Sarnia Asset Management

Crypto is here to stay as a financial asset class in spite of the current shakeout. But anyone looking to start a crypto fund should think very carefully about where they do it. We provide answers to some of the most common questions.

You may be surprised to hear that the average family office has 1% of its portfolio in cryptocurrency, illustrating its adoption as a tool for portfolio diversification, investment and (dare we say it) speculation. In fact, in spite of the sell-off in the spring, a recent survey suggested that 41% of capital allocators would look to increase their exposure to digital assets in 2022, which is more than triple the number from the previous year’s survey.

It is hard to ignore the fact that crypto is now becoming integrated into the financial ecosystem as a recognised investment vehicle and asset class. But with governments and authorities across the globe taking radically different approaches to the regulation of the crypto sector, anyone looking to get involved – either as an investor or as someone looking to establish a crypto fund or related business – needs to tread very carefully. In this article we’ll explain why we believe one of the best places to venture into crypto is actually the home of our very own Sarnia Asset Management – the island of Guernsey.

But before we begin, let’s be very clear about something. Guernsey is most certainly not the easiest place in the world to set up a crypto fund or related product. There are plenty of jurisdictions out there where regulatory standards are, quite frankly, pretty lax, and where the authorities would waive through a new crypto fund without much of a fuss. However, at a time of increasing geopolitical instability, regulatory clampdowns and cyber-security threats (to name but a handful of the risks facing operators in the crypto space), we would advise against taking what appears to be the path of least resistance – you may well end up regretting it later.

If you’re looking for a jurisdiction that has a firm but fair regulatory regime, with a reputation for quality products and reliable governance, whilst also being at the forefront of financial innovation and expertise, then Guernsey could be for you. Such jurisdictions come at a premium, but we firmly believe that this is a time to choose very carefully when it comes to situating one’s businesses or assets.

Guernsey: a competency centre, not a tax haven

In light of the above, there is an opportunity for those jurisdictions that move quickly to build out their blockchain ecosystems to reap the long-term benefits as the asset class continues to move into the mainstream. One jurisdiction that is doing just that is the island of Guernsey, which launched its first cryptocurrency fund – and the world’s first Tier 1 Bitcoin exchange-traded fund (ETF) – in January 2022. Achieving a world first in the crypto space is nothing short of an advertisement that Guernsey is open for business in this rapidly evolving and exciting field.

Contrary to popular belief, Guernsey is a competency centre, not a tax haven. In Guernsey, the finance sector and its ancillaries such as legal and accounting services make up no less than 44% of the island’s GDP (Gross Domestic Product). Some readers may be surprised to learn that the island is also home to The International Stock Exchange (TISE), a recognised exchange which hosts more than 3,000 listed securities from around 1,700 issuers, with a combined market capitalisation of more than £450 billion. To put this in perspective, this is more than the market cap of the stock exchange of Belgium, a country whose population is 200 times larger than Guernsey’s.

TISE caters to a wide range of international issuers, but it has been particularly successful in attracting high-yield corporate bond listings. In fact, this is a great example of where the one-size-fits-all and bureaucracy-laden approach of a large jurisdiction (in this case, the EU) has played into the hands of a nimble and pragmatic jurisdiction (Guernsey), so it’s worth looking at in some detail.

The EU’s Market Abuse Regulation reform of 2016 banned what is referred to in the industry as “selective disclosure”, a hitherto widely accepted practice where companies give more information to some investors and less to others. While this might sound like an unfair practice on the face of it, the reality is that companies prefer to speak to small groups of professional investors when it comes to bond issues because it minimises costs, as professional investors do not require the same level of protections as “retail” investors.

The result? TISE accounted for 30% of all European high-yield bond issues ($25.65 billion) in 2018, from next to none just a few years earlier. Guernsey has had a debt market for some time, but the depth of expertise now available is generally accepted to be unmatched anywhere in Europe. In addition to this, Guernsey sits firmly on the OECD White List, meaning it adheres to very high standards of financial conduct and transparency, contrary to popular (media-led) opinion. This even makes it attractive to high-profile blue-chip names such as Netflix and Blackstone, both of whom recently opted for a TISE listing for their European bonds.

