• the regulator should have adequate powers, proper resources and the capacity to perform its functions and exercise its powers (Principle 3);

• the regulator should adopt clear and consistent regulatory processes (Principle 4);

• the regulator should have comprehensive inspection, investigation and surveillance powers (Principle 8);

• the regulator should have comprehensive enforcement powers (Principle 9); and

• the regulatory system should ensure an effective and credible use of inspection, investigation, surveillance and enforcement powers and implementation of an effective compliance programme (Principle 10).

It is against the IOSCO standards that we have made our assessment. The areas where we consider development is necessary are contained in the issues and recommendations section below.

For the purpose of this report we have defined securities/investment business as covering the following range of activities:

• dealing in securities;

• arranging deals;

• investment management; and

• investment advice.

Legislation and regulation relating to collective investment schemes/mutual funds (referred to hereafter as mutual funds) and the Bermuda Stock Exchange are covered in the following sections.

• arranging deals;

• managing;

• giving advice.

The IBA does not cover the operation or administration of mutual funds or the provision of custodial services, however the BMA has proposed amending the legislation to include these activities. No specific timescale has been set for amending the legislation to achieve this.

Included in the exemptions contained in the Schedule to the BMA are persons who are not market intermediaries and provide investment services exclusively for investors who are:

• sophisticated private investors;

• high net worth private investors;

• high income private investors; and

• a mutual fund approved by the authority under the Bermuda Monetary Authority (Collective Investment Scheme Classification) Regulations 1998.

Exemptions are also granted for:

• persons who provide investment services to not more than 20 persons at a time and who do not solicit the provision of such services to the public; and

• those who carry out investment business outside Bermuda from a registered office or place of business in Bermuda provided they are licensed or authorised by recognised regulatory authorities to conduct such investment business in that country or territory.

The effect of the exemptions is primarily to ensure that the IBA is restricted to market intermediaries (those who engage in the business of buying and selling securities as principal or agent) and those who deal with unsophisticated private investors. These are the areas where Bermuda feels the greatest need for regulatory protection lies as they represent the smaller and less experienced investor.

Supervisory responsibility under the Act falls to the BMA.

Under the IBA the following Orders have been issued.

"The Investment Business (Excluded Activities) Order 1999" provides additional exclusions from the definitions of investment business. These exclusions mainly concerned trustees and personal representatives.

"The Investment Business (Exemptions Order) 1999" amended Schedule 2 of the Act removing the exemption in the Act to those people doing business exclusively with non-Bermudians.

Bermuda does not have in place general legislations criminalising insider trading and market manipulation.

6.3.2  Regulations

6.3.2.1  Powers to make regulations

Under Section 30 of the IBA the Minister of Finance may, after consultation with the BMA, prescribe regulations covering areas such as:

• regulating the conduct of investment business;

• prescribing the standards of operational capability and qualifications for any person conducting investment business;

• prescribing forms, fees and charges;

• providing for the discipline and control of investment providers or any person employed by or acting on behalf of an investment provider;

• prescribing the manner in which clients' assets are to be held in trust and preserved by an investment provider;

• prescribing capital and liquidity requirements for any person conducting investment business;

• prescribing systems for maintaining the records and controlling the operations, of an investment business;

• prescribing systems for clearing and settling securities transactions;

• regulating advertising and the solicitation of business by whatever means (including electronic solicitation); and

• the prohibition of untrue or misleading statements.

Under Section 22 of the IBA the BMA may, after consultation with the Minister of Finance, issue Codes of Conduct. These Codes may in particular cover the following areas:

• the form and content of advertisements; and

• the full and proper disclosure to clients of the capacity in which the licence holder is acting.

6.3.2.2  Regulations in place

The Investment Business Regulations 1999 have been issued under Section 30 of the IBA.

These cover a number of areas including:

• contents of the Register of Licences;

• form and content of application for review;

• duty to provide confirmation note;

• duty to keep accounting records;

• minimum capital requirements; and

• liquidity requirement.

Breaches of the Investment Business Regulations are offences under Section 25 of the IBA.

On 1 January 2000 the BMA adopted two codes of conduct pursuant to Section 22 of the IBA. These were a "General Business Conduct and Practice" and an "Advertising Code of Conduct".

The "General Business Conduct and Practice" Code contains the requirements on ensuring fair dealing with customers and prohibits such acts as churning and overcharging. It also details the requirements of skill, care and due diligence and the requirements for a formal agreement with the client.

