provides the registered office in Bermuda.
With regulatory certainty and a government that is constantly very actively working to facilitate fund structuring and investment in digital assets, Bermuda is once again showing its ability to innovate and become a market leader in this transformative space.
Originally published by HFM Global
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.