While segregated structures have been common place in offshore jurisdictions, Alan Dickson highlights the growing use of Segregated Portfolio Companies in Asia to structure investments into China.
Despite the many challenges presented by one of the most severe global financial crises in modern history, offshore financial centres remain active, vibrant and innovative.
When the recent financial crisis was unfolding, perennial onshore critics pointed to the tax neutral attributes of offshore centres such as Bermuda, the Cayman Islands and the British Virgin Islands, and focused the attention of international bodies and tax authorities in the world’s giant economies on possible illicit offshore activity.
Significant offshore jurisdictions responded constructively to this focused attention. Protocols for inter-jurisdictional co-operation have now been established, assuring mutual information exchange and investigative processes with major onshore economies and virtually ensuring transparency in the offshore world at a more sophisticated level than exists in many onshore jurisdictions.
At this date, no serious observer would conclude that the offshore financial world had anything to do with causing the financial crisis nor that offshore governments were interested in being part of any illicit offshore activity. The truth is, major offshore jurisdictions, including those mentioned above, are sophisticated and innovative financial centres that play an important role in legitimate international financial activity. These jurisdictions are striving to become even more efficient, by constantly updating their practices and legislation to meet the needs of the international financial community and the expectations of the regulators of that community. Recent efforts include the development of modern, flexible investment fund and insurance laws, which keep red tape and regulation offshore to a minimum, ensuring efficiency and ease in structuring offshore financial products.
By way of example, a common concern of fund managers in emerging economies is how to cost-effectively launch a new offshore investment fund. New managers face strong investor pressure to control start-up and operating costs. Most managers of multiple fund products now know about the cost-saving benefits offered by the use of offshore incorporated segregated fund platforms. These segregated portfolio products are efficient options and an excellent example of how offshore innovation and a business as usual attitude prevails offshore, notwithstanding increased focus and attention of enforcement agencies in the onshore world.
A segregated portfolio company, or ‘SPC’, is an efficient and cost effective option for structuring an offshore investment fund.
SPC structures were commonly used by private legislation as early as the 1990s in Bermuda and are now available via public legislation under the laws of most recognised offshore jurisdictions, including Bermuda, the Cayman Islands and the British Virgin Islands.
An SPC structure offers the opportunity to launch new, structurally separate fund products within an existing fund company and is an optimum way to manage cross-liability issues arising in entities issuing multiple asset linked securities. The cost savings arise from avoiding the need to incorporate, license and service a separate new legal entity for each separate fund. SPCs are routinely used now by many fund managers in major jurisdictions including in Asia, the USA and Europe.
In Asia, another interesting use of offshore SPCs has developed, as offshore SPCs have been used to structure investments into China under the Qualified Foreign Institutional Investor (‘QFII’) scheme. The QFII and a similar program, the Renminbi Qualified Foreign Institutional Investor Scheme (‘RQFII’), enable certain foreigners to use offshore foreign currency, or in the case of the RQFII, Renminbi held outside of mainland China, for investment in the Mainland China securities markets. Offshore SPCs have been qualified under the QFII scheme to allow multiple investors to participate in the QFII scheme without holding QFII licences – only the SPC is required to hold the QFII licence. Multiple investors in an SPC holding a QFII licence enjoy the benefits of the licence, without the red tape required to obtain one.
The use of offshore SPCs to participate in the QFII scheme was not forseen when the SPC legislation was developed, however, such usage highlights the innovative thinking offshore, which envisaged a potential for any number of uses of an SPC product, and responded by developing the SPC product. There are other potential uses for an offshore SPC product and it is a tool that onshore advisors would do well to research and understand.
An SPC is a single company that acts like a host or honeycomb for any number of separate portfolios, with the assets and liabilities of each portfolio being legally segregated and separate in all ways from all the others. An application to register as an SPC is generally made at the same time as an application is made to register a new company. The assets and liabilities of each portfolio are as separate from all other portfolios of the hosting company as though they were in a separate company. Each portfolio can issue special securities to investors that can be specifically tailored to meet its individual business goals. Creditor and investor recourse is limited only to the particular assets and liabilities of the portfolio they invest and/or deal with. Each portfolio is treated as a separate company for the purposes of legal and regulatory tests for dividend declaration and distribution. SPCs offer an ideal solution where there is a substantial risk of such ‘cross-class’ liability.
