Cayman Islands: Regulation of Cayman Islands Hedge Funds – Achieving the Balance

In an article which appeared in the Legal Week edition of 13 October 2005, I highlighted the Cayman Islands position as the leading domicile for offshore hedge funds. As it turned out, 2005 was another record year for the Cayman Islands hedge fund industry with some 1,700 new funds being registered compared with some 1,500 in 2004. At the end of November 2005, the Cayman Islands Monetary Authority (CIMA) announced the 10,000^th fund to be approved for registration since the passage of the Mutual Funds Law of the Cayman Islands in 1993. Somewhat ironically¹, the 10,000^th fund was an example of a new source of investment funds business for the Cayman Islands, namely, funds transferring from Bermuda and the Bahamas to take advantage of exemptions that the Cayman Islands has under the European Union Savings Tax Directive.

I also noted that, given the success of the Cayman Islands in attracting hedge funds and the limited number of failures, any proposal to increase the level of regulation would require careful review and detailed analysis. Fortunately, the need to strike a balance between commercial flexibility and an appropriate level of regulation of hedge funds is widely recognized by regulators and stakeholders in the Cayman Islands hedge fund industry. This is well demonstrated in the report of a working group established by CIMA, comprising government officials and private sector representatives, which reviewed the Mutual Funds Law and made recommendations for certain amendments.² Some of the key recommendations of the working group are summarised below.

In response to concerns expressed by the International Organisation of Securities Commissions (IOSCO) and the International Monetary Fund (IMF), it is recommended that the distinction between public and non-public funds is clarified. The term 'mutual fund', which is more typically associated with the retail market in other jurisdictions, will be replaced with the term 'investment fund' to bring the Mutual Funds Law (to be renamed the Investment Funds Law) more in line with international terminology. Four categories of investment fund are proposed - public funds, managed private funds, recognised funds and professional funds. The change of name of the fund categories will not affect the current regulatory regime, but will ensure consistency with investment fund classification in other jurisdictions.

It is also proposed that the minimum investment threshold for professional funds is increased from US$50,000 to US$100,000, bringing Cayman into line with the rules in many other jurisdictions (for example, the minimum for funds listing on the Irish Stock Exchange) and satisfying a recommendation of the IMF. This change is likely to have little impact in practice, as 80 per cent of funds registered with CIMA have a minimum subscription of US$1m or more, and only 5 per cent have an investment minimum of less than US$100,000. Existing funds will be 'grandfathered', and will not be affected by the change.

Other noteworthy proposed changes include: allowing CIMA to waive the submission of audited financial statements in certain circumstances such as where a fund was not launched or was in the process of being wound up; no longer requiring funds domiciled in IOSCO member jurisdictions which are administered in Cayman to be registered as foreign companies in Cayman and regulated by CIMA; and the introduction of a 14 day grace period within which professional funds could operate legally without registration while an application was being processed by CIMA.

In addition to these changes to the Mutual Funds Law and in order to meet the burden of supervising the ever increasing number of hedge funds and fund administrators, CIMA is also proposing to introduce new information systems to allow for electronic filings. Under the proposal key data, reporting requirements and audited accounts will be filed electronically with CIMA’s Investments and Securities Division. Electronic reporting will provide reliable aggregate statistics relating to the Cayman Islands funds industry and permit CIMA to conduct its existing supervisory and co-operative responsibilities more efficiently.

It is anticipated that the proposed amendments to the Mutual Funds Law will be enacted, and the electronic reporting system implemented, during the course of 2006.

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