“Look before you leap” and “Don’t count your chickens before they hatch”.  Numerous sayings derived from Aesop’s fables encapsulate how one might approach investment.

The message, however, is not: “Do not participate”. Rather, it is: “Participate but be aware and manage the risks”. 

Bermuda’s FinTech laws and non-charitable purpose trusts can enhance investor confidence when investing in digital assets.

Investors in digital assets and projects associated with them face numerous potential risks. It can be difficult to adequately determine the fundamental underlying value of a digital asset. Digital assets used as an alternative to fiat currencies are not backed by a central government and only some are collateralised by underlying assets.  The market may lose confidence in the digital assets and leave investors unable to trade, exchange or redeem them.

The financial technology sector remains relatively new and untested and is rapidly evolving.  Many jurisdictions have struggled to regulate to meet demands and risks posed by the FinTech revolution.

The Bermuda Government’s ability to work with industry groups and experts to efficiently develop quality legislation has again been demonstrated in the FinTech sector.  Bermuda’s FinTech regime is being developed to balance market integrity, innovation with consumer protection. 

Bermuda’s Companies and Limited Liability Company (Initial Coin Offering) Amendment Act 2018 and regulations (ICO Laws) are operative, making it possible to launch and conduct legal and regulatory compliant initial coin offerings (ICOs) in and from within Bermuda. 

Issuers within the scope of the ICO Laws must meet certain criteria including obtaining the consent of Bermuda’s Minister of Finance (assisted by Bermuda’s Fintech Advisory Committee) through a rigorous and efficient application process. Such process includes detailing the: proposed development of any product, project or service relating to the ICO; timeline for completion; technology to be used; how investor information will be protected; and compliance and auditing arrangements.

Bermuda’s Digital Asset Business Act (DABA) and ancillary regulations will soon be operative. DABA imposes a licensing regime on companies that are seeking to carry on “digital assets business” in or from within Bermuda. 

Issuers launching ICOs from Bermuda will typically require the services of Bermuda service providers, including those licensed under DABA.  Consequently, issuers, promoters and owners will be subject to due diligence by such licensed service providers whereby, in addition to anti-money laundering and anti-terrorist financing checks, the service provider must endeavour to sufficiently understand the business to form a view regarding its substance and classify it for risk purposes. While there are inherent risks with ICOs (and indeed all initial product offerings), licensed service providers inevitably do not wish to be associated with poorly conceived ICOs as they may expose the service provider to regulatory attention and reputational risk.

As a further measure to attract and provide further confidence to investors, trusts can be used to hold proceeds of ICOs to secure:

  • redemption payments that the issuer may make under the ICO’s terms; and
  • payments towards projects being developed by the issuer under the ICO’s terms.

An express trust is a legal relationship created by a person who places assets under the control of trustees for the benefit of beneficiaries or for specified purposes.  While trust law has not been around as long as Aesop’s fables, trusts were being used to protect and manage property well before legislation made it possible to form companies.

Bermuda trusts are flexible and Bermuda law enables trusts to hold property for non-charitable purposes. In the commercial world, trusts are frequently used to hold property as security. For example, to hold funds to discharge payments to note-holders or other creditors who otherwise may have been disinclined to provide funding to the company. In the insurance context, a captive insurer may establish a trust to provide security for its obligations to the reinsurer under a reinsurance contract. 

In the ICO context, the specific terms of a trust to hold issue proceeds may vary depending on the nature and requirements of the issuer, the investors and the terms of the offering. The issue might, for example, provide for the:

  • appointment of a licensed trustee or a private trust company established by a licensed trustee and whose directors are employees of the licensed trustee and, potentially, persons who satisfy other criteria;
  • trustee to only invest in investments prescribed by the trust instrument;
  • direction of appointment of an independent investment manager to manage such investments;
  • application of funds from the trust toward the project or for certain parts of the project being developed pursuant to the ICO; and
  • issuer’s ability to direct the trustee to make payments to satisfy redemptions, if applicable, to all or to certain investors.

Trusts terms can also provide for the issuer, or a committee of investors and the issuer, to be granted powers to veto or direct certain actions of the trustee. 

Bermuda’s recent FinTech legislation is already providing legal certainty for issuers and their service providers and confidence to those who may invest in an ICO. Bermuda trusts are vehicles that issuers can use to provide security and confidence to ICO investors.

With technological innovation transforming offshore businesses and markets, Appleby has led the way amongst the offshore firms by launching a dedicated Global Technology and Innovation Group. With experts in Bermuda and across its network of 10 offices, the group supports clients across a broad range of emerging technologies.

Article first published in the Royal Gazette August 2018

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