By Stephen J. Inglis, CFA

On March 4th of this year, the Financial Analysts’ Society of Puerto Rico in its ongoing mission to promote Puerto Rico as an important financial center, held a roundtable discussion between industry leaders representing various segments of the Financial Services sector, the Department of Economic Development and Commerce (DDEC), InvestPR and staff members of the Economic Growth and Revitalization team at the Financial Oversight & Management Board for Puerto Rico (FOMB). The discussion focused on opportunities, challenges and recommendations for the growth of the financial services, fintech and crypto industries in Puerto Rico identified by private sector participants. The event took place in San Juan at Parallel 18 headquarters. The format was a brief presentation by each of the FASPR participants with response and discussion by the FOMB, DDEC, and InvestPR side for about an hour and a half, followed by a Q&A from the audience.

‍‍Financial Oversight & Management Board for Puerto Rico

‍Juan Eugenio Rodríguez, Economic Growth & Revitalization
Romano Zampierollo, Economic Growth & Revitalization

Departamento de Desarrollo Económico Y Comercio

‍Diego Salinas Garrido, Ayudante Ejecutivo Senior

Invest Puerto Rico

‍Alan Taveras,Business Development Director

FASPR Roundtable Participants

‍Omara Méndez Bernard, Esq., Partner at Pirillo Law, LLC
Sergii Grybniak, PhD, Founder of Waterfall
Baxter Hines, CFA, Managing Partner, Honeycomb Digital Investments
Jesús Daniel Mattei, CFA Vice President, Sygnus Capital PR, LLC
Angel M. Rivera, CFA, CPA, FRM, Popular Asset Management, LLC, Subsidiary President
Jaime Rodota, Senior Portfolio Manager, Parallel 18

‍Moderator

Stephen J. Inglis, CFA, CEO,AI Capital LLC

‍The objective of the roundtable was to proactively identify solutions to bottlenecks for Puerto Rico to improve its standing as a financial center. There was a general consensus acknowledging that the incentives in place are second to none and are the primary reason companies and individuals from the mainland relocate to the Island.

Puerto Rico’s most recent official ranking placed it at 65th out of 190 economies in the World Bank’s Ease of Doing Business Index (2019), the final year the index was published treating Puerto Rico as a sovereign state. To put this ranking in perspective the mainland USA ranked 6th and neighbor Dominican Republic rank 115th in that year. Historically the Island Commonwealth ranked well in contract enforcement and investor protections, but poorly in permitting, tax complexity, and bureaucratic delays.

Act 60 of 2019 was drafted to consolidate and update existing incentives such as Act 20 & 22 along with new incentives under one law. Among the first beneficiaries of Act 60 were the legal and accounting communities who are needed to navigate the labyrinth of incentives, tax, the bureaucracy and to obtain permits. Access to skilled professionals makes doing business in Puerto Rico relatively easy, but quite difficult for those who don’t have the budget for competent accountants and lawyers.

A basic constraint shared among various participants to elevate Puerto Rico’s position as an important financial center is access to capital. This applies across the finance spectrum from venture capital to portfolio asset management and especially business loans. There is a risk stigma from both off and on Island financial institutions that is no longer deserved.

‍L-R- Alan Taveras, Romano Zampierollo and Juan Eugenio Rodriguez

Attendees shared a belief that best practices implemented through the Financial Oversight & Management Board (FOMB) policy prescriptions, have made great progress improving the fiscal integrity of the Island economy. One of the goals is to achieve investment grade status for Puerto Rico’s debt to once again be able to tap the debt markets. To reach this goal there a number of public policy initiatives were proposed that could be implemented alongside private actions. ‍ ‍

Asset managers face a dilemma. At the round table discussion Banco Popular’s Angel Rivera raised the problem of lack of critical assets under management (AUM) to attract investors. The dilemma is that to attract sizable investments, a manager needs to have a sizable AUM in spite of having an excellent track record.

‍Angel summed up the situation and proposed the following fixes. To develop Puerto Rico as a leading ﬁnancial center, it is vital to expand opportunities for the local asset management industry to serve diverse sectors within the region. To that end, he suggested that the Government of Puerto Rico could strategically assign elevated importance to the advancement of local money managers as an essential element for developing and maintaining a resilient and sophisticated ﬁnancial sector. This approach can serve as a foundation for high-quality job creation, and increased tax revenues for Puerto Rico.

