Tax law changes that were expected to hurt the mutual fund business in Bermuda appear to have had little effect on industry growth there.

There was no exodus of funds and fund-related business from Bermuda last year, said attorneys and accountants in the U.S. and Bermuda. Fund executives said they were surprised by the lack of reaction to a change in U.S. tax law which made it easier for fund companies to register their funds in Bermuda but move operations to the U.S. without subjecting themselves to U.S. taxes.

"There hasn't been a massive exodus from the offshore servicers to come onshore," said Anthony Evangelista, a partner in the Boston office of PricewaterhouseCoopers. "I think the offshore service providers have stepped up their game."

U.S. and other non-Bermuda money managers establish funds in Bermuda to avoid domestic taxes, to be under the jurisdiction of foreign rather than SEC securities regulation and to provide confidentiality to investors. However, two years ago, accountants and lawyers expected Bermuda's business to begin eroding.

Tax laws historically required offshore funds that wanted to preserve their tax status as offshore investments, to keep much of their operations such as custodial work out of the U.S. In April, 1997, however, the U.S. Treasury Department proposed dropping the requirement, a change it expected would reduce the cost of operating offshore funds. The new rules went into effect last year.

Despite the change, the number of funds applying for registration in Bermuda last year increased to 121, roughly double that of 1996 and up from 104 in 1997. Bermuda had approximately $20 billion in offshore fund assets under management as of Dec. 31. In addition, attorneys and accountants said there was no wholesale movement of fund administration operations from Bermuda.

"Our feeling has been that (the tax law change) has had very little effect," said Gregory Haycock, a partner with KPMG Peat Marwick in Bermuda. "There hasn't been any movement of significance onshore."

Haycock attributed the continued growth in Bermuda's fund business to changes that the country's financial regulatory agency - the Bermuda Monetary Authority - made to streamline fund registration. The regulatory changes have made government review of new fund applications quicker, Haycock said. Regulators also have established a new category of funds for high net worth investors. And, in the face of the adverse changes in the tax law, Bermuda executives have increased their marketing efforts in the U.S. and United Kingdom, Haycock said.

The importance of confidentiality to offshore investors also has become more apparent, Haycock said. Investors perceive that it is less likely that the SEC or private litigants will obtain their records if fund records are located outside of the U.S., offshore executives and U.S. lawyers said.

"Confidentiality has come through as a much bigger reason for being here than anyone anticipated," Haycock said.

Haycock said it is impossible to know what business Bermuda did not get because of U.S. tax law changes.

While Bermuda increased its business last year, there are reasons to believe its growth could slow, some observers say. State tax laws still may pose problems for funds which move administration to the U.S., said Geoffrey Kenyon, a lawyer with the firm of Goodwin, Procter & Hoar in Boston. States often lag the IRS in updating their own laws to match federal tax rules. While state tax laws may discourage funds from moving here for now, Bermuda probably faces a long-term threat to its market share, Kenyon said.

"Over time, I think it's likely that there will be an erosion in the U.S. component" of Bermuda's business, Kenyon said.

Kenyon and other observers also said that Bermuda does not have the advantage of a big domestic market in which to sell funds. That fact, they said, should limit the growth of Bermuda's fund business.

Countries in the European Union can require offshore funds which sell in European countries to keep their fund administration business in an EU country. David Masters, a senior fund analyst for Standard & Poor's Micropal, said the two largest offshore fund domiciles, Luxembourg and Ireland, have the advantage of being able to offer distribution to the European market, a market which fund advisers wish to reach. Luxembourg has approximately $590 billion in assets and Ireland approximately $60 billion, Masters said.

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