The Cayman Islands Government as a result of ongoing discussions with the U.K. Foreign and Commonwealth Office have developed new regulatory requirements and fee increases for the Cayman Islands financial industry. However, for the first time they have proposed an extraterritorial regulatory regime for foreign administrators to Cayman Islands funds.
The Mutual Funds Law was introduced to the Cayman Islands on 26 July 1993 and has been consolidated and revised in the Mutual Funds Law (2009 Revision) (as amended) ("MFL"). The MFL regulates all hedge funds falling within the definition of a "mutual fund" (as defined below as supplemented by the Mutual Funds (Amendment) Law, 2011) established in or operating from the Cayman Islands, and those who administer mutual funds in or from the Cayman Islands. Furthermore, the MFL regulates certain 'master funds' which are also mutual funds established in or operating from the Cayman Islands, with at least two investors, at least one of which is a regulated mutual fund.
With one exception, the MFL requires all mutual funds (note that this term does not include closed ended funds) to be regulated. The exception is for a mutual fund in which the equity interests are held by not more than fifteen investors, the majority of whom are capable of appointing or removing the operator of the fund (eg the Directors in the case of a corporate mutual fund) (the "Exception"). A mutual fund of this type escapes regulation altogether. The Exception does not apply to master funds, which, typically have one or more 'Feeder Funds' as investors.
A Cayman hedge fund can be organised as a limited partnership, a unit trust or a company (either an exempted company or a Segregated Portfolio Company as described below).
While a Cayman company is the vehicle most commonly used for new hedge funds, the location of the investors the fund hopes to attract may have a bearing on the ultimate structure of the fund. For example, managers looking to raise money from Asian-based investors would be advised to consider using a unit trust structure as this product is particularly popular and tax efficient for Asian investors.
Managers looking to attract US-based investors will often be advised by US counsel to set up a master/feeder structure. A typical master feeder structure will have: an onshore feeder fund through which US taxable investors can enter the fund; an offshore feeder fund, generally based in the Cayman Islands, through which non-US and US tax-exempt investors can enter the fund; and a master fund through which all trading activity is carried out which will usually also be a Cayman vehicle. Because the onshore feeder fund is typically organised as a limited partnership (generally in Delaware) some US counsel prefer to mirror this structure by using a Cayman limited partnership for the master fund and/or the offshore feeder fund.
A manager looking to establish an "umbrella" fund may wish to use a Segregated Portfolio Company ("SPC") as the fund vehicle. An SPC fund can create sub-funds in the form of individual segregated portfolios, the assets and liabilities of which are legally segregated from the assets and liabilities of the other segregated portfolios. The sub-funds are not individually regulated meaning new, legally segregated, sub-funds can be created within the umbrella fund for a fraction of the cost of setting up an entirely new hedge fund.
Regulation and Compliance
The Cayman Islands investment funds industry is governed by the Mutual Funds Law (as revised) (the "Mutual Funds Law"). Oversight falls to the Cayman Islands Monetary Authority ("CIMA").
The Mutual Funds Law applies to companies, unit trusts and partnerships that issue "equity interests" for the purpose of pooling investment funds. It is important to note that the definition of "equity interest" excludes investment funds that are closed ended (i.e., funds that do not offer investors the right to redeem their investment). Managers that do not wish to grant redemption rights to their investors can therefore save considerable time and cost by using a closed-ended structure which will fall outside the scope of the Mutual Funds Law. It is also important to note that the definition of "equity interest" excludes funds that exclusively issue debt instruments such as bonds or notes.
Set Up Process
Once the structure of the hedge fund has been determined, the fund's legal counsel will draft the main offering circular and constitutional documents. In the case of a corporate structure the main constitutional documents of the fund will be the memorandum and articles of association; in respect of a unit trust this will take the form of a declaration of trust and for limited partnership structures it will be in the form of a limited partnership agreement. These documents will normally go through a number of drafts before being finalised.
Ancillary documents include the subscription agreement, redemption request form, and agreements with the various service providers including the fund manager and advisor. These will either be drafted by the fund's legal counsel or provided by the relevant service provider.
Once the fund documentation is in order the fund's legal counsel will form the fund vehicle either by incorporating the company, or registering the partnership or trust.
