SETTING UP OF OFFSHORE FUNDS CASE STUDY - SAXON BROTHERS

SETTING UP OF OFFSHORE FUNDS


Saxon Brothers is a private bank established in the mid-19th century with branches in London and New York. In the late 20th century the available range of investment opportunities and techniques expanded very rapidly, and this proved challenging for Saxon Brothers, as its high-net-worth investors became more sophisticated and alternative types of investment appeared offering higher rates of return.
During the 1980s and 1990s Saxon Brothers responded to the demand for innovative investment vehicles by creating a number of managed funds. By the mid '90s the fund management subsidiary (Saxon Trust Group) had become by far the most important part of the firm, with a large array of unit trusts and other funds.
Like many other fund managers, Saxon Trust reacted to the remorseless increase in levels of taxation by creating offshore funds for its clients, who were themselves increasingly footloose and fancy free, in a strictly financial sense of course. Initially Saxon used Luxembourg to list and domicile its offshore funds, for the standard reasons: because Luxembourg is an EU member, public marketing of funds is allowed in the EU, while at the same time there is no withholding tax on income from the funds.
The New York branch of Saxon Brothers behaved rather differently, using limited partnership structures to channel client assets into different types of investment as fashions changed during the 80's and 90's.
Unlike London, the New York branch did not develop a large business in public mutual funds, preferring to remain within the less-regulated and more flexible territory available to funds with limited numbers of participants.
Specifically, Saxon Brothers New York did not venture into offshore funds, largely because of 'The Ten Commandments' - the set of IRS rules which prohibited offshore funds from carrying out almost any activity at all inside the US. Saxon was not prepared to relinquish detailed control and management of its clients' assets into what it saw as being doubtful custody.
In the mid- to late 90s, several developments took place which caused Saxon to rethink its business model:
It became clear that the Internet would provide a new marketing, sales and even operating channel for banks and financial institutions; several of Saxon's main competitors launched Internet marketing sites.
Saxon Trust Group began to have misgivings about the use of Luxembourg for offshore funds for its high-net-worth clients; the trend of EU regulation was ever tighter; and the shadow of an EU withholding tax began to fall across the investment fund sector.
In 1997 the IRS repealed The Ten Commandments, allowing virtually the whole of an offshore fund's administration to be carried out onshore; and the 'check-the-box' rules permitted an incorporated offshore fund to be taxed as if was a limited partnership from the point of view of US investors.
A joint US/UK Saxon working party was set up and decided early on that the Internet would allow world-wide marketing of offshore funds, and that the firm should develop a strong offshore presence in a suitable jurisdiction. Saxon wanted to continue to list its funds whenever possible, as part of gaining the greatest possible degree of marketing freedom in highly-regulated target countries. Given Saxon's predominantly US and European client base, time-zone considerations, and growing fears about the EU's tax regime, the choice came to be between Bermuda and the Caymans.
Both jurisdictions have strong mutual fund industries with excellent infrastructure; the listing requirements and regimes are similar; both are carried on Bloomberg so that individual funds have their own stock tickers, with daily updates to NAVs; importantly, both exchanges provide Internet services, with home pages provided free of charge for each listed fund, and both (with the Caymans rather in the lead) are implementing mutual fund marketing/operational support packages on their servers which will give fund administrators direct access to trading details, NAV calculations and which will allow direct dealings with existing and prospective subscribers.
Finally the choice came down to a regulatory issue: which jurisdiction would give Saxon the greatest freedom to market funds in its existing markets? The winner by a short head was Bermuda, which is both a member of the OECD (via the UK), an SEC Designated Offshore Securities Market, and was granted UK Designated Investment Exchange status in August 2005.
So Saxon decided to start a new fund management company in Bermuda. According to its normal practice, its partners would be the sponsor (owner) of the funds as well as the manager, and a new holding company would be set up in Bermuda with separate ownership from the existing London and New York branches, gaining freedom from taxation for Bermudian profits for the owners. Corporate and legal arrangements for the new venture involved a number of separate stages:
The setting up of a Bermudian holding company and documentation for the first six funds was undertaken by a Bermudian law firm with links to Saxon's London lawyers;
Listing of the funds was the responsibility of a Bermudian brokerage, again previously known to Saxon through its London brokers;
Arrangements for custody and fund administration were made with the BerCo group, which had already developed strong Internet links with the Bermudian Stock Exchange, and which already administered a large number of Bermudian investment funds.
A long list of administrative tasks could thus be passed over to the Internet-based administrator, gaining substantial cost savings; these tasks include:
Download brokers' trades and pass to custodian
Calculate NAV on demand and in real time
Update portfolio holding and dividend records
Receive clients' and manager's transaction requests; pass to broker Update subscriber/unit holder records, produce advice, transaction notes
Conduct routine and ad hoc portfolio analysis and performance measurement
Maintain accounting records, calculate and debit fees
Feed derivative action-planning systems
Feed VAR and other risk-measurement systems
Although BerCo offered to outsource marketing and sales activities as well, Saxon decided to set up an office in Bermuda for these purposes. Saxon therefore set up its own web-site on BerCo's server with their help and constructed a sales and marketing presence on the Internet using the services of a London-based site-design agency and an e-business consultancy firm which procured and knitted together the various systems tools that were needed, according to Saxon's specification. Internet clients can set up payment either by credit card or by direct debit, using digital signatures, or can choose to sign up off-line by fax or mail.
All normal communication between clients and Saxon including requests for trading of fund shares and valuation can take place though the Internet site. Sales that take place on Saxon's own site are passed through to the administrator's site for detailed processing at an early stage.
The first batch of six Bermudian funds were launched in late 1999, using Saxon's new Internet site in addition to traditional methods of direct mail and coupon advertising in Saxon's established markets. Early results showed that a significant proportion of new sales were being generated through the Internet site, and that even those clients who had subscribed off-line were mostly choosing to switch administration of their accounts onto the Internet site. However it was clear that conventional methods of marketing were going to remain dominant for some years to come.

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