This memorandum has been prepared for the assistance of promoters and onshore counsel in selecting a domicile for an investment fund and in considering structuring an investment fund in the British Virgin Islands ('BVI'), Cayman Islands, Guernsey and Jersey. It is intended to provide a summary of the main legal requirements and practical considerations applicable to the formation, registration, and operation of investment funds in those jurisdictions. It is not intended to be comprehensive in its scope and it is recommended that a client considering an investment fund in the BVI, Cayman Islands, Guernsey, or Jersey should contact the appropriate Ogier office of the Ogier group to obtain detailed legal advice on the proposed transaction prior to taking steps to implement it.
This memorandum has been prepared on the basis of the law and practice as at July 2008.
The various terms used to describe collective investment schemes are often used interchangeably. 'Investment Fund' is a broad generic term that encompasses all types of collective funds and schemes, including hedge funds and private equity funds. This memorandum primarily covers open ended funds, including hedge funds, and does not deal with closed ended/private equity funds which are the subject of a separate Ogier briefing note. There is no standard definition of 'hedge fund'; the term dates back to the first such fund founded by Alfred Winslow in 1949, generally viewed as the father of the hedge fund industry. Jones's innovation was to minimize the risk in holding long-term stock positions by short-selling other stocks. Jones also employed leverage in an effort to enhance returns and, in 1952, Jones altered the structure of his investment vehicle, inter alia, by adding a 20% incentive fee as compensation. Accordingly, a hedge fund will generally display the following characteristics:
- use of some form of short selling to reduce risk;
- the use of some form of leverage;
- a fee payable to the manager based on the performance of the fund;
- investments in a liquid asset pool; and
- periodical subscriptions and redemptions of equity interests - generally monthly or quarterly.
The foregoing list is not exhaustive and with the proliferation of investment strategies and convergence of hedge funds and private equity funds, characteristics are constantly evolving.
CHOICE OF DOMICILE
- Onshore Or Offshore?
Quite apart from the tax advantages of domiciling an investment fund offshore, promoters and managers have found other advantages in choosing offshore over onshore for domiciling their funds including:
- ability to define investment strategies and objectives without restrictions imposed by onshore regulators in the name of consumer protection and the consequent absence at fund level of expensive reporting requirements to onshore regulators such as the SEC in the United States and the FSA in the United Kingdom;
- in relation to certain types of funds, (an example being property unit trusts), an offshore fund can be more widely marketed to institutional investors and is often listed on an offshore exchange to facilitate this;
- if the investment management of a fund is conducted offshore, there may be regulatory advantages for the investment manager and adviser, e.g. if management services are provided offshore, so that investment advisory services only are provided from within the UK, this can reduce the regulatory burden on the investment adviser in the UK which may not require full FSA regulation;
- certain of the offshore centres, in particular BVI, the Cayman Islands, Guernsey and Jersey are home to a concentrated level of fund expertise, including experienced law firms, administrators and all of the major accounting firms and hedge fund specialist audit firms.
- Selection Of Offshore Jurisdictions
Once the decision has been made to go offshore, there are the following key considerations:
(a) Political And Economic Stability
BVI And Cayman
The BVI and the Cayman Islands are both British Overseas Territories and although a governor is appointed by the British Government there is a large measure of internal self-government. However, the British Government retains responsibility for internal security, defence, external affairs and the appointment of certain public officers, including the judges.
The final court of appeal is the Judicial Committee of the Privy Council in London and it is common practice for advocates from the UK to appear before the British Virgin Islands and the Cayman Islands courts on major litigation matters. Legislation dealing with commercial matters is specifically relevant to its role as an offshore financial centre and the general law is derived from English common law.
Guernsey And Jersey
Guernsey and Jersey do not form part of the United Kingdom. Each is a self-governing dependency of the British Crown. By constitutional convention established over some 900 years, each jurisdiction has complete autonomy in all matters of internal government, including taxation. The legal systems are separate but similar, derived in part from the customary laws of Normandy but strongly influenced by English law in company and commercial matters. The Judicial Committee of the Privy Council in London remains each jurisdiction's ultimate court of appeal.
