The aftermath of the Covid-19 pandemic has started to bite. The IMF’s World Economic Outlook as at October 2022 records a broad-based and sharper-than-expected slowdown in global economic activity. Inflation is at decades high levels. Russia’s invasion of Ukraine and the costs of the pandemic have led to a global cost-of-living crisis. Global growth is forecast to slow from 6% in 2021 to 3.2% in 2022 to 2.7% in 2023. Global inflation is forecast to rise from 4.7% in 2021 to 8.8% in 2022 and then, thankfully, to decline to 6.5% in 2023 and 4.1% by 2024.
The IMF’s prognosis is that monetary policy should stay the course in order to restore price stability and fiscal policy should aim to alleviate the cost-of-living pressures, whilst maintaining a sufficiently tight stance aligned with monetary policy. The IMF economists are of the view that structural reforms can further support the fight against inflation by improving productivity and easing supply constraints, while multilateral cooperation is necessary for fast-tracking the green energy transition and preventing fragmentation.
How to implement and facilitate these macroeconomic goals on a microeconomic day-to-day basis? A major driver of global investment, trade, value creation and productivity has been the private equity (PE) industry, including its subset, the venture capital (VC) sector. Preqin estimates that the PE market has tripled in the past decade growing from approximately $2 trillion in 2010 to over $6 trillion in 2021. The PE industry is a major driver of adding value and often provides much-needed consolidation in the business sectors and asset classes to which the PE and VC funds deploy their investments. In addition, the industry has been at the forefront on environmental, social and governance (ESG) investment considerations, bringing about positive societal interventions. This is particularly relevant now considering the challenges that the global power-generation sector faces flowing from the Ukrainian invasion and the movement to green energy.
Two crucial questions face PE sponsors in launching new funds and investment portfolios, namely the choice of jurisdiction and the choice of vehicle. International Financial Centres (IFCs) (aka offshore jurisdictions) have always been popular and well-utilized in launching PE funds (targeting more mature assets and classes) and seeking to add value to those private investments and businesses and VC funds (in targeting start-ups and new technology businesses). Certain of the IFC advantages, such as tax neutral environments are well documented and often over emphasized, particularly by onshore competitor jurisdictions. However, there are a myriad of reasons as to why private fund sponsors and investors make use of jurisdictions such as the British Virgin Islands (BVI) as their closed-ended fund domicile.
In response to European Union overtures that the BVI should regulate closed-ended as well as open-ended funds, in 2020 the BVI introduced an innovative and commercially orientated regulatory regime for PE, VC and other sector closed-ended funds. The BVI private investment fund (PIF) infrastructure provides for recognition by the BVI Financial Services Commission (FSC) of PIFs. As at Q2 2022, 2,257 BVI limited partnerships have been formed of which 295 are PIFs that have been recognized by the FSC. The PIF regime therefore now opens BVI closed-ended funds to those institutional investors whose investment parameters restrict investment only to regulated funds.
PIFs will generally be formed as a BVI company (including as a segregated portfolio company), a limited partnership or a unit trust. BVI limited partnership law underwent a material modernization and commercialization exercise in 2017 through the promulgation of the BVI Limited Partnership Act 2017. The drafters of this legislation were specifically driven by the needs and wants of the PE and closed-ended funds sector more generally. The end result being a built-for-purpose, world-leading PE and VC vehicle.
The benefits and appeal of BVI limited partnerships, however, is not the sole rationale for PE fund sponsors electing to use the BVI as the jurisdiction of domicile for their funds. The BVI is renown as a corporate incorporations centre. BVI active business companies’ number (as at Q2 2022) over 370,000. These companies are often utilized by PE funds as downstream asset holding entities and facilitate mergers, consolidations and acquisitions of assets held in those companies.
Due to the sheer volume of companies incorporated in the BVI, the FSC and its corporate registry division have in place two of the most innovative and efficient electronic financial services systems, the Virtual Integrated Registry Regulatory General Information Network (VIRRGIN) and the Beneficial Ownership Secure Search System (BOSSs). The VIRRGIN and BOSSs electronic platforms make the BVI one of the most technologically advanced and user-friendly IFC jurisdictions facilitating transactions and corporate registry and FSC filings.
The BVI has, to date, elected not to enact specific legislation incorporating ESG principles. In working with clients, particularly PE clients, in setting up and operating BVI ESG PE funds, it is the fund’s constitution or partnership agreement which sets out the fund’s ESG and investment and operating principles. These principles deal with environmental, social, and/or health and safety objectives and schedules identifying prohibited activities which the fund will not invest in or finance and provides the mechanism for enforcement. This freedom and flexibility offered in the BVI corporate, partnership, trust structures and funds regime provide the ESG fund manager with maximum versatility in structuring an ESG fund.
In the event that the PE fund is to leverage the equity held in the fund and maximize investment returns through fund financing, the BVI is often the lender’s jurisdiction of choice. This is because, in taking security over assets of the borrower and affiliated entities in order to secure the loan, the BVI offers a bespoke creditor-friendly environment. Under BVI law, a dual system of registration of security over assets exists. A mandatory private registration regime whereby the grantor (chargee or mortgagee) of the security must enter details of the security granted over its assets in the BVI company’s private register of charges and a voluntary public registration regime whereby the security may be registered on the file for that BVI company as maintained by the BVI corporate registry. The order and timing of the public registration determines priority of security interest in the charged assets. This system provides a clear and determinable mechanism to ascertain what security is registered over the assets of the BVI company and the priority of those interests and thereby provides lenders and other creditors with certainty and comfort.
In the final analysis the flexibility of BVI’s corporate and limited partnership laws, the Territory’s legal and regulatory infrastructure coupled with the strength and expertise of its service providers and of the BVI’s commercial court mean that the BVI is and remains a highly attractive domicile for PE and VC funds.
For further information, please contact:
Jeffrey Kirk, Partner, Appleby
jkirk@applebyglobal.com
