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THE NEW AND EVOLVING SECURITIES AND INVESTMENT ENVIRONMENT IN THE BAHAMAS

BY CHRISTINA R. ROLLE

The Digital Assets and Registered Exchanges Act, 2020 (the DARE Act) and the Investment Funds Act, 2019 (the IFA) have gained international acclaim for their innovative, pragmatic responses to vexing regulatory concerns. Legislative initiatives are opportunities to solve problems, but they are also opportunities to innovate. We approach them as such, with the view that what will distinguish the Securities Commission of The Bahamas (SCB) is our deep commitment to providing pragmatic solutions in response to regulatory risk.

To illustrate this, the investment funds legal framework, prior to the promulgation of the 2019 legislation, had not kept pace with international best practices and standards. It had supported The Bahamas’ wealth management industry at the start of the millennium, but by the time The Bahamas underwent its peer review under the International Monetary Fund’s Financial Sector Assessment Programme in 2012, the framework was found to be deficient in several key areas. As for the digital assets space, despite its growing importance to investors and wealth managers, there was no legal framework in place to provide much‑sought‑after legal and regulatory clarity. In both instances, the SCB found itself positioned to demonstrate its innovative prowess, as it set out to update or develop the respective legislation.

The SCB’s approach to these initiatives can be simplified into developing a practical understanding of regulatory concerns as well as stakeholder needs (the problems to be solved), prioritising those needs, and determining and implementing pragmatic, sustainable, best‑in‑class regulatory solutions.

Christina R. Rolle is Executive Director of the Securities Commission of The Bahamas

NEED: PRAGMATIC LICENSING TRIGGERS FOR REGULATING INVESTMENT FUNDS

Under the IFA, an investment fund that carries on/attempts to carry on business in or from The Bahamas must be licensed as a Standard, Professional or Specific Mandate Alternative Regulatory Test (SMART) fund. ‘Carrying on business’ in this context now applies to an investment fund that is incorporated in The Bahamas or offered for sale to non‑accredited investors in The Bahamas. Therefore, investment funds are eligible for licensing based on the activity they conduct or intend to conduct, and who will be impacted by those activities, rather than whether or not certain service providers to the fund are located or licensed in The Bahamas.

NEED: RIGHTING REGULATORY RESPONSIBILITY AMONG RELATED PARTIES

Absent a framework for the regulation of investment managers, the previous investment funds legislation consequently burdened the investment fund administrator with all responsibilities for a Bahamas‑licensed investment fund. This may have met the needs of the primary users of investment funds in the early 2000s – private banks and trust companies servicing their clients – but as the funds industry evolved, this misalignment of responsibilities became too onerous for administrators and did not address the lacuna of fiduciary duties that should be the responsibility of the investment manager. It also meant that administrators licensed in The Bahamas were at a disadvantage to administrators licensed in other jurisdictions, where they may not be saddled with fiduciary responsibilities.

Funds needed flexibility in selecting administrators, and non‑accredited investors expected vetted and licensed investment managers. By developing a framework for the licensing and supervision of investment managers, the IFA framework now answers the call in both areas.

ADMINISTRATORS FROM ANY PRESCRIBED JURISDICTION

A Bahamas‑based fund is no longer required to appoint an investment fund administrator in The Bahamas to provide its principal office. Investment fund administrators for Bahamian investment funds may be licensed under the IFA or licensed and operating in any prescribed jurisdiction anywhere in the world. This approach opens the door for international administrators to license funds under the IFA.

APPOINTMENT OF INVESTMENT FUND MANAGERS

Under the IFA, funds must appoint an investment fund manager, except in very specific circumstances. The investment manager must be licensed if the fund is sold to non‑accredited investors but does not need to be licensed if the fund is being sold to accredited investors only. Importantly, investment funds may appoint investment managers licensed or registered in prescribed jurisdictions without the need for licensing of the investment manager in The Bahamas. In such cases, there is a simple registration process.

CUSTODIANS AND OPERATORS

Funds must appoint a custodian, who must be independent of the administrator, manager and operator of the investment fund, and is obliged to segregate the cash and other assets of the fund from those of the custodian itself. Funds are also required to appoint operators, based on how the fund is structured. Operators have responsibility for the operation of the fund in compliance with the IFA and the fund’s constitutive documents. They are subject to fit and proper

assessment and must be independent of the administrator unless exempted from this requirement or structured as an investment condominium.

EU MARKETS ACCESS

Finally, the IFA is also compliant with the EU’s Alternative Investment Fund Managers Directive. This allows The Bahamas to qualify for passporting under the Directive. The framework grants a distinct licence for managers operating in the EU or managing funds from the EU. The IFA also addresses the EU’s standards for investment funds regarding the regulation of auditors. Under the framework, all funds that do not submit to a full annual audit are required to receive a certification every three years from a qualified accountant that its books are being maintained within International Financial Reporting Standards or US Generally Accepted Accounting Principles standards. Auditors must be approved by the SCB to act on behalf of regulated persons.

NEED: LEGAL CERTAINTY REGARDING DIGITAL ASSETS BUSINESS

The SCB’s primary objective in developing the DARE Act was to bring regulatory certainty to the dynamic, fast‑paced and evolving crypto space. The SCB had observed the potential the space represented for The Bahamas’ wealth management industry, with increasing investor interest in fintech and crypto‑assets globally. The SCB fielded interest from international fintech operators seeking to operate in a well‑regulated, compliant jurisdiction. Enveloping these opportunities, the Government of The Bahamas had also made clear its intention to transform the jurisdiction into a regional fintech hub.

NEED: REGULATORY FLEXIBILITY AS THE SPACE DEVELOPS

Given that the digital assets or crypto space was (and is) still in its infancy, or in any event, far from maturity, it was clear to the SCB that it needed to establish a legislative framework that was not overly prescriptive. This allows the jurisdiction to be nimble and to react to new risk trends or market development opportunities.

To develop the legislation, the SCB initially conducted a benchmarking exercise of 13 select jurisdictions, homing in on regulatory approaches, global standards and best practices in the digital or virtual assets space. The SCB reached out to other regulators with relevant experience and consulted with industry and other stakeholders to develop the legal framework.

The DARE Act came into effect on 14 December 2020. The legislation provided sought‑after clarity and successfully established a Bahamian legal and regulatory framework for the registration of digital token exchanges and for the issuance of digital tokens via initial token offerings.

The DARE Act provides key legal definitions for salient terms, including digital asset business, digital assets service provider, digital token, non‑fungible token, utility token and virtual currency token. It intentionally does not set out to answer the question of whether a digital asset is a security or not. Throughout the DARE Act, although various types of digital asset are clearly defined and the legislation is clear about what is in scope for regulation, digital assets or crypto‑assets are recognised as their own asset class. By giving the space its own regulatory regime, The Bahamas has removed the narrow question, and its inherent uncertainty, of whether a crypto‑asset is a security and instead provided a framework whereby digital assets can be addressed holistically.

NEED: COMPLIANCE WITH AML/CFT/CPF STANDARDS

How the DARE Act addresses global anti‑money laundering, counter‑financing of terrorism and counter‑proliferation financing (AML/CFT/CPF) standards is vitally important. The SCB continues to home in on the Financial Action Task Force’s (FATF’s) Recommendation 15 and its evolving explanatory/interpretative notes. In keeping with the principles, under the DARE Act, digital assets business is subjected to the primary national AML/CFT/CPF legislation, including the Proceeds of Crime Act, 2018, the Anti‑Terrorism Act, 2019 and the Financial Transactions Reporting Act, 2018. In line with the FATF Recommendations, the DARE Act focuses AML/CFT supervision and oversight on the digital asset service provider, rather than the new technologies themselves.

The term ‘beneficial owner’ in the DARE Act is assigned the same meaning as in The Bahamas’ Proceeds of Crime Act, 2018, harmonising the definition with this key legislation. The DARE Act requires financial institutions to perform initial risk assessments prior to launch. It requires digital assets businesses to have systems in place to prevent, detect and disclose money laundering, terrorist financing and suspicious transactions. They must also comply with the SCB’s rules, policies and guidelines on risk management and the prevention of money laundering and terrorist financing.

On 16 March 2022, the SCB published its AML/CFT/CPF rules for the DARE Act. These rules are based on the FATF’s Recommendation 15 and its interpretative notes and provide specific requirements for the digital assets space. They are supplementary to the DARE Act and are also expected to evolve as the space evolves.

CONCLUSION

Pragmatism is a key consideration in The Bahamas’ approach to regulation, and the jurisdiction continues to watch as trends indicate a move toward securities and other asset classes becoming tokenised. We are also mindful of recent emerging risks that came to the fore in the aftermath of the great ‘crypto winter’. These risks must now be addressed in the regulatory framework and clear best practices must be established to protect investors.

If you know anything about The Bahamas, you know we do not view our size as a handicap, but a reality we can leverage to our benefit. The access that we as regulators have to industry players and regulatory addressees, policymakers and the consumers and investors we aim to protect allows us to identify and act on urgent matters and to be innovative in providing pragmatic solutions to regulatory concerns.