Guernsey and Jersey's special constitutional position has been recognised by the European Union in a protocol (No.3) attached to the United Kingdom's treaty of accession to the EU. The protocol provides that the Treaty of Rome shall apply to each jurisdiction only to the extent necessary in relation to the arrangements for the free movement of goods. Accordingly, European Union directives on fiscal harmonisation, financial services and company law do not have effect in Guernsey or Jersey, and, in this respect, the jurisdictions enjoy significant advantages over Luxembourg and Ireland.
(b) Integrity And Reputation
Each of BVI, Cayman, Guernsey and Jersey is a recognised jurisdiction for the purposes of the Financial Action Task Force ('FATF') for its anti-money laundering legislation thereby enabling investors in any jurisdiction to be satisfied that it has adopted standards equivalent to or higher than those of their own jurisdiction. Such considerations are important for institutional investors and government organisations.
In respect of investments, it is also often to the fund's advantage that it can demonstrate to the authorities in the jurisdiction where it seeks to invest that it is properly regulated in an internationally recognised jurisdiction. Payments are also assisted in and from the target jurisdiction due to the recognition of Cayman, Guernsey and Jersey by the FATF. Cayman, Guernsey and Jersey funds invest in most jurisdictions throughout the world.
(c) Cutting Edge Legislation And Regulations
Each of BVI, Cayman, Guernsey and Jersey have governments that recognise the importance of working closely with the private sector to provide legislation which meets market needs.
(d) Absence Of Direct Taxes And Exchange Controls
Investment funds can be established in each jurisdiction without the imposition of direct taxes. None of BVI, Cayman, Guernsey or Jersey have exchange controls.
(e) Good Communications And Access
The communications system in each jurisdiction is first class and the legal and financial service providers operate information technology systems on par with those available in any other major financial centre.
BVI is accessible by regular flights via Puerto Rico and remains on the same time (GMT-4 hours) throughout the year. Grand Cayman is accessible by regular direct flights from London, New York, Chicago, Boston, Toronto, Miami, Atlanta, Houston, Tampa and Nassau, and remains on the same time (GMT-5 hours) throughout the year. Located in the Gulf of Normandy, Guernsey and Jersey are easily accessible by regular direct flights from London (Gatwick, Stansted, City) and other United Kingdom airports and are in the same time zone as the United Kingdom.
(f) Recognised Stock Exchange
Both the Cayman Islands Stock Exchange and the Channel Islands Stock Exchange (based in Guernsey) have been designated as 'recognised stock exchanges' by the UK Inland Revenue and the Channel Islands Stock Exchange has been classified as a 'designated investment exchange' by the UK FSA.
(g) Location Of Investors Or Target Markets
If, for example, many of the prospective investors or targets for an investment fund are in the United States, BVI or Cayman may be an appropriate location to domicile the fund because of the proximity and close time zone. If the investors or targets are in Europe, Guernsey or Jersey may be preferred.
(h) Type Of Vehicle
The different types of fund vehicles are discussed below. Although there is overlap, certain types of vehicles are not available in all jurisdictions.
As at September 2007, the current number of regulated open ended funds in each of the jurisdictions was as follows:
- Fund Vehicles
All four jurisdictions allow different structures to be used for investment funds and a combination of structures may also be permitted. There are other Ogier briefing notes describing the types of vehicles available in more detail which are available on request.
- The companies law of all four jurisdictions are based upon internationally familiar English company law principles and all offer companies with limited liability.
- There are no minimum authorised or issued share capital requirements imposed in each jurisdiction.
- No par value shares are available in each jurisdiction.
- All four jurisdictions permit the incorporation of segregated portfolio companies (BVI/Cayman) or protected cell companies (Guernsey/Jersey) whereby each segregated portfolio or protected cell's assets and liabilities are legally segregated.
- Guernsey and Jersey also offer an incorporated cell company which is similar to a portfolio cell company, except that each cell has a separate legal identity.
- Cayman and Jersey companies may be incorporated as limited life companies or limited duration companies.
