The international wealth management industry came under significant pressure to improve performance following the global financial meltdown in 2008. International head offices found themselves evaluating the value proposition of all aspects of their businesses, with many determining to reduce their operations in certain markets and jurisdictions.

The investment funds sub-sector, however, has been one of the areas of The Bahamas’ wealth management industry which has stood up to this trend, experiencing growth in recent years. The number of licensed investment funds has increased by an annual average of 10.8 per cent over years 2013 through 2015. Furthermore, after a few years of stagnation, the number of investment fund administrators has seen an uptick, showing an annual increase of 6.5 per cent to 66 administrators at the end of 2015.

This growth signals an opportunity to gain ground and expand The Bahamas’ investment funds industry. To realize The Bahamas’ potential, the legislative framework will have to expand the reach and scope of regulation to provide effective oversight for funds in a private wealth supporting role, and also, for market share in the institutional funds space as well.

Regulatory framework
The Securities Commission is in the process of developing a new regulatory framework that does just that, having embarked on a project in July 2016 to repeal and replace the existing investment funds legislation.

In initiating the project, the commission had three overarching objectives for the development of the legislation and regulatory framework:

1. To address the concerns raised in the 2012/2013 financial sector stability assessment, with the goal being to achieve best-in-class regulatory standards;

2.To develop the legislative infrastructure that would enable The Bahamas to enhance its competitive landscape and to attract institutional as well as private funds business; and

3.To put in place the necessary legislative framework that would enable The Bahamas to achieve AIFMD/EU passporting status thereby enabling Bahamas-based-funds and fund managers to market to Europeans.

Background
The passage of the Mutual Funds Act in 1995 declared that The Bahamas intended to actively engage in and regulate collective investment schemes. Prior to this, the investment funds business in The Bahamas could easily have been described as ad hoc or bespoke, with a few funds being set up for small groups of “family and friends.” The administration was usually carried out by a trust company, as it was presumed that the trustees’ natural understanding of fiduciary risks enabled them to function as de facto administrators.

There were, however, a few players who recognized The Bahamas as a prime jurisdiction for fund administration and they began to set up shop. These, along with the need to provide a proper regulatory framework to protect investors and the reputation of the jurisdiction, provided the catalyst needed to bring long overdue regulation and oversight to an industry that had primarily provided tax and estate planning structures for a few high-net- worth individuals.

Since 1995, the Mutual Funds Act has evolved into a new piece of legislation –the Investment Funds Act, 2003. The new legislation was largely structured to be in line with the operations of fiduciary administrators and did not necessarily account for the appropriate regulation of the various roles within a fund structure. As a result, several key gaps persisted in the legislation. These gaps were evident in 2012 when The Bahamas underwent a peer review under the International Monetary Fund’s Financial Sector Stability Assessment Programme (FSAP).

The review identified significant weaknesses in the regulation of custodians and fund managers. While The Bahamas was largely compliant with principles set forth by the International Organisation of Securities Commissions (IOSCO), the consensus was that it had not kept pace with global regulatory standards for collective investment schemes. It became clear that there was a need to update the legislative and regulatory framework.

Project launch
Against this backdrop, the Securities Commission of The Bahamas, in July last year, launched a project to completely overhaul the Investment Funds Act. The commission engaged two top-tier law firms to act as drafting and technical consultants for the development of the legislation. The drafting consultant will produce drafts of the legislation in accordance with the commission’s instructions, while the technical consultant has responsibilities which include benchmarking the proposed legislation against comparable legislation in select jurisdictions, particularly for best practices, competitiveness in the sector and preparation for the EU passporting process.

The commission also assembled a project team for the overhaul consisting of a small group of leading industry professionals. The project team, along with a legislative drafter assigned by the attorney general, review and provide input to the proposed legislation at various stages during the drafting process.

It was anticipated that the entire drafting of both the primary act along with accompanying regulations would take place over a six-month period and be completed by the end of last year. During the process of developing the legislation, the commission had two periods of industry consultation to facilitate direct input from various stakeholders, as well as the general public.

Shoring up the legislationa
Some of the main areas to be addressed from the 2012 FSAP review centre around licencing and oversight of key players in a fund structure, including the fund operator, fund manager, investment manager and custodian. The principles set out by IOSCO require standards to be put in place to address how each of these conduct their activities. Also required are ongoing oversight for each.

