Crypto Hedge Funds In Gibraltar: A Modern Approach Informed By Experience

Technology has played a huge part in the financial markets since the advent of mainframe computers. It was deployed by financial institutions across the world to optimise and add additional security layers to existing processes, as well as allow new avenues such as algorithmic trading. Technology has allowed financial institutions to trade in volumes, speeds, and global locations in ways that could not previously have been imagined.

However, these great advances had, for many years, been focused on optimising the trade of established assets, such as fiat, bonds and physical commodities. Today, this is not the case. In more recent years, technology has enabled the creation of a new generation of assets, specifically digital assets. This emerging asset class is best known to most consumers as cryptocurrencies such as Bitcoin, an asset that has been known over the last decade as a grabber of headlines, both positive and negative. For years, cryptocurrencies were perceived as the ‘wild west’ for many traders.

Despite this, as more institutional investors explore the advantages to digital assets, there is a growing demand for the space to become more regulated, offering the stability of the traditional markets. Gibraltar’s principles-based Distributed Ledger Technology (DLT) framework represented the first national regulatory framework in this space and it is certainly encouraging to see major jurisdictions also taking important steps in the regulation of digital assets - allowing asset allocators and consumers to have a great degree of certainty that their money is safe.

In addition to the growing trust in the sector, on an operational level digital assets have never been more attractive. Technology offers the fastest and most secure way to trade, providing huge cost efficiencies. In an era of low returns largely due to the global recession and the current pandemic, reducing costs while improving speed and reliability will make the difference between failure and success.

The industry is waking up to digital assets, and when institutions wake up, so do jurisdictions. While major financial centres remain popular with the next generation of assets, they do have distinct downsides. They are located in large complex jurisdictions that have a reputation for their slow-moving systems with a lot of in-built interests to consider before being able to implement something. Smaller jurisdictions, such as Gibraltar, that rapidly evolved at the advent of online gaming to become a hub for the industry, have been able to take the same legislative steps to create a suitable environment for the trade digital assets, but much quicker. Through consultations with lawyers, businesses and academics, the Government of Gibraltar has been able to get ahead of the tide and develop a leading regulatory framework, based on the overarching ‘right touch, not light touch’ model.

As with the gaming legislation before it, the new model for digital assets has proven popular with the financial community of Gibraltar and the 'Core Principles' based DLT regulatory approach is well respected and in demand on the global stage. Building on the jurisdiction’s previous strengths in traditional hedge funds, Gibraltar is attracting a new generation of cryptocurrency hedge funds, drawn by both this longstanding knowledge and the dynamic approach to digital assets.

Indeed, a recent report into the global crypto hedge fund landscape from PwC and Elwood Asset Management[i] highlighted Gibraltar as the third highest jurisdiction of choice for crypto hedge fund managers, only behind the US and UK. Additionally, Gibraltar is listed as having the fourth highest number of domiciled crypto hedge funds, ahead of financial centres such as Singapore, Malta, The Netherlands, Hong Kong, Switzerland and many others, despite the comparatively small size. These rankings point to a high degree of favourability towards the jurisdiction, achieved through constructive dialogue as opposed to a 'top-down' centralised approach. As well as showcasing its considerable presence in the global market, a look back at the previous (2019) report points to Gibraltar’s impressive growth, having been unranked on both indicators the previous year.

In addition to strong local growth, the crypto hedge fund market is developing strongly on a global scale. The PwC and Elwood report showed that the overall Assets Under Management (AuM) by Crypto Hedge Funds doubled to US$2 billion in the last year. Over the same period, the industry saw the percentage of crypto hedge funds with an AuM of over US$20 million increased in 2019 from 19 per cent to 35 per cent, broadly in keeping with the overall trends of Crypto Hedge Funds getting larger, with the average AuM increasing from US$21.9 million to US$44 million, while median AuM increased from US$4.3 million to US$8.2 million. This growth points to the industry seeing this new technology as not just the means of asset trading but the end in itself.

The fast growth in overall AuM by crypto hedge funds show the scale of the opportunities available to investors, hedge fund managers and jurisdictions. Fast-growing sectors in any industry always draw comparisons and therefore, it is incumbent on market leaders, such as Gibraltar, to innovate, streamline their offer, and shore up their market share - which is already a growing slice of the metaphorical pie.