(b) Unit Trusts
- In contrast to an investment company, a unit trust is not a separate legal entity as such, but a trust arrangement whereby legal ownership of the fund's assets is vested in a trustee who holds the assets of the fund on trust for the benefit of the unitholders.
- The unit trust will generally be constituted by means of a trust instrument which regulates the rights of the unitholders. Typically the manager will promote and manage the trust with the trustee delegating the administration to a third party service provider. Subscription proceeds will be paid to the trustee which will act as custodian of the investment assets of the fund. In addition, the trustee will generally supervise compliance by the manager with its obligations to the trust.
- The trust instrument will generally contain provisions regulating the issue, redemption and valuation of units, the appointment and removal of the trustee, its duties and remuneration, borrowing powers, investment restrictions and for the winding-up of the trust.
- Each jurisdiction has a modern statute-based trusts law.
- For most practical purposes a unit trust scheme will operate and be regulated in the same manner as a corporate investment fund.
(c) Limited Partnerships
- Limited partnerships may be established and operated in each jurisdiction under comprehensive and modern legislation.
- A limited partnership may be an appropriate structure for a number of different purposes. A principal use will be to provide an additional form of investment vehicle for mutual funds, in particular for the venture capital industry. A limited partnership will also be an attractive structure for various tax planning purposes as the partnership is generally treated as being fiscally transparent.
- There is no maximum imposed on the number of limited partners of a limited partnership established in BVI, Cayman, Guernsey or Jersey.
- The general partner will manage the business of the partnership and have unlimited liability for its debts. The liability of investors taking interests as limited partners (and who do not participate in the management of the business) will be limited generally to the amount of their investment subject to certain limited exceptions which are set out in the relevant legislation.
- A Guernsey or Jersey registered limited partnership may elect to have separate legal personality.
- Regulatory Framework
The establishment and operation of investment funds is governed in each jurisdiction by the legislation, rules and guidance discussed below. BVI, Cayman and Guernsey distinguish between the level of regulation applied to open-ended investment funds and closed-ended investment funds. Generally, open-ended investment funds permit investors to redeem their holdings at a price related to the value of the underlying assets. Closed-ended investment funds do not entitle investors to redeem at their option. Jersey looks principally at the number of investors to which the fund will be offered.
The establishment and operation of investment funds is regulated by The British Virgin Islands Financial Services Commission (the 'FSC') pursuant to The Mutual Funds Act, 1996.
If the fund vehicle is open-ended (e.g. investors have a right to demand a redemption of their shares/withdrawal of their partnership interests), the fund vehicle will require licensing with the FSC. Where the fund vehicle is closed-ended (e.g. investors have no right to demand a redemption of their shares/withdrawal of their partnership interests), the fund will be beyond the scope of the FSC's jurisdiction and will not require licensing.
There are three categories of licensed funds in the British Virgin Islands, namely:
(a) Private Funds - A private fund is essentially a fund whose constitutional documents specify that it will have no more than fifty (50) investors and/or that the making of an invitation to investors to subscribe for shares/interests in the fund is to be made on a private basis. Unlike professional funds, there are no minimum investment or investor suitability requirements for private funds.
A private fund is not required under the Mutual Funds Act to file a prospectus with the FSC, although it is accepted practice to do so upon applying for recognition.
(b) Professional Funds - A professional fund is a fund whose shares/interests are only made available to professional investors.
A "professional" investor is a person whose ordinary business involves, whether for its own account or the accounts of others, the acquisition or disposal of property of the same kind as the property, or a substantial part of the property (e.g. stocks or securities for a hedge fund), of the fund or who has signed a declaration that he, whether individually or jointly with his spouse, has net worth in excess of US$1,000,000 or its equivalent in any other currency and that he consents to being treated as a professional investor.
A professional fund has a minimum investment requirement in that the initial investment of the majority of the investors must invest not less than US$100,000 or its equivalent in any other currency.
A professional fund is permitted to operate for 14 days before receiving its licence from the FSC. A professional fund is not required under the Mutual Funds Act to file a prospectus with the FSC, although it is accepted practice to do so upon applying for recognition.