The allocation of investment reserve assets by several governmental agencies in Puerto Rico currently favors external money managers over qualiﬁed local professionals who have demonstrated competitive performance. For example, the Pension Reserve Trust (“PRT”), created to secure pension obligations and funded by the Government of Puerto Rico, follows an investment policy framework that inadvertently excludes local portfolio managers from participating in the Request for Proposal (RFP) processes due to minimum AUM requirements that are set at levels most local ﬁrms cannot meet, thus substantially limiting their participation opportunities. By considering adjustments to the selection criteria and actively including local portfolio managers, the Government has the potential to support and strengthen Puerto Rico’s ﬁnancial sector.

Most of the jurisdictions throughout the United States have established policies giving preference to regional money managers over non-local ﬁrms. To be recognized as a bona ﬁde local money manager, an organization must maintain a signiﬁcant operational presence in Puerto Rico, directly oversee assets from within the Island, and show sustained commitment to developing Puerto Rican talent. The mere presence of a sales representative in Puerto Rico does not suffice—local managers are expected to employ local professionals in critical decision-making positions and actively foster the advancement of the Island’s ﬁnancial expertise and workforce.

Currently, many talented ﬁnance students feel forced to leave Puerto Rico because there are not enough professional opportunities for them in their ﬁeld. By fostering the growth of our industry, we can reverse this trend, hiring and retaining exceptional talent locally. As the sector expands, Puerto Rican asset managers will be better equipped to pursue and fulﬁll mandates from which they are currently excluded due to their relatively modest AUM.

Policies that remove unnecessary barriers in government investment mandates will catalyze innovation, and stimulate job creation. Prioritizing local asset management expertise will help Puerto Rico grow as a regional ﬁnancial hub and achieve lasting economic gains. This is a relatively easy policy to implement, requiring nothing more than political will.

The risk premium in Puerto Rico was also noted by investment banker Jesús Daniel Mattei at Sygnus. In many ways Puerto Rico is treated as if it had sovereign risk. Vetted local deals face a higher, and arguably unjustified, risk premium from financial institutions, especially larger transactions that require funding from the mainland. This being a prime example of the need for local financial institutions to have much larger capital bases and AUMs.

Similar capital needs are experienced in the venture capital sector. There are several incentives in place, such as the Young Entrepreneurs program, that encourage start-ups. However, as recounted by Jaime Rodota at Parallel 18, Puerto Rico does not need to be a high-volume startup hub. It needs the small amount of venture capital available to be aligned with its structural advantages. Local funds do not need to lead every round, but they need to be present early enough to share in upside and maintain durable relationships. (It’s uncommon for a company outside of SF/NYC who skips local VCs for their first few rounds to return to their home market later.)

Financial centers are built through liquidity, not just capital inflows. For Puerto Rico to rank and attract more venture capital investment requires one or two locally rooted, venture-backed companies that scale globally, generate meaningful employee ownership, and exit successfully.

L-R Sergii Grybniak & Jesús Daniel Mattei

That liquidity creates operators, angels, LPs, and future fund managers. Without that recycling of human and financial capital, venture remains programmatic rather than self-sustaining.

Sergii Grybniak, PhD, Founder of Waterfall, pointed out that the small country of Estonia made its mark in venture capital with the development of Skype. After being sold to eBay in 2005, Skype was sold to Microsoft in 2011 for $8.5 billion. PR is well positioned as an innovation lab for a Skype type blockbuster deal by offering low-cost ‍‍‍‍validation in the local market to gauge the potential success of a national product launch in the mainland. Sergii, who has been involved in several “crypto hubs” including Puerto Rico recommends avoiding over-speculation; prioritize utility, compliance, and sustainable funding. To be a major financial center PR needs to continue blending traditional finance (asset management, private equity) with next-gen tech (tokenization, stablecoins) and non-tokenized use cases, driving growth, and reversing outflows.