The "Advertising Code" lays down requirements for licence holders in relation to the issue of investment advertisements. It covers such areas as the accuracy and non-misleading nature of advertisements and requirements relating to the advertising of specific investments.

6.3.3  Guidance notes

The BMA has provided guidance notes to licence holders and prospective licence holders.

The areas covered by the Guidance Notes include:

• licensing criteria including the fit and proper test that is applied by the BMA;

• the BMA's supervisory process; and

• investment business conducted over the internet.

The Guidance Notes also contain the application form to be used including a personal questionnaire.

6.3.4  Supervision - systems and procedures

6.3.4.1  Regulatory structure

The responsibility for licensing, supervision and enforcement is vested in the BMA. The BMA is a full member of IOSCO.

The day-to-day supervision functions in the BMA are undertaken by the Investment Division which is also responsible for the supervision of collective investment schemes. This division currently has five staff.

6.3.4.2  Licensing

The BMA vets all applications for licensing. The shareholders, director and officers of the applicant are required to complete a Personal Declaration. The IBA does not, however, require a full vetting of all controllers and senior officers.

In the case of applicants who are already subject to regulation in another jurisdiction the BMA seeks confirmation from the regulator in that jurisdiction that they have no objection to the applicant seeking to establish a presence in Bermuda.

6.3.4.3  Off-site supervision

The BMA requires quarterly financial reports from licence holders in addition to annual financial statements. The senior executive with responsibility for the investment business will be required to annually file with the BMA a statement of compliance with the IBA.

The statement of compliance must indicate that the licence holder was in compliance with its statutory responsibilities under the IBA, including any regulations issued under the IBA.

There is also an auditor's statement in respect of businesses holding client assets.

The BMA will also hold at least annual prudential meetings with licence holders' senior management.

6.3.4.4  On-site supervision

The BMA has power to conduct on-site inspections. At the time of our visit no inspections had yet occurred as the IBA was not yet fully in force and licences were only then being issued.

The BMA proposes that all licence holders will be subject to an initial visit after which a risk based schedule will be developed. The BMA proposes that these initial visits will be conducted on an informal and voluntary basis to obtain an overview of systems, procedures and culture. However, we have been advised that detailed testing of systems and controls will be included in the subsequent on-site visits. The BMA has access to client files for the purposes of its on-site inspection.

6.3.5  Enforcement - systems and procedures

6.3.5.1  Licence holders

Under Section 20 of the IBA the BMA has power to require from a licence holder the production and submission of relevant documents and information.

The BMA can vary, suspend or cancel licences; it can also give direction to ensure compliance. It can also appoint a custodian or manager to manage the investment business and safeguard assets.

Under Section 19 of the IBA the Authority can appoint an inspector to investigate the affairs of a licence holder.

The BMA has power to seek the winding up of a former licence holder on just and equitable grounds. There is no power to apply to the court to wind up a firm which is still a licence holder.

6.3.5.2  Non-licence holders

Contracts in connection with investment business where a person has breached the requirement to be licensed are unenforceable by that person. In addition persons who carry on investment business without a licence (where one is required) are guilty of an offence punishable on conviction on indictment to a period of imprisonment of up to five years. This provides a strong deterrent to persons attempting to undertake unlicensed activities in Bermuda.

However, in respect of persons who are suspected of undertaking investment business without the appropriate authorisation, the BMA's power under Section 19 of the IBA to appoint an inspector does not apply. Nor are there powers under the IBA for the BMA to take action against persons suspected of acting in breach of the legislation, other than via the court in specific circumstances. As a criminal offence, such matters are dealt with by the police.

6.3.6  Publicly available information

Under the IBA the BMA is required to publish in the Gazette notice of every grant of a licence.

Additionally the BMA keeps a publicly available register containing:

• the name of the licence holder;

• their address;

• the date of grant (and expiry if applicable) of the licence;

• any conditions imposed;

• any variation to the conditions; and

• the date of suspension or cancellation of the licence (if applicable).

The BMA have advised us that they propose to make this information available on the World Wide Web.

6.3.7  Investor compensation scheme

There is no compensation scheme in place in respect of securities/investment business.