As one of the world’s leading offshore financial centres, Guernsey has always been a pioneer in the realm of financial innovation and has a reputation for expertise and stability. As the example of the European high-yield bond market demonstrates, Guernsey has a knack for carving out niches – and crypto could very well be next. (If you’d like to learn more about the benefits of doing business in Guernsey – and why we chose to make it the home of Sarnia Asset Management – we recommend you also read our article: British Switzerland by the sea: why Guernsey’s future is brighter than ever.)

Guernsey: a pioneer in the world of crypto

In early 2017, Guernsey hosted the first ever commercial deployment of blockchain technology for the private equity market, which was developed in Guernsey by Northern Trust and IBM. The blockchain the partners developed is used for the management and administration of a private equity fund run by Unigestion, a Geneva, Switzerland-based asset manager with $20 billion in assets under management. The group opted for a Guernsey-based fund because the use of blockchain technology for administrative purposes had already been approved by the Guernsey authorities. Other administrators have since followed suit in adopting technologically backed systems for conducting customer due diligence, thereby demonstrating Guernsey’s trailblazing status in this sector.

The next major milestone for Guernsey’s crypto space came in October 2021 when the island’s financial regulator, the GFSC (Guernsey Financial Services Commission), authorised Jacobi Asset Management to launch the world’s first Tier 1 Bitcoin exchange-traded fund (ETF). Launched in January 2022, the ETF was designed by Guernsey-based regulatory consultancy Midshore Consulting, led by Managing Director, Christopher Jehan, also Head of Fund Architecture at Jacobi Asset Management which launched the fund.

While there are several Bitcoin ETFs in the world, this one stands out for the quality of the offering to investors. Unlike many of its peers, the Jacobi Asset Management ETF does not use derivatives to track Bitcoin and instead holds the asset itself with a custodian. Crucially, the custodian is Fidelity Digital Assets, a top tier investment firm and one of the biggest out there, which provides the ETF’s institutional investors – and importantly, the GFSC – with that extra layer of security that they need.

As Christopher Jehan explains in a piece for IFC Review, the benefits of holding Bitcoin in an ETF like this one are manifold:

“At the moment, Bitcoin, as with any crypto asset, is highly unregulated. So, we’ve created a regulatory product around that unregulated asset to give more certainty to institutional investors. For example, if you invest in Bitcoin directly yourself, you hold it in a wallet and you have a key; if you lose that key, then you have lost your Bitcoin. Here, the onus for ensuring safe custody of that key is placed on Fidelity so it provides more certainty because the fund is backed by a quality custodian which is responsible for the safekeeping of those assets. The fund can also benefit from discounts in trading higher values of Bitcoin.”

So the Jacobi ETF simultaneously solves two problems for investors when it comes to investing in Bitcoin: custody risk and regulatory risk. This is the essence of what Guernsey does – it puts the end-customer’s interests first and helps to facilitate the development of products that solve problems and meet unmet needs.

Why Guernsey?

As we discussed earlier, Guernsey has always been a pioneer when it comes to financial innovation, so it seems natural that it should also help to drive forward the evolution of the blockchain and crypto sector, which currently sits at the cutting edge of finance. Crucially, the island possesses a robust but pragmatic and fair regulatory regime that is willing to discuss alterations to the rules where there is a justifiable reason for making them.

In the case of the Jacobi ETF, the requirement for a Guernsey-based custodian (which is a requirement for all open-ended funds in Guernsey) was waived on the basis that Fidelity is well respected, secure and has particular expertise in this area: in other words, it was the right decision for the end-users of this particular product.