A capital market unique to Puerto Rico is being established based on R&D Tax Credits. Act 60 provides an incentive that issues tax credits on 50% of invested capital attributed to R&D. The definition of R&D is loosely described as “solving a business problem” and the tax credits, when received, can be sold for cash to a Puerto Rican taxpayer. Since the time to receive tax credits is subject to filing a tax return and having the application for the tax credits to be audited and processed, there is somewhat indeterminate lag. Therefore, there is a need for debt instruments so future tax credits can be sold at a discount. While these credits are already being monetized by some local banks and fund managers in private transactions, a new transparent debt capital market is now being launched in conjunction with the University of Puerto Rico (UPR).

The online marketplace currently being set up provides a registry of research capabilities across the UPR system to match up with an Act 60 company in need of R&D support. The company presents a proposal for research which, following third party due diligence, is matched to a UPR department. A contract to carry out the research is then entered into with the initial payment made either by direct payment or by monetizing future expected tax credits. The company pledges all future R&D tax credits for the life of the contract. The first such contract has already been initiated with UPR Mayaguez’s Department of Engineering to design a mobile modular cacao fermentation plant by Act 60 company Green Acres R&D Processors. For more information and how to participate in the UPR Tax Credit Exchange contact cbx@nexusmarkets.io.

While it is acknowledged thatthegovernment incentives in place are attracting investors and companies to Puerto Ricothere are a number of ways “ease of doing business” can be improved.

Amendments to the Legal framework to further strengthen PR’s position as a financial center were proposed by Omara Méndez Bernard, Esq., Partner at Pirillo Law, LLC. She identified certain laws and regulations affecting the financial industry and capital creation, that need to be modernized. Specifically, update the Puerto Rico Uniform Securities Act (PRUSA) and its regulations to incorporate recent amendments and regulatory approaches under the U.S. Securities Act and the federal securities framework. Aligning local laws with Federal laws would support more efficient offerings and exemptions for small businesses and their investors, so that great companies can be built using the capital markets. Such an initiative would require a bill to amend PRUSA and the Puerto Rico Investment Company Act, as well as legislation to update or consolidate other financial industry laws including Act 136-210 – Money Services Business Regulatory Act; Act 68-1964 – Retail Installment Sales and Financing Companies Act; Act 214-1995 – Financial Intermediary Act; and Act 106-1965 – Small Personal Loans Act, among others. This would require also updating corresponding regulations under some of these statutes. With respect to the Puerto Rico Investment Company Act (Act 93‑2013), amendments could help clarify the framework following the post‑2018 elimination of Puerto Rico’s exemption under the U.S. Investment Company Act (ICA), including whether locally organized investment vehicles should look solely to the federal ICA or also Act 93‑2013 for registration or exemption requirements and other compliance matters. She also identified the possible adoption of recently proposed Article 12 of the Uniform Commercial Code to provide legal certainty for digital asset transactions. Given recent updates to Federal rules and guidance regarding crypto assets, an important business segment in PR, now is a good time to consider legal amendments.

To further improve the ease of doing business, Baxter Hines of Honeycomb Digital Investments proposes that Puerto Rico considers a Singapore approach to adopting crypto and blockchain technology.

Q&A Session‍

By implementing smart contracts for inventive programs that automatically process and dispense tax credits and tax exemptions to bypass the bureaucratic delays and time-consuming application process. Off-the-shelf distributed ledger (aka blockchain) technology exists, which a number of small countries like Singapore are adopting to impose smart contract ‍‍‍payments and business permitting issuing protocols. This would reduce bureaucratic frustration, allow faster attrition of the civil service and thereby reduce the government overhead.

‍Rosy scenario. Puerto Rico is already poised to be an important financial center. Capital investment continues to grow as companies and investors continue to migrate to enjoy the incentives, educated labor force, and a Caribbean lifestyle. The March 4th FASPR-FOMB round table discussion distills to a need for a greater access to local capital. A number of easily implemented actions to improve the ease of doing business were identified. None of the proposals discussed are difficult to implement apart from getting the political will. Government action aside, the current environment does lend itself to capital market innovations such as the UPR R&D Tax Credit Exchange and the introduction of blockchain technology smart contracts. While doing business in Puerto Rico still has some challenges to address, the outlook is for a robust and efficient financial industry. ‍

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