• the absence of regulatory coverage of those engaged in the operation and administration of mutual funds or the provision of custodial services;

• the need for provisions prohibiting insider dealing and price manipulation, beyond the current provisions relating to investment providers and Bermuda Stock Exchange members;

• that the existing capital adequacy provisions are inadequate to deal with investment businesses undertaking material positions or trading risks;

• that there is no requirement for consolidated supervision contained in the IBA; and

• the need to enhance the BMA's ability to co-operate with other regulators. This is in the areas of compulsory powers and gateways.

It is reassuring to note that these areas have already been identified and action proposed in advance of this review.

6.4.3  Exemptions from the IBA

We consider the restriction of scope of the IBA to market intermediaries and those providing services to unsophisticated private investors to be too narrow. Whilst the regulations which apply to persons who deal with different categories of investment business or different categories of client may vary, the principal requirement should be that all persons engaged in investment business be verified as being "fit and proper" and licensed. It is also important that a regulator has power to take action against anyone engaging in this activity in an inappropriate manner. Furthermore, it is important that investors who may receive a lower level of regulatory protection are aware of this fact.

6.4.4  Enforcement powers

The BMA currently lacks full powers to "police the perimeter", that is, investigate situations where investment business may be being carried on in breach of the IBA. Currently any such investigation would be usually undertaken by the police as a suspected criminal offence although there is a power to go to the courts for injunctive relief in the case of non-licensed persons carrying on business in contravention of the prohibition or where the court is satisfied there is a reasonable likelihood of such a contravention.

We consider this to be a weakness, as the BMA are in a better position than the police to perform this function given their understanding and experience in this area. This inability also means that the powers available in relation to licence holders (excluding the power to petition the courts for winding up ) are not available for use against those acting in breach of the IBA.

We consider it would be helpful if the BMA's powers to petition the courts to wind-up a non-licence holder could be extended to licence holders. This would avoid the necessity of revoking a licence (and therefore losing some regulatory control) before a petition is made.

6.4.5  Anti-money laundering

Whilst we accept that a breach of the anti-money laundering code could be considered not being "fit and proper" we consider that, to make the position absolutely clear, a breach of any anti-money laundering laws, codes, guidance or regulations should formally be grounds for disciplinary action against a licence holder, including possible revocation of its licence.

6.4.6  Regulatory resources

Whilst resources have been allocated to the supervision of licence holders, the need for on-site supervision and the additional activities which it is proposed be included means that these resources may not be adequate. However, this cannot be gauged with certainty at this point.

We therefore consider that the adequacy of current resources needs to be closely monitored.

The BMA has experience in the on-site inspection of the overseas investment operations of licensed banks. However, we consider that, as this legislation is new there is inevitably a lack of direct experience in the supervision of licence holders, particularly on-site.

Therefore, we consider that a structured training programme in investment business supervision should be instituted.

6.4.7  Supervisory process

On-site supervision

Whilst the supervisory process, particularly the on-site process, has not yet been finalised; the proposed approach to on-site inspection appears to be in accordance with IOSCO Principle 8 and good practice. We particularly note that the proposed BMA on-site visit structure includes substantive testing of compliance with the regulatory requirements, as well as prudential discussions with the licence holder. The verification of compliance with conduct of business requirements can only be effectively achieved through such an approach.

We consider that any on-site supervisory regime developed for investment businesses should pay particular attention to the methodology for supervising licence holders with no real presence in Bermuda.

6.4.8  Additional supervisory checks

Licensing

Where applicants are already subject to regulation in another jurisdiction, the BMA seeks confirmation from the regulator in that jurisdiction that they have no objection to the applicant seeking to establish a presence in Bermuda. This should be followed up with ongoing information sharing arrangements to enable co-ordinated cross-border supervision to occur.

Off-site supervision

We consider that, provided off-site monitoring requirements are supplemented by notification requirements under which the licence holder must advise the BMA on the occurrence of certain specified events (for example, an error resulting in a client loss), these procedures will be in accordance with IOSCO Principles 8 and 10 and good practice.

6.4.9  Public register

We consider that making the register available on the World Wide Web is a very positive action.

We do, however, consider the information on the file could be enhanced to provide full transparency, should therefore be expanded to include details of directors and senior officers.

6.4.10  Insider trading and market manipulation

The OECD Principles consider these activities are a breach of good corporate governance as they violate the principle of equitable treatment of shareholders. As Bermuda does not have insider trading or market manipulation legislation in place this principle is not currently being complied with.

We therefore recommend that legislation criminalising insider trading and market manipulation legislation be put in place.