Once the fund vehicle has been formed or registered the fund's legal counsel will, if required, file an application with CIMA to have the fund registered or licensed. Assuming the documents are in good order CIMA will normally approve applications within 10 working days, at which time the fund can begin taking subscriptions, issuing equity interests and implementing its investment objective
Categories of funds regulated under the Law
- the licensed fund
- the administered fund
- the registered fund
Types Of Investment Fund Structures
The Cayman Islands has company, trust, partnership and related laws which allow a high degree of flexibility for establishing investment funds. The three vehicles commonly used for operating investment funds are the exempted company, the unit trust and the exempted limited partnership.
The exempted company may redeem or purchase its own shares and may therefore operate as an open‐ended corporate fund. Close‐ended corporate funds can also be established using the exempted company, and it is a relatively straightforward procedure to convert from one to the other. The Companies Law also allows re‐domiciling of companies and corporate reconstruction so that fund mergers are easily facilitated.
The unit trust is usually established under a trust deed with the investors interests held as trust units.
The exempted limited partnership provides a second unincorporated vehicle and it can be formed as easily as the exempted company or the unit trust.
The Cayman Islands Mutual Funds Law provides for the regulation of mutual funds by the Cayman Islands Monetary Authority. In this Law, a mutual fund is defined as "any company, trust or partnership either incorporated or established in the Cayman Islands, or outside the Cayman Islands, which issues equity interest redeemable or repurchased at the option of the investor, the purpose of which is the pooling of investors funds with the aim of spreading investment risk and enabling investors to receive profits or gains from investments
The Law permits one category of funds to carry on or attempt to carry on business in or from the Cayman Islands without any filing whatsoever with the Monetary Authority. This exempt status is available only to those funds in which the equity interests are held by not more than 15 investors, the majority in number of whom are capable of appointing or removing the trustees of a unit trust mutual fund, the general partners of a limited partnership mutual fund or the directors of a corporate mutual fund, as the case may be. Note that, in order to meet this requirement, the power to appoint and remove directors etc. must be vested in a majority in number of the investors, rather than a majority in terms of the value of equity interests. Funds which are structured so that the investors are issued with a class of shares which carry participation rights but which do not carry voting rights will not qualify as Exempted Funds.
In considering whether or not a particular fund qualifies as an Exempted Fund, it should be borne in mind that the Law defines "investor" to mean the legal holder of the equity interest in a fund and does not "look through" to the beneficial or indirect owners. Despite the exempt status of such funds under the Law, all law firms, banks, trust companies, fund administrators and other service providers in the Cayman Islands have a responsibility under the Proceeds of Criminal Conduct Law (Revised) (the "PCCL") to make suitable inquiries before providing services to any client in order to prevent their services being used in connection with the proceeds of criminal conduct. The PCCL contains provisions for such service providers to report any suspicious activity to the relevant authority.
A mutual fund having more than fifteen investors and not being a licensed or registered mutual fund will be an administered mutual fund (an "Administered Fund") if its principal office in the Cayman Islands is provided by a licensed mutual funds administrator. In accepting an engagement to provide the principal office of an Administered, Registered or Licensed Fund (a fund of any such category, a "Regulated Fund"), an Administrator is required to satisfy itself, and make a declaration to the Monetary Authority, that (a) each promoter of the Regulated Fund is of sound reputation, (b) the administration of the Regulated Fund will be undertaken by persons who are of sound reputation and have sufficient expertise to administer the Regulated Fund, and (c) the Regulated Fund's business and any offer of equity interests in it will be carried out in a proper way. This declaration must be filed with the Monetary Authority (on Forms MF2 and MF2A) as soon as the Administrator starts to provide its principal office, along with the following documentation:'
- the fund's current offering document or the latest draft; a letter of consent from an approved Cayman Islands auditor indicating the name of the fund, the date of the financial statements, and the accounting principles to be used, and including a statement that the auditor is aware of and agrees to fulfil his obligations pursuant to section 34 of the Law (the "section 34 statement");
- a letter of consent from its administrator indicating the name of the fund and giving a summary of the services to be provided. Please note however, that if the fund decides to appoint a separate net asset value calculation agent (other than the administrator) the Monetary Authority will require a similar consent letter to be prepared and filed by such entity on behalf of the fund;
- where applicable, a certified copy of the certificate of incorporation or registration issued by the Registrar of Companies or evidence of registration or establishment of a partnership or a unit trust; and
- the first annual Administered Fund's fee of US $3,048.78 (CI $2,500.00).