Currently, there is no requirement in The Bahamas for the fund manager to be licensed by the commission. The new legislation, however, will likely require some form of licensing or registration, depending on the level of sophistication of the fund’s investors. Moreover, the commission must be able to set standards for the activities of the custodian, as well as monitor such activities and conduct onsite examinations. The same goes for the activities of the fund operators. The new legislation and regulatory framework will also provide for minimum standards with respect to the management and valuation of the underlying assets of an investment fund with the aim of ensuring the appropriate level of protection for the fund’s investors.

In revamping the regulatory framework, the commission is looking at the fiduciary responsibilities and the appropriate ongoing reporting obligations of each of the players. In the end, the regulatory environment must establish a regime which includes appropriate frameworks for the licencing, ongoing supervision (inclusive of onsite and offsite examinations), investigation and enforcement of regulatory and supervisory requirements for various investment fund participants.

Enhancing competitiveness
To improve The Bahamas’ visibility and selection as a jurisdiction of choice for both private and institutional investment funds, the development project reviewed the challenges faced by the country over the years. The commission is seeking to meet those challenges and remove barriers that may be inadvertently hindering the industry’s potential, as far as it is possible to make these improvements through the legislative and regulatory infrastructure.

One particular area the proposed legislation will seek to revamp is the centring of fiduciary risks and responsibilities around the fund manager as opposed to the current structure which makes the principal office, that is, the fund administrator, the focal point.

This inappropriate recognition of the administrator’s role versus the fund manager’s responsibilities perpetuated an imbalance that proved too onerous for the administrators of large institutional funds. The jurisdiction must now correct this imbalance if The Bahamas is to have a chance to vie in the institutional arena.

The legislative overhaul is also seeking to rationalize the oversight of non- Bahamas-based funds by reviewing the criteria by which a nexus for regulation ought to be created. This will mean much needed changes to the current structure of recognized foreign funds and the commission is looking to resolve the very sore topic of marketing funds to Bahamian entities and service providers.

Other features the commission is seeking to improve relate to providing for a sensible and streamlined licensing structure with respect to the master/feeder relationship, as well as providing definition and clarity for self- administered funds.

Passporting requirements
On July 22, 2011 the Directive 2011/61/EU on Alternative Investment Fund Managers (AIFMD) entered into force in the EU. The directive creates a comprehensive and effective regulatory and supervisory framework for alternative investment fund managers (AIFMs) within the EU as well as establishing certain regulatory requirements for non- EU AIFMs that provide services to EU investment funds. The European Commission adopted a number of the provisions of the directive for implementation in July 2012, which were incorporated into the national laws of Member States. The rules of the AIFMD therefore became applicable to AIFMs as from July 22, 2013.

The AIFMD also applies to non-EU AIFMs that manage or market AIFs in the EU. Thus, Bahamian investment managers to EU funds are subject to the impact and requirements of the AIFMD. The commission has already engaged with and executed 27 memorandums of understanding with counterpart regulators in EU member states in order to facilitate participation in their respective countries. However, as part of the broader regulatory framework for AIFs in the EU, the directive provides for an EU passport for non-EU AIFMs.

This passport became a requirement for industry participants beginning in 2016. The passport enables non-EU AIFMs to enjoy the same rights and be subject to the same obligations as EU- based AIFMs. While the directive does not require that the non-EU country where an AIFM is established must have AIFMD-equivalent rules, the non-EU AIFMs must be able and willing to operate in the EU in compliance with rules established in relation to the AIFMD.

The commission has a sense of urgency in performing this review within the context of the AIFMD/EU passporting developments. While meeting international standards, The Bahamas must also maintain its capacity to conduct business within jurisdictions relevant to the Bahamian industry by meeting the various regulatory oversight requirements that have been established by those jurisdictions.

The commission is therefore seeking to ensure the new legislation meets the standards to enable granting of the EU passport. While this still appears to be a moving target, it is possible for our legislative development to model standards from jurisdictions which have been granted the EU passport and to learn from those who have been denied. The commission is engaging with European Securities and Markets Authority (ESMA) to seek review in its next round of assessments for passporting.

Conclusion
It is certainly true that the goals for the overhaul of the Investment Funds Act, along with its timeline, are ambitious. It is imperative though that The Bahamas rises to the challenges of these goals, if it is to forge a new identity as an international financial centre and ensure its survival in the face of increasing global standards and shifting goal posts. The jurisdiction must ensure the viability of this sector as an alternative to tourism and in order to do this, robust and modern legislation is just the beginning.