NEWS & INSIGHTS
Alison Dyer-Fagundo, of Estera, takes a look at Bermuda’s enhanced regulatory landscape in the age of economic substance.
Bermuda continues to move forward in navigating the offshore and global regulatory environment and continues to be a leader in tax transparency, maintaining high levels of compliance, cooperation and information exchange. The recently implemented substance regulations are just another example of an enhancement to the existing robust Bermuda regulatory framework and the fact that Bermuda is a tax neutral domicile is more clearly demonstrated today than ever before.
Bermuda’s Economic Substance Act 2018 (the Act) and the Economic Substance Regulations 2018 (together, the Substance Regulations), became operative on 31 December 2018. The Substance Regulations are based on framework set by the European Union’sAl (EU) Code of Conduct Group (COCG), with the general objective that jurisdictions should not facilitate offshore structures or arrangements aimed at attracting profits which do not reflect economic activity in that jurisdiction.
The Substance Regulations require Bermuda registered entities that fall within scope, to evidence adequate local resources, facilities and control over their relevant income generating activities.
Economic Substance and the insurance industry
There has been ongoing discussion around the insurance and funds industries on how the requirements of the Substance Regulations will be met. The Regulations state that an entity engaged in insurance activities complies with economic substance if it follows the requirements of the Companies Act 1981 (Companies Act) relating to corporate governance and the Insurance Act 1978 (Insurance Act), including the Code of Conduct.
It is no surprise that generally Bermuda licensed insurance companies are essentially compliant with the new substance framework given the structuring of the Bermuda domestic insurance legislative regime. Bermuda remains one of only two non-EU jurisdictions that enjoy Solvency II equivalency, which was granted by the European Commission in 2015. This demonstrates Bermuda’s commitment to enhanced regulation and innovation and the EU’s views on Bermuda’s insurance regime being on par with their own. At the same time as Solvency II equivalency was granted, Bermuda was approved as a qualified jurisdiction by the National Association of Insurance Commissioners, further distinguishing the jurisdiction.
There are three general classifications of insurance companies under the Insurance Act, each of which likely comply with the general aim of economic substance for various reasons. Commercial Insurers provide a full portfolio of insurance under the Insurance Act and must already comply with “Head Office” requirements, which are very similar to the requirements of the Substance Regulations.
Captive Insurers do not have all the same requirements as commercial insurers under the Insurance Act, due their limited purpose. However, this bifurcation already existed when Solvency II was granted and therefore the EU, at the time, accepted the reasons for this difference in legislative regime. Regardless, the regulation of captive insurers under the Insurance Act is currently broadly considered sufficiently robust considering the limits placed on the business that can be written by captives.
Special Purpose Insurers (SPI’s) are the third general classification of insurers in Bermuda and similar to captives, most SPIs are not set up in Bermuda purely for tax planning purposes, are licensed for a limited purpose and have a limited life span. Most of the business they write is ‘fully funded’ and little to no underwriting risk is retained by the SPI.
The main reasons for setting up insurance companies in Bermuda have traditionally been centred around regulations that are sensibly applied and allow for innovation; accessibility to regulators; a ready choice of talented insurance professionals including auditors, actuaries, lawyers and insurance accountants; and the island’s excellent reputation in the global insurance and reinsurance market. Bermuda has always been a transparent and co-operative jurisdiction with 41 tax information exchange agreements (TIEA’s) in place, including the TIEA with the United States which has been in place since 1986.
Economic Substance and the funds and investment industry
Investment funds were originally seen as out of scope of the Substance Regulations, as they are distinctively different from other entities. An investment fund is a supply of capital belonging to numerous investors and overseen by investment fund management companies. However, a Bermuda incorporated fund manager may still be subject to the requirements of the Act and will need to determine whether the requirements apply.
As a response to the Substance Regulations, and to enhance the regulatory framework that applies to exempted or excluded funds, a number of amendments were made to the Investment Funds Act 2006 (IFA). Among the amendments is the removal of the term “Excluded Funds”. “Exempted Funds”: will now be called “Professional Funds”. These funds included Class A Exempt Funds and Class B Exempt Funds. Additionally, Professional Funds and Private Funds will both be called “Registered Funds”. Pursuant to the amendments, funds that were previously exempted or excluded now come into scope of the IFA and have oversight from the Bermuda Monetary Authority (BMA), who can exercise greater supervision over the funds.
With the recent amendments, there are also additional benefits for fund managers to choose Bermuda as a domicile for their funds particularly in the case of ILS where the underlying assets of the fund is already issued out of Bermuda.
Bermuda’s attraction for ILS and funds
Bermuda continues to move forward in navigating the offshore and global regulatory environment and continues to be a leader in tax transparency, maintaining high levels of compliance, cooperation and information exchange. The Substance Regulations are just another example of an enhancement to the existing robust Bermuda regulatory framework.
The Substance Regulations will provide businesses with more confidence when conversing with tax regulators in their own jurisdictions. Bermuda’s response to the EU’s requirements was without hesitation and the government is keen on maintaining and supporting Bermuda’s reputation of a world-class jurisdiction.
To ensure that Bermuda remains an attractive domicile for investors and businesses, a recent amendment has been made to the Economic Substance Act. The Economic Substance Amendment Act 2019 (the Amendment Act) which comes into force on 1 July 2019 acknowledges the need to ensure a level playing field between the affected jurisdictions.
The Amendment Act amends the existing economic substance legislation by excluding, from the definition of entities within scope, those entities that are tax resident in a jurisdiction outside of Bermuda and excluded from Annex 1 of the EU list of non-cooperative jurisdictions for tax purposes.
Another recent amendment aimed to enhance transparency is the Beneficial Ownership Regulation. In March 2018, the Bermuda Government enacted legislation requiring all companies to gather and maintain information regarding their beneficial owners. This legislation aims to extend the existing beneficial ownership regulation to meet standards of transparency set by the Financial Action Task Force and the Organization for Economic Co-operation and Development.
With enhanced regulations, regulators are continuing to evolve the insurance and fund industries. An example of this is the introduction of the BMA’s new regulatory sandbox, which became available to new insurers in 2018. This new option is designed to provide an incubator for newly registered insurance companies with a need to test innovative ideas including the use of technology such as insurtech. The regulatory sandbox allows the insurer to operate within a “regulatory lite” environment for a limited period of time, designed to allow the insurer to test the market and offer new insurance products, with an appropriate level of oversight from the BMA.
More recently, the BMA introduced a Consultation Paper which sets out a proposed regulatory regimes for new classes of Limited Purpose Insurers (including reinsurers) (LPIs) and a new category of an intermediary (insurance /reinsurance) market place). The BMA proposes to introduce new classes of LPI’s (a fully collateralised reinsurer class (Collateralised Insurers) and an innovation class (Class IIGB), for innovative business models utilising digital assets.)
How can Estera assist with Economic Substance?
Estera is well positioned to assist clients to understand and respond to the applicable requirements, following the introduction of the Substance Regulations. Estera will determine if the entity has established tax residency in a jurisdiction which is subject to this new law. If the analysis is positive, a substance test will follow. The substance requirements differ depending on the type of relevant activity the entity performs. The tests include a gap-analysis versus the requirements for adequate control, people, facilities and expenditure.
Alison Dyer-Fagundo is the Managing Director of Estera Services (Bermuda) Limited
Alison has extensive experience in private equity transactions, derivatives, public and private company M&A activity, equity and debt markets, corporate governance, and partnerships in relation to both their formation and on-going transactions.
Click here for a link to the article as it appeared in HFM Bermuda Special Report 2019