(c) Public Funds - A public fund is essentially a BVI fund which is not a private or professional fund. The regulatory requirements (and so licensing procedure) for a public fund are more stringent than those required for private or professional funds, given the nature of the investors who are likely to be investing in a public fund (public funds are for retail investors).
A public fund is required to file with the FSC a copy of its prospectus, which must contain provisions as specified in the Mutual Funds Act and its regulations.
No private or professional fund may carry on business in the BVI unless it is 'recognised' under the Mutual Funds Act and no public fund may carry on business in the BVI unless it is 'registered' under the Mutual Funds Act. An exception is granted to professional funds which may carry on business for up to 14 days prior to being recognised.
The FSC maintains a register of mutual funds which must contain certain details. Any change in such details must be filed with the FSC within 21 days of such change. If a private or professional fund wishes to change a manager, administrator, investment advisor or custodian, it must obtain the prior consent of the FSC. A public fund requires the FSC's prior consent for any material change to its prospectus or structure, including changes to directors, functionaries or auditors.
A public fund must appoint an approved auditor acceptable to the FSC. A private or professional fund does not have to appoint an auditor.
The Mutual Funds Law (2003 Revision) of the Cayman Islands ('Mutual Funds Law') requires mutual funds to be licensed or registered with the Cayman Islands Monetary Authority ('CIMA') before they commence carrying on business unless they are exempt from the need to be registered or licensed.
(a) The statutory definition of a 'mutual fund' (which is used in the statute instead of the generic term 'investment fund') is any company, trust or partnership either incorporated or established in the Cayman Islands, or if outside the Cayman Islands, managed or administered from the Cayman Islands, which issues equity interests redeemable at the option of the investors, the purpose or effect 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.
(b) Unless exempt, open-ended funds must comply with one of the three alternatives prescribed by the Mutual Funds Law:(i) registration with CIMA if the minimum aggregate equity interest which may be purchased by a prospective investor is at least US$100,000 (or its equivalent in another currency) or the equity interests are listed on a recognised stock exchange;
(ii) registration with CIMA if a mutual fund administrator licensed in the Cayman Islands provides its principal office in the Cayman Islands; or
(iii) licensing by CIMA if all the operators of the fund have been approved by CIMA as 'fit and proper' persons;
A mutual fund will be exempt from the requirements to be registered if the equity interests are held by not more that 15 investors, the majority of whom are capable of appointing or removing the operator. For this purpose, there is no look through to beneficial ownership, the term 'investor' is defined to mean the investor of record. If, therefore, all the equity interests are issued to a single institutional nominee or custodian, the mutual fund will fall outside the scope of the Mutual Funds Law.
(c) Closed-ended funds and those funds which only issue debt instruments are outside the scope of the Mutual Funds Law.
Regulated mutual funds are subject to the supervision of CIMA, which has wide powers including the power to require the substitution of a director and, at the expense of the fund, to appoint a person to advise the fund on the proper course of its affairs and/or to appoint a person to assume control of the affairs of the fund.
With the exception of requiring a sign off by an auditor based in the Cayman Islands on the audited financial statements filed with CIMA each year for a registered or licensed fund, there are no requirements that the operator (except if an exempted trust is used) or any other service provider be located in the Cayman Islands.
The establishment and operation of investment funds in Guernsey is governed principally by the Control of Borrowing (Bailiwick of Guernsey) Ordinances, 1959 to 2003 ('COBO') and the Protection of Investors (Bailiwick of Guernsey) Law, 1987 ('POI Law') together with the rules made thereunder. In addition, where an investment fund is listed on the Channel Islands Stock Exchange, LBG ('CISX'), the CISX Rules will apply. Among other things, the CISX Rules impose certain additional disclosure obligations. Further information can be provided on the CISX Rules if required.
In practice COBO will apply to closed-ended funds where investors are not entitled to redeem their holdings. Application for consent under COBO must be made to the Guernsey Financial Services Commission (the 'GFSC'). The consent, if granted, will specify the maximