Originally published in The Lawyer, January 2006.
A Review of Private Sector and Regulatory Response to Developments in Cayman's Hedge Funds Industry
The Cayman Islands Monetary Authority ("CIMA") will shortly publish statistics for calendar year 2005 confirming another record year for the hedge funds industry in the Cayman Islands. New hedge fund registrations in a single year have reached an all time high of 1,700. This follows a 112% increase in new hedge fund registrations in 2004, with 1,495 new hedge funds established.
With CIMA also recently announcing registration of the 10,000th new Cayman hedge fund, there are now 150 licensed fund administrators and a total of 7,100 active hedge funds regulated by CIMA, taking into account hedge funds de-registered by CIMA since initial registration.
The world's leading financial institutions and investment fund managers have long recognised swift turnaround time for fund establishment, depth of relevant professional expertise and services and the absence of a prescriptive regime mandating location of service providers, and rewarded Cayman with a steady increase in institutional investment funds business.
To deal with continued exponential growth and maintain Cayman's competitive edge, CIMA has announced two critical reforms – the first major overhaul of the Mutual Funds Law since 1993 and the introduction of a new electronic filing and information system.
A Working Group established by CIMA, comprising government officials and private sector representatives, has recently concluded a complete review of the Mutual Funds Law and has made detailed recommendations for amendments likely to be accepted by the Cayman government and become law during 2006.
Dealing with major concerns expressed by the International Organisation of Securities Commissions (IOSCO) and the International Monetary Fund (IMF), the distinction between private funds and public funds will be strengthened.
Four categories of investment fund are proposed by the Working Group (public funds, managed private funds, recognised funds and professional funds) clearly demonstrating Cayman's commitment and clear interest in providing services to the institutional/professional market. In addition, the name 'mutual fund', more synonymous with public funds, will be abandoned and the legislation will be known as the "Investment Funds Law" to bring it into line with international terminology.
The four investment fund categories proposed will not affect the current regulatory regime, but will ensure consistency with investment fund classification in other jurisdictions. A key change to note will be an increase in the minimum investment threshold for funds in the 'professional' category from US$50,000 to US$100,000, again ensuring consistency with other jurisdictions, including Bermuda, BVI, Isle of Man and, particularly, Ireland where the minimum for funds listing on the Irish Stock Exchange is US$100,000.
This is unlikely to have a significant impact in practice as 80% of funds registered with CIMA have a minimum subscription of US$1M or more, and only 5% have an investment minimum of less than US$100,000. CIMA itself has expressed the view that it would have no objection to the threshold being set even higher. Existing funds will be 'grandfathered' and will not be affected by the change.
The most significant changes affect Cayman based hedge fund administrators. A more precise definition of 'physical presence' for Cayman licensed administrators, and a clear statement of ongoing duties and obligations to 'managed private funds' (i.e. investment funds with minimum investment of US$10,000 requiring a licensed administrator with a physical presence in Cayman to provide the funds principal office), will be specified.
In addition, a key recommendation of the Working Group will see investment funds domiciled in IOSCO member jurisdictions administered in Cayman without the need for those funds to be registered as foreign companies in Cayman and regulated by CIMA. Cayman fund administrators will be required to notify CIMA of services provided to non-Cayman funds in an annual declaration. This will provide Cayman administrators with the level playing field they have lobbied for for some time in respect of BVI, Bermuda and US onshore funds, enabling them to price services in Cayman without those funds needing to incur a second tier of costs associated with dual registration and regulation in Cayman.
Other key changes proposed will see a requirement for more significant disclosure in offering documents in respect of directors, greater authority for CIMA to waive submission of audited financial statements in circumstances where a fund otherwise in good standing with CIMA did not launch or was in the process of winding-up, clarification of provisions of the law that have proved somewhat ambiguous in practice, a review of CIMA registration fees for additional regulatory supervision required of Segregated Portfolio Companies and the introduction of a grace period allowing investment funds in the 'professional' category only to operate legally for up to 14 days as the registration and authorisation procedure with CIMA is completed.
The Investment Services Division of CIMA, mindful of the increasing burden of supervising greater numbers of hedge funds and fund administrators, is also proposing the implementation of an electronic reporting system for all hedge funds regulated under the Mutual Funds Law in which key data, reporting requirements and audited accounts would be migrated to an electronic platform.
E-Reporting will provide reliable aggregate statistics relating to the Cayman funds industry, permit CIMA to conduct its existing supervisory and co-operative responsibilities more efficiently and provide 'scalability' enabling CIMA to accommodate increasing numbers of regulated entities without a proportionate increase in staff and costs.
Legislative reform of the benchmark Mutual Funds Law says much about the confidence of Cayman as an offshore jurisdiction and the strength of CIMA as an international regulator. Despite improving business trends CIMA and Cayman's financial sector have been far from complacent. Regulators and industry stakeholders (particularly lawyers, auditors and fund administrators) recognise that effective regulation, critical to the prosperity of an offshore financial centre like Cayman, must continue to strike a balance between maintaining Cayman's competiveness as the domicile of choice for 80% of the world's hedge funds (and the financial institutions and investment fund managers that promote them) with the need to ensure that Cayman continues to meet the developing standards of the international financial community, particularly the IMF and IOSCO.
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