Following publication in Monday's Royal Gazette of the formal response of the Bermuda Government to KPMG's Review of Financial Regulation, Business reporter Sue Stuart today files the second of a series of articles, looking at the Investment Business and Collective Investment Schemes sectors. Tomorrow she will examine the fiduciary sector -- companies, trusts and partnerships.

In general, the international accountancy firm KPMG seemed impressed with Bermuda's supervision of investment businesses.

Their report did recommend some additions and enhancements, many of which are already in hand and some of which the Bermuda Government rejects.

KPMG noted some regulatory weaknesses which had already been identified by the Bermuda Monetary Authority, such as provision for prudential vetting of controllers, directors and senior executives of investment businesses and a need to increase capital adequacy provisions for businesses undertaking material positions or trading risks.

All the above points raised are being addressed in a consultative paper for the industry which has been prepared with a view to amending the Investment Business Act (IBA) 1998 next year.

One area being examined for change is that of exempting certain categories of business from the need for supervision under the IBA. KPMG said, "We consider the restriction of scope of the Investment Business Act to market intermediaries and those providing services to unsophisticated private investors to be too narrow. The principal requirement should be that all persons engaged in investment business be verified as being `fit and proper' and licensed.'' However Government is not prepared to include most current exemptions, believing that exemption from strict regulation for those doing business with wholesale or sophisticated investors is fully justified and in line with practices in most other countries.

The recommendations that the BMA be given stronger powers to enforce regulation and to petition the courts to wind up licence holders are both agreed by Government. They are on track to be included in the proposed amendments to the IBA.

Government does not agree with the suggestion that breaches of the anti-money laundering code by investment businesses should be formally considered a regulatory breach. As with the banking and insurance industries, Government feels there are other adequate powers in place to take action where necessary.

The review said, "We consider that a structured training programme in investment business supervision should be instituted.'' This is already being dealt with and the BMA has increased its staff training programme over the past couple of years.

KPMG expressed a need for attention to methodology of a supervisory regime for investment businesses that do not have a physical presence in the Island.

Government agrees with this, and is working on a supervisory programme for all in the sector. The BMA is visiting all licensed entities to construct an appropriate supervisory programme for each.

The recommendations that enhanced information sharing with other regulators and more notification requirements should be instituted are being addressed in the proposed amendments to the IBA, which Government hopes will be enacted by September.

Government is slightly more reticent in its approach to expanding details on the public register to include directors and senior officers. It will consider this as possible for inclusioon in the amended Act, but will be assessing the relevant costs and benefits of such action.

"We recommend legislation criminalising insider trading and market manipulation legislation be put in place,'' said KPMG. This is in line with OECD principles which consider these activities a breach of good corporate governance and a violation of the principle of equitable treatment of shareholders.

Government fully concurs and intends to introduce appropriate legislation, probably in 2002.

KPMG recommends enhancing BMA enforcement powers over Collective Investment Schemes and the BMA is already in the process of drafting a consultation paper for the industry to this effect. The paper is expected to come out in the next month.

Also addressed in the consultation paper are other KPMG recommendations such as: "We consider off-site monitoring should be designed to enable the BMA to assess the activities of a fund and to identify potential risk areas which may be evidence of regulatory breach or increase the likelihood of such a breach in the future. This should be achieved through a formal documented review programme.

"We consider that the present restriction on the ability of the BMA to conduct on-site inspections in respect of Standard schemes results in a failure to comply with IOSCO ( International Organisation of Securities Commissions) Principles 8 and 10.

"We consider that some enhancements (of the BMA's powers) would assist in achieving full compliance with IOSCO Principle 9. The BMA should be able to: require the substitution of any service provider to the scheme; apply to the court to appoint a custodian to manage the assets of the scheme; fine a scheme for breaches of the law or any regulations; issue directions.'' The recommendation that regulations be instituted for the segregation of client assets is a matter being currently discussed in the House of Assembly and is expected to be formalised shortly.

Redefining collective investment schemes to include those constructed as limited partnerships is another recommendation that is being addressed by Government. This falls under amendments to the BMA (Collective Investment Scheme Classification) Regulations 1998, which are in the consultative stage now.

KPMG suggested that the BMA should continue to vet foreign incorporated schemes, instead of passing them to the schemes' administrators as is currently proposed. But Government sees no need for this, particularly as fund administrators in the Island will be subject to licensing and regulation.