European UnionErik Nelson was working in Stamford, Connecticut, as a research analyst at FMG USA LLC, the U.S. arm of FMG, a fund of funds specializing in emerging and frontier markets, when his bosses called him into a meeting in September 2009.

They had recently moved FMG’s corporate headquarters to Malta fromBermuda and now they wanted Nelson, 27 at the time, to head up the new office. “I’ll have to think about it,” Nelson replied. Then he went home and tried to find Malta on a map.

Three months later, the young American touched down on the rocky, sun-drenched island in the middle of the Mediterranean Sea, joining a wave of hedge-fund executives washing up on Malta’s shores, lured by low taxes, cheap labor and a coveted address inside the European Union, Bloomberg Markets magazine reports in its February issue.

As of early November, the number of funds located in Malta had grown to more than 500 with 8 billion euros ($10.7 billion) under management from 165 funds with less than 5 billion euros under management in 2006, according to the Malta Financial Services Authority, or MFSA.

While that’s not much compared with Luxembourg, which has more than 143 billion euros under management across more than 700 hedge funds and funds of hedge funds, the number of funds in Malta and the amount of their assets are expanding.

Since the end of 2010, the number of funds increased almost 30 percent and their total assets were up nearly 15 percent as of early December.

Demanding Transparency

Malta has also begun to win business from more-established fund jurisdictions. The island has benefited from a growing demand by investors for transparency as well as from fears among hedge funds that the EU was becoming increasingly hostile to firms based outside of it.

In 2010, nine companies from the British Virgin Islands, seven from the Cayman Islands and six from Luxembourg switched their legal domicile to Malta, according to the MFSA.

In addition, at least a dozen large U.K. hedge funds and funds of hedge funds have shifted part of their operations, including accounting and investor relations, to Malta.

These include Clive Capital LLP, which has about $4 billion under management, Comac Capital LLP, which has $5.2 billion under management, the $1.2 billion commodities and energy hedge fund BlueGold Capital Management LLP and the $2.8 billion fund- of-funds company Liongate Capital Management LLP.

Many of these larger hedge funds, while serviced from Malta, remain legally domiciled elsewhere, so those assets aren’t counted in Malta’s official tally.

Strategic Location

If they were, the total amount of money managed by Malta- based companies would be as high as 80 billion euros, estimates James Farrugia, director of investment services at the Maltese law firm Ganado & Associates.

The growth of Malta’s fund industry has been so rapid that Prime Minister Lawrence Gonzi says he worries whether Malta, with a population of just 414,000, has enough accountants and financial analysts to keep up with demand.

Invasions, friendly or otherwise, are nothing new to the Maltese. Phoenician sailors, Roman centurions, Arab traders, pirates and Norman mercenaries were all drawn to the island’s natural harbors and strategic location between Europe and North Africa.

The Knights of St. John, a Catholic military order popularly known as the Knights of Malta, ruled the island for more than 250 years beginning in the early 16th century.

Baroque Palazzos

The legacy of their trading wealth can be glimpsed in the baroque palazzos and lavishly decorated churches of Valletta, Malta’s compact, walled capital city.

Napoleon conquered Malta en route to Egypt in 1798. Two years later, the British fleet seized it from the French and remained until the islanders were granted independence in 1964.

The British left three bequests that have been critical to Malta’s rise as a financial hub. One is the English language, which gives the island an advantage over some other popular fund locations. The vast majority of Maltese speak it fluently, along with the island’s second official language, Maltese, which is similar to Arabic yet written in Latin script.

Another legacy is English commercial law, which Andre Zerafa, a lawyer at Ganado & Associates, says was grafted onto the island’s civil law system. “The Maltese Companies Act is roughly based on English company law principles from the U.K. Companies Act,” Zerafa says.

Finally, there’s Malta’s “Anglo-Saxon” work ethic, as fund managers describe it.

‘Beer Drinkers’

“They definitely work more like beer drinkers than wine drinkers,” says Andrew Frankish, the director of client relations for IDS Group, a South African fund services company that set up offices in Malta in 2010.

A 125-square-mile (324-square-kilometer) island with scarce natural resources, Malta has had to think creatively to attract investment. In 1988, Malta introduced business-friendly low taxes.

Today, while companies pay a nominal income tax rate of 35 percent, refunds can reduce that to 5 percent or less for most foreign-owned corporations. Most capital gains and dividends aren’t taxed.

Business friendly doesn’t mean offshore in the sense of being lightly regulated.

“We want to be a financial center of the highest reputation possible,” Gonzi says during an interview, sitting beneath the 20-foot-high (6-meter-high) ceilings of the Auberge de Castille, a palazzo that once belonged to the Knights of St. John and now serves as his office.

Preferring Transparency

In the late 1980s, before it joined the EU, Malta tried positioning itself as an offshore haven. In addition to low taxes, it offered foreign companies total confidentiality and a laissez-faire regulatory regime.

In the mid-1990s, the country reversed course, bringing its regulations in line with the EU ahead of becoming a member state in 2004. Among other requirements, Malta demands audited quarterly financial statements and background checks for fund owners and directors.

Since the early days of the financial crisis, with investors preferring transparency to secrecy, Malta’s regulatory scrutiny and accountability have become selling points.

At the time, some offshore hedge funds instituted rules prohibiting investors — from individuals to pension funds — from withdrawing their money. Because the hedge funds were based in offshore jurisdictions, the aggrieved investors had little recourse as they endured losses in their accounts.

Range of Funds

“At the beginning of 2008, we started to see investor sentiment changing,” FMG’s Nelson says. “Regulation, liquidity and transparency were becoming real factors in the decisions that investors were making.”

Nelson says that change prompted FMG — which has about $200 million under management across a range of funds that invest in markets from Brazil to Iraq, to Mongolia — to shift its headquarters to Malta.

FMG has also shifted Chief Investment Officer Andrew Jameson, an Englishman who was living in Geneva, to Malta, becoming one of the first foreign fund companies to relocate investment strategists to the island.

For Malta, the influx of hedge funds has been a boon. The firms’ profits feed into the local economy, as do the legal and accounting fees the companies generate. Total income from financial services constituted about 12 percent of the island’s gross domestic product of 6.2 billion euros in 2010.

Government Goal

While the government takes in relatively little direct revenue from fund companies because of the island’s low taxes, the firms have boosted employment on Malta, along with spending on everything from office space and hotel rooms to restaurants and transportation.

The government’s goal is for financial services to become a pillar of the economy, accounting for 25 percent of Malta’s GDP by 2015.

Malta has a way

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