Administered Funds are therefore to be contrasted with Licensed Funds in that the Administrator has a statutory duty to conduct suitable inquiries to satisfy itself of the probity of the promoters, administration and business of the Administered Fund whereas, in the case of a Licensed Fund, this responsibility is vested directly in the Monetary Authority. To this extent, the regulatory regime is characterized by the principle of private sector self‐regulation although, as described below, the Monetary Authority retains comprehensive powers to intervene where appropriate.
The principle of private sector self‐regulation is further expressed in the duty of the Administrator to notify the Monetary Authority immediately if it should become aware, or have reason to believe, that an Administered Fund (or a promoter, trustee, general partner or director of such an Administered Fund) is or is likely to become insolvent, or is carrying on business unlawfully or in any manner that is or is likely to be prejudicial to its investors or creditors. There is every reason to believe the legislature's apparent faith in the ability of the mutual fund administration industry in the Cayman Islands to assist in the regulation of mutual funds is well founded.
As a further alternative to obtaining a mutual fund license or appointing an Administrator to provide its principal office in the Cayman Islands, section 4(3) of the Law provides that a mutual fund may carry on or attempt to carry on business in or from the Cayman Islands if the minimum equity interest purchasable by a prospective investor in that mutual fund is US $100,000 or its equivalent in any other currency, or if its equity interests are listed on a stock exchange recognised by the Monetary Authority (including an over‐the‐counter market). A recognised exchange for this purpose is one that is either:
- a US licensed exchange; or
- an EU licensed exchange; or
- a Canadian licensed exchange; or
- a full member of the World Federation of Exchanges that is located in a Schedule 3 country; or
- the Cayman Islands Stock Exchange.
Such a fund may apply for a certificate of registration from the Monetary Authority by filing the prescribed details (on Form MF1) in respect of its current offering document or the latest draft which should be accompanied by:
- a letter of consent from an approved Cayman Islands auditor, indicating the name of the fund, the date of financial statements and the accounting principles to be used, and containing the Section 34 statement;
- letter(s) of consent from its administrator (and net asset value calculation agent, if applicable) indicating the name of the fund and giving a summary of the services to be provided;
- where applicable, a certified copy of the certificate of its incorporation or registration issued by the Registrar of Companies or evidence of registration or establishment of a partnership or a unit trust; and
- the first annual Registered Fund's fee of US $3,048.78 (CI $2,500.00).
The lighter regulatory touch which is applied to Registered Funds is premised on the assumption that investors who are in a position to invest the minimum subscription amount of US$100,000 are likely to be sophisticated investors who can assess for themselves or afford professional advice on the risks associated with an investment in the fund or, alternatively, that listed funds will be subject to effective regulation by the relevant stock exchange. Registered Funds are the most common category of mutual fund regulated under the Law.
Section 5(1) of the Law provides that, unless a mutual fund is an Administered, Registered or Exempted Fund, it shall not carry on or attempt to carry on business in or from the Cayman Islands unless it has a mutual fund license and has either a registered office in the Cayman Islands or, in the case of a unit trust, has as its trustee a trust company licensed under the Banks and Trust Companies Law (Revised).
The grant of a mutual fund license is within the discretion of the Monetary Authority. In considering an application for a mutual fund license, the Monetary Authority may require such information as it may deem necessary to satisfy itself that each promoter of the applicant fund is of sound reputation, that its administration will be undertaken by persons who are of sound reputation and have sufficient expertise to administer the applicant fund, and that its business and any offer of equity interests in it will be carried out in a proper way. Such an application is to be made in the prescribed form (Form MF3) and must be accompanied by:‐
- a copy of the current offering document or latest draft;
- a copy of the most recent annual audited accounts (if the applicant is an existing fund);
- where applicable, a certified copy of the certificate of incorporation or registration issued by the Registrar of Companies or evidence of registration or establishment of a partnership or a unit trust;
- completed personal questionnaires, three references and police clearance certificates for:‐
- all directors of a corporate mutual fund; or (b) all directors of a corporate trustee of a unit trust mutual fund; or (c) all directors of any corporate general partner of a limited partnership mutual fund;
- a letter of consent from an approved Cayman Islands auditor accepting an appointment as auditor , indicating the name of the fund, the date of the financial statements, and the accounting principles to be used, together with completed Section 34 statement; letter(s) of consent from its administrator (and net asset value calculation agent, if applicable) indicating the name of the fund and giving a summary of the services to be provided; and
- the application fee of US $3, 048.78 (CI $2,500.00). (The annual license fee is also US $3, 048.78 (CI $2,500.00).
