Private funds and hedge funds are already required to comply with the AML/CFT/PF/Sanctions regime. Private funds and limited investor hedge funds are now required to provide details of their compliance arrangements to the regulator, CIMA, as part of registration. This will bring them into line with larger hedge funds.
Private funds and hedge funds have a range of good options for how best to comply with the Cayman Islands AML/CFT/PF/Sanctions regime, with those most frequently used summarised below. This is an ideal opportunity for all funds to check whether their arrangements meet mandatory requirements and suit their preferred approach.
What are the fund's obligations?
A fund has certain initial and ongoing investor-related obligations ("Investor Procedures") and must also implement certain internal controls ("Internal Controls"), which include designating suitable individuals to be MLRO, Deputy MLRO and AMLCO of the fund. Please click on the headings below for further details.
Who is responsible for the fund's compliance?
The obligations apply to the investment fund itself - not its overseas manager or advisor (which has no Cayman AML/CFT/PF/Sanctions obligations unless agreed contractually with the fund). The fund's "operator" is responsible for ensuring the fund complies with AML/CFT/PF/Sanctions. The "operator" means the fund's board of directors, general partner or trustee, depending on the fund's legal form. AML/CFT/PF/Sanctions compliance is typically a fund expense.
How can funds comply in practice?
As funds have no staff, in practice they invariably rely on, or delegate to, other entities to perform their AML/CFT/PF/Sanctions functions on their behalf. Typical arrangements are as follows and may include allocating performance of Investor Procedures and Internal Controls between two providers.
- If the fund has an administrator, the administrator generally performs the Investor Procedures and may also agree to provide the Internal Controls (which must include providing suitable individuals to be designated as MLRO, Deputy MLRO and AMLCO of the fund). If the administrator is not providing the Internal Controls, this must be done by another entity, in practice meaning either the fund's investment manager or advisor or a specialist service provider such as Walkers Professional Services.
- Alternatively, the fund's investment manager or advisor may perform the Investor Procedures (generally only in relation to private funds and with the support of legal counsel) and/or the Internal Controls (which must include providing suitable individuals to be designated as MLRO, Deputy MLRO and AMLCO of the fund). Walkers' specialist Regulatory & Risk Advisory group of lawyers can provide occasional or comprehensive support to the fund's investment manager or advisor. We can support the fund's investor identification and verification process, including via its onshore counsel. We can advise on the roles and responsibilities of the MLRO, Deputy MLRO and AMLCO and provide training and day-to-day support, on routine matters or just more sensitive and urgent issues. We can assist with any reports of suspicious activities and sanctions breaches to the Cayman Islands Financial Reporting Authority and help ensure all necessary documentation, including policies and procedures, board reports, audit checklists and risk assessments, are in place.
- Another alternative for a fund is to engage a specialist service provider such as Walkers' law firm's affiliate Walkers Professional Services, which offers a full suite of Investor Procedures and Internal Controls (including providing suitable individuals to be designated as MLRO, Deputy MLRO and AMLCO). Alternatively, Walkers Professional Services can provide Investor Procedures only or Internal Controls only or simply provide the necessary investor screening element for private private funds using specialist subscription databases.
While funds are subject to an internal audit requirement as part of the Internal Controls, this does not necessitate engaging a third party auditor. All the fund's Internal Control procedures including audit, reporting and compliance oversight can be performed by the fund's Internal Controls provider.
Which standards must be applied?
The fund must ensure that the policies and procedures of an administrator, investment manager or advisor or other service provider performing AML/CFT/PF/Sanctions functions for it are adequate to satisfy Cayman standards - even if the service provider is located and regulated in another jurisdiction. For example, this means applying the AML Regulations' definitions of "beneficial owner" (using a 10% threshold) and "politically exposed person" and screening for sanctions as applicable to the Cayman Islands (with OFAC screening alone not sufficient) and reporting any suspicious activity or any sanctions breaches to the Cayman Islands Financial Reporting Authority (even if reports are also made in another jurisdiction).
What are the Investor Procedures?
The AML Regulations require a fund to conduct Investor Procedures which are, in summary, as follows.
- Investor due diligence and risk rating - investors must be risk rated and there must be verification of the identity of investors and any beneficial owners (based on a 10% threshold) and persons acting on investors' behalf (such as authorised signatories). This means obtaining prescribed customer due diligence ("CDD") information, with documentary evidence being certified copies or legitimate electronic documents. Simplified due diligence ("SDD") can be applied to certain categories of lower risk investor or when relying on prescribed written assurances from certain third parties. Enhanced due diligence ("EDD") must be applied where higher risks are identified (for example, in the case of politically exposed persons).
- Sanctions screening of investors - The Cayman Islands implements the international sanctions obligations of the UK which are extended to the Cayman Islands by Orders in Council. The majority of the sanctions in effect in the UK come from the UN Security Council and the European Union. OFAC is not directly applicable in the Cayman Islands and OFAC screening alone will not suffice.
- Ongoing monitoring - ongoing monitoring of investors and transactions, including ensuring CDD remains relevant.
What are the Internal Controls?
- Suspicious activity reporting - the fund must implement procedures for the reporting of suspicious activity and potential sanctions breaches internally and externally, including the designation of two senior individuals as Money Laundering Reporting Officer ("MLRO") and Deputy MLRO. All reports of suspicious activity and potential sanctions breaches must be made to the Cayman Islands Financial Reporting Authority, even if a report is also made in another jurisdiction;
- Compliance oversight - including the designation of a senior individual as anti-money laundering compliance officer ("AMLCO") (who may be the same individual as either the MLRO or the Deputy MLRO) to be responsible for ensuring that the measures required by the AML Regulations are complied with by the fund and who functions as the point of contact with competent authorities.
- Record keeping - records relating to investor due diligence and transactions must be retained for at least five years following termination of the investor relationship. Various logs and registers must also be maintained.
- Internal audit - The fund must have an independent internal audit function to test its AML/CFT/PF/Sanctions programme. This does not necessitate engaging a third party auditor. The term "audit" is used by CIMA in the sense of testing the efficacy and efficiency of the fund's AML/CFT systems, policies and procedures.
- Training - while funds have no employees and are technically exempt from employee training requirements, CIMA requires the fund's operator, MLRO, Deputy MLRO and AMLCO and relevant staff involved in the business of the fund (in other words, at the providers of AML/CFT/PF/Sanctions functions to the fund) to receive training to ensure awareness of the Cayman Islands AML/CFT/PF/Sanctions regime, the fund's AML/CFT/PF/Sanctions programme and how to identify and treat suspicious activity.
Does the fund retain any residual obligations?
The fund retains certain residual obligations. It is ultimately responsible for ensuring compliance, notwithstanding any reliance or delegation. The fund's operator must ensure the fund has a documented risk assessment, which must include specified content and can be prepared by Walkers Regulatory & Risk Advisory group or WPS. The fund must ensure that any reliance on, or delegation to, a provider of AML/CFT/PF/Sanctions functions is compliant. The fund's operator retains responsibility for approving certain investors and introducer arrangements and must report suspicious activity or sanctions breaches to the MLRO . The operator should receive training covering the above and also on areas such as data controller responsibilities and responding to information requests from authorities relating to the fund or its investors, all of which Walkers Regulatory & Risk Advisory group can provide.
What roles need to be assigned to individuals?
The fund must designate suitable senior individuals to perform the roles of MLRO, Deputy MLRO and AMLCO. These will be employees of the service provider which is providing the Internal Controls. These are not officers in a corporate law "directors and officers" sense.
What key AML/CFT/PF/Sanctions documentation for the arrangements are required?
There must be written policies and procedures covering the fund's various AML/CFT/PF/Sanctions obligations. However, in practice a fund will typically rely on the policies and procedures of its service provider(s). If that is its investment manager or advisor, it may prefer to have Cayman Islands policies and procedures for the fund which are separate from its own non-Cayman Islands version. A fund may choose to also maintain its own brief fund-level policies and procedures to cover its residual obligations.
The fund's AML/CFT/PF/Sanctions reliance or delegation arrangements must be subject to a written agreement containing certain prescribed terms. This does not need to be a standalone agreement - the necessary terms can be added to the administration agreement or investment management agreement or investment advisory agreement.
What are the key sources of AML/CFT/PF/Sanctions obligations?
The principle sources of the AML/CFT/PF/Sanctions regime are the Proceeds of Crime Law, the Terrorism Law, the Proliferation Financing (Prohibition) Law, the Anti-Money Laundering Regulations ("AML Regulations") and the Guidance Notes on the Prevention and Detection of Money Laundering and Terrorist Financing in the Cayman Islands (the "Guidance Notes") issued by CIMA, all as revised and amended from time to time). The AML Regulations reflect the Financial Action Task Force ("FATF") Recommendations and codify a risk based-approach. The Cayman Islands AML/CFT/PF/Sanctions regime is recognised as reflecting international standards. The Cayman Islands Monetary Authority ("CIMA") supervises ongoing compliance and suspicious activity report and sanctions breaches must be reported to the Cayman Islands Financial Reporting Authority ("FRA").
What are the risks of failure to comply?
Any person who breaches the AML Regulations commits an offence and is liable on summary conviction to a fine of up to USD 600,000 or on indictable conviction to an unlimited fine and imprisonment for two years. Where an offence by an entity is committed with the consent or connivance of, or to be attributable to neglect on the part of, a director, member, partner, manager, secretary or other similar officer as applicable, that person as well as the entity are both liable.
In addition, CIMA now has power to impose administrative fines on licensed and regulated individuals and entities for non-compliance with the AML Regulations. These range from USD 6,000 fixed penalties for minor offences to USD 125,000 for individuals and USD 1.25 million for entities for very serious offences.
Walkers' specialist Regulatory & Risk Advisory group's extensive fund client base means it has an unparalleled overview of the market and regulatory expectations. We can advise on the options and provide support to help ensure that proposed arrangements are compliant. Walkers Professional Services can be relied to deal with a fund's Investor Procedures and/or Internal Controls.
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.