As Christopher Jehan argues, the flexibility of Guernsey’s regulator lends itself to the development of new products:

“Previously, it was private equity which became something Guernsey does as standard. Now, it’s areas like cryptocurrency that demonstrate innovation. We’re well aware that not every fund will get through the regulatory process, but for funds of the right quality with the control framework being properly explained to the regulator, with early engagement, this is a case study to show we can do it.”

A great example of how Guernsey’s financial regulator has been engaging with firms to facilitate this development is the “Innovation Soundbox”, which was introduced as a hub to serve enquiries regarding innovative financial products and services. The GFSC encourages firms and individuals to use this facility to discuss potential applications in the field of virtual currencies at an early stage, without charging any fees for this service.

What about tax?

Guernsey is tax transparent and has cultivated a reputation for abiding by the highest standards when it comes to global taxation accords. That’s why it was on the OECD’s “White List” right from inception in 2009. As we explained earlier, this is the list of compliant, supportive jurisdictions that you want to be in so that you don’t face any restrictions on doing business elsewhere. As part of all this, Guernsey-based companies routinely provide tax reporting based on the investor’s country of domicile. (You can read more about how tax reporting for Guernsey funds works in our article: Tax reporting for Guernsey funds – how it works.)

Given that there are no specific cryptocurrency taxation laws currently in place in Guernsey, individuals and businesses can expect to be taxed in accordance with the island’s existing general taxation provisions. The tax treatment of individuals is very favourable, with a flat rate of income tax of 20%, and no capital gains tax, value-added/consumption tax or inheritance tax to pay. The corporate taxation picture is even more attractive, with most companies that are tax-resident in Guernsey being taxed at a standard rate of 0%. However, income arising from certain activities is taxed at 10% or 20%. This includes (but is not limited to) income arising from fund administration, investment management (except in relation to funds) and fiduciary business (each of which are taxed at the 10% rate).

Guernsey has a culture of lean government, which is why the overall tax burden in the jurisdiction is less than half of what you would pay in most Western members of the OECD.

Guernsey’s crypto future

Given everything we’ve discussed in this article, three things appear relatively assured over the coming years:

It is only a matter of time before more crypto products are established in Guernsey. While this may initially amount to a steady flow rather than a torrent, these products will be marked out for their quality, relative safety and governance standards, which will stand in stark contrast to many of the products offered elsewhere.
Guernsey will attract one or two high-profile crypto innovators. The GFSC’s open invitation to crypto innovators has the potential to provide a massive boost to Guernsey’s reputation in the crypto space, as we believe it is only a matter of time before it is taken advantage of by one or more industry heavyweight. This process is likely to be accelerated by the current sell-off in the crypto market, as quality operators will no doubt look to set themselves apart from their peers.
Guernsey will attract a growing range of service providers as its crypto space develops. At Sarnia Asset Management we are passionate about promoting Guernsey, our home, and we are more than willing to point people in the right direction when it comes to reliable service providers. A good starting point is the resource list below, but feel free to reach out to us if you’d like to discuss this further.

Resources

If you’re looking to get involved in the crypto space in Guernsey, then you might find these online resources to be helpful:

Regulation and compliance: https://www.gfsc.gg

https://www.midshoreconsulting.com

Tax: https://www.gov.gg/revenue-service

https://www.careyolsen.com/

Fund custodian services: https://locations.northerntrust.com/gg/st-peter-port/trafalgar-court-les-banques

Innovation Soundbox: https://www.gfsc.gg/commission/innovations/innovation-soundbox

Business directory: https://www.weareguernsey.com

Disclaimer: This blog is intended for informational purposes only. This blog is not intended to invite, induce or encourage any persons to engage in any investment activities and is not a solicitation or an offer to buy or sell any stock, investment product or other financial instruments. If in doubt, please seek financial advice from an independent financial adviser. Sarnia Asset Management is licensed by the Guernsey Financial Services Commission (GFSC). Past performance is not an indication of future returns. Investments carry risk, including the risk that you will not recover the sum that you invested.