A mutual fund license may be granted on terms that it will take effect upon the incorporation of a corporate mutual fund or, in the case of a foreign company, upon its registration as a foreign company under Part IX of the Companies Law (Revised), or on the establishment of any unit trust. A mutual fund license may also be granted subject to such conditions as the Monetary Authority may consider appropriate and the Monetary Authority may, upon application, waive, vary or revoke any such condition
Provisions common to all mutual funds
All regulated mutual funds are required to:
- at launch, provide CIMA with letters of consent to act from the fund's administrator and local auditor;
- submit to CIMA, and keep current, a copy of its most recent offering document (save that this requirement does not apply to regulated master funds that do not have an offering document);
- provide CIMA with audited annual accounts (see below); and
- pay an annual fee of approximately US$3,659 (or US$3,000 for master funds).
Offering documents must describe the equity interests in all material respects and contain such other information as is necessary to enable a prospective investor to make an informed decision as to whether or not to invest.
Regulated mutual funds which are required to be licensed or to employ a licensed mutual fund administrator are only to be administered by persons with sufficient expertise and of sound reputation and either CIMA or the licensed mutual fund administrator will have to be satisfied that the business of the mutual fund and any offering which it makes is to be carried out in a proper way.
The MFL also contains enforcement provisions allowing CIMA to inspect books and records, call for accounting and to take action to protect investors where appropriate. The penalties imposed by the MFL for breach of any statutory requirement are relatively stringent.
Under the Law, the requirement that Licensed Funds and Administered Funds have their current offering documents filed with the Monetary Authority, and that Registered Funds have prescribed details in respect of their current offering documents filed with the Monetary Authority, is not satisfied unless:‐
- each such offering document describes the equity interests in all material respects, and contains such other information as is necessary to enable a prospective investor to make an informed decision as to whether or not to subscribe for or purchase the equity interests; and
- where there is a continuing offering of equity interests and any promoter, director, trustee, or general partner of the fund becomes aware of any change that materially affects any information in the offering document (or the prescribed details) filed with the Monetary Authority), the fund files an amended offering document (or amended prescribed details) incorporating that change within twenty‐one days of the promoter or operator becoming so aware. In addition, every Regulated Fund is required to file accounts audited by an approved auditor within six months of the end of each financial year. Further, every Regulated Fund must pay its annual fee of US$3,048.78 (CI $2,500.00) to the Monetary Authority on or before 15th January in each year. The Law is expected to be amended in December 2006 or January 2007 to require the operators (i.e.; a director if the fund is a company, the trustee if a trust, or a general partner if a partnership) of Regulated Funds (with fiscal years ending on or after December 31, 2006), to complete a return referred to as the Key Data Elements ("KDE") Form (which sets out general, operational and financial information on each fund).
The Regulated Fund will be required to submit on an annual basis, both its audited accounts and the KDE to the Monetary Authority through the fund's approved audit firm in the Cayman Islands.
Although the Regulated Fund may wish to appoint another service provider (e.g.; a registered office or its administrator) to complete the form on the fund's behalf, ultimate responsibility for the timely and accurate filing of the KDE Form will remain with the operator.
Local audit sign off
Since 1 July 2002, CIMA has required local audit sign-off on all mutual funds and mutual fund administrators regulated by CIMA. Only auditors with a physical presence in the Cayman Islands are approved as auditors of record for locally incorporated or established mutual funds and other entities subject to regulation by CIMA (see list below). This policy does not, however, require that all of the audit work is carried out locally in the Cayman Islands or carried out solely by the approved auditor of record. The audit can be performed wherever the principal books and records of the entity are maintained provided that a Cayman auditor is included in the process. Please note that this policy does not apply to branches of international companies licensed in the Cayman Islands and foreign domiciled funds that are administered in the Cayman Islands but not otherwise registered as foreign companies doing business in the Cayman Islands.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.