Gibraltar’s commitment to innovate and streamline regulation is evident by the development of the world’s first code of conduct for crypto hedge funds. The Gibraltar Funds and Investments Association (GFIA), the authors of the code, considered best practice from traditional funds as well as studying the potential of cryptocurrencies to put together the dynamic document. Within the code, GFIA sets out clear frameworks for the structure of crypto funds, best practice in corporate governance, risk management, and valuation, as well as setting out expectations for safekeeping and security, liquidity management, and anti-money laundering safeguards.[ii] The code, praised by the Government, lawyers, and thought leaders could be used as a basis for codes of conduct in other jurisdictions seeking to replicate the ‘Gibraltar model’.

In addition to its dynamic and flexible approach to legislation and regulation and simple and attractive tax structure, Gibraltar offers many other benefits to those looking to domicile in the jurisdiction. From facts as simple as the local language being English, to points of emerging importance, such as its unique position to act as a “gateway” to the vital UK market post-Brexit - Gibraltar is a solid choice of jurisdiction.

These benefits have and continue to create a robust financial services industry, with an ecosystem of internationally competitive providers of legal and professional services, banking, and real estate. This network of services, combined with the points around ease of doing business, makes Gibraltar a one-stop-shop on a par with major financial centres. Despite being seen as an 'offshore' financial centre, Gibraltar does not come with the 'baggage' that others do. Indeed, the Rock, as it is known locally, has made great reputational strides, particularly around transparency. This is evidenced by a recent report by the Organisation for Economic Cooperation and Development (OECD) that found Gibraltar’s tax information exchange frameworks are on a par with those of leading western nations including the US, the UK, Germany, and Spain.[iii]

Of course, these points are not just attractive for those looking to set up new crypto hedge funds, but also those looking for a fitting home for their existing entity. Gibraltar has put together a compelling offer for those looking to redomicile. The importance of picking the correct domicile for any entity cannot be overstated. If done right, the process can be painless and offer substantial benefits; if done badly it can either cause high costs and complex admin or, worse still,  look appealing but present a series of disruptive roadblocks in the mid-to-long-term.

Gibraltar has seen an influx of interest from funds looking to redomicile as the jurisdiction has specific purpose-built regulations allowing for the re-domiciliation of companies into and out of Gibraltar, thereby enabling companies to move their domicile as their business demands require. Additionally, companies looking to move their domicile will still benefit from a process that does not interrupt its existence and does in no way operate to create a new legal entity, prejudice or affect the continuity of the company, contracts or its property.

While jurisdictions around the world continue to evolve their legislation and regulations to keep up with smaller more flexible jurisdictions such as Gibraltar, there still remains a number which do not provide for re-domiciliation, making Gibraltar an appealing option. The regulations have been in place since 1996 and, from a fund’s perspective, allowing funds to re-domicile into and out of Gibraltar offers a powerful overall package.

Without specific re-domiciliation legislation, a re-domiciliation would typically be affected by establishing a new fund structure, transferring the assets of the existing fund to the newly created fund and ultimately winding up the ‘shell’ of the original fund. While this does enable continuity, the new entity is effectively a new legal structure.

However, Gibraltar’s re-domiciliation process enables funds that have a proven track record and established investors to move its domicile in a way that ensures its investors, contracts, and potentially counterparties remain un-interrupted. Similarly, the regulations provide for a seamless transition out of Gibraltar, providing a degree of comfort for newly established entities to seamlessly transition their business out of Gibraltar should their future business requirements change. This streamlined process for re-domiciliation makes moving to, or setting-up, in Gibraltar and benefiting from an established and trusted financial system with its feet firmly in the future an obvious choice.

With political uncertainty which is likely to create economic headwinds in traditional asset classes over the next few months and years, Gibraltar’s trusted financial services community and dynamic approach to regulation means there has never been a more opportune time to look at domiciling a crypto hedge fund on the Rock. 

Footnotes:

[i] https://www.pwc.com/gx/en/financial-services/pdf/pwc-elwood-annual-crypto-hedge-fund-report-may-2020.pdf

[ii]www.gibraltarlawyers.com/uploads/documents/GFIA-Code-of-Conduct-for-Crypto-Funds.pdf

 [iii] https://www.oecd-ilibrary.org/taxation/global-forum-on-transparency-and-exchange-of-information-for-tax-purposes-gibraltar-2020-second-round_8b4242db-en

Jonathan Garcia
Jonathan specialises in Banking & Regulation, Company Law, Funds & Investment Services and Fintech. He has co-authored a number of articles and chapters in high-profile industry publications, such as the U.S. Chamber of Digital Commerce’s ‘Understanding Digital Tokens: Market Overviews, and Proposed Guidelines for Policymakers and Practitioners’ and the Global Legal Insights’ Blockchain and Cryptocurrency Regulations 2019 & 2020.