Once duly established, most SPCs can establish any number of segregated portfolios and issue different classes of shares, the proceeds of which will be held within or on behalf of its various segregated portfolios. The assets, liabilities, income and expenditure attributable to a segregated portfolio will be applied in the books of the SPC only to such segregated portfolio, and no other. Where assets are not ascribed to a particular segregated portfolio, they will comprise the ’general assets’ of the SPC.
In practice, this means that, for example, a multi-class, umbrella or master-feeder investment fund is able to ‘ring-fence’ against cross liability issues between its segregated portfolio,s without the need to incorporate separate companies or resort to trust or contractual ‘limited recourse’ structures. A good example of where this is particularly significant is when an investment fund wishes to protect certain of its portfolios from the risks associated with any leverage employed by another portfolio within the group.
A creditor of an SPC will have recourse only to the assets of the segregated portfolio with which it has contracted and not to the assets of any other segregated portfolio. An SPC may also maintain general assets; available for the benefit ‘pro rata’ of all portfolios, but generally this is not a material part of most SPC structures.
This ‘ring-fenced’ liability between portfolios was the subject of review in a significant decision of the Cayman Islands Court of Appeal in ABC Limited (SPC) v J & Co (May 2012). This decision affirmed the integrity of the segregated portfolio company structure under Cayman Islands law and is expected to be highly persuasive in any similar litigation in other offshore common law jurisdictions such as Bermuda or the British Virgin Islands.
SPC companies. which are also open ended investment funds will be regulated by the applicable offshore regulators, (ie, in Cayman – the Cayman Islands Monetary Authority). An SPC is typically required to include in its name a designation such as the letters ‘SPC‘ or the words ‘Segregated Portfolio Company’. Each segregated portfolio must be separately identified or designated in such identification as a segregated portfolio. The set up of an SPC will include all the paperwork associated with the launch of a traditional investment fund, including an offering memorandum where the SPC will be an open ended investment fund, constitutional documents and contracts with service providers.
The opportunity to achieve a segregation of assets and liabilities within a single company can otherwise be achieved only by incorporating separate subsidiary companies. Within the investment fund industry this is particularly useful for managers wishing to establish master feeder fund structures, structures providing for multiple classes of shares linked to only certain types or classes of investments, or any structure where the statutory segregation of assets is desired across multiple investment fund strategies. In Bermuda, a segregated account of an SPC may also invest in another segregated account of the same SPC, which is a further useful innovation to be taken into account when planning.
Separate books and records must always be carefully maintained for an SPC and each of its segregated portfolios, to ensure the integrity of the segregated structure. Upon liquidation, after application of the assets held for the account of each segregated portfolio to pay the liabilities of that portfolio, the surplus assets of the portfolio will solely benefit holders of shares attributed to that portfolio.
The advantage of using an SPC structure involves more than just cost savings. Subsequent portfolios avoid the initial effort and expense incurred in setting up the host SPC structure. An SPC that is properly structured will offer a fast launch opportunity for a new fund by the same management group, by offering a segregated portfolio of the group’s existing SPC. An established SPC may create additional segregated portfolios and issue related shares, generally as its board of directors determine. When creating a new segregated portfolio, the directors can decide the relevant investment objectives, policies, whether or not to use leverage, and all other incidental terms, conditions and any investment or other restrictions or guidelines relating to each new segregated portfolio.
It is important to highlight that each segregated portfolio within a single SPC may have a distinct investment objective, style and characteristics, and may employ different investment techniques and strategies to fulfil the relevant investment objectives. The investment objective, policy and strategy of each segregated portfolio in an open ended investment fund structure will usually be required to be set out in a prospectus supplement relating to the relevant segregated portfolio.
Investment fund promoters will generally consider establishing a new investment funds as an SPC from the outset. But existing offshore investment funds may also wish to consider the alternative of converting to be registered as an SPC. Such a conversion may offer attractive cost-saving alternatives for established investment funds with a ‘portfolio structure’, particularly multi-class and umbrella funds. The conversion procedure is generally straight-forward, involving a filing process that is focused on identifying the assets and liabilities to be segregated and notifying/obtaining consent from relevant creditors and shareholders of the segregation process.
The opportunity to structure a vehicle as an SPC should not be overlooked when planning a new financial product that will require an offshore component. This type of structure is a true example of how the world’s most significant offshore financial centers are responsibly managing their affairs to offer innovative products of real use in complex international financial transactions.
Alan Dickson Director and Head of Singapore Office
Conyers Dill & Pearman Bermuda, British Virgin Islands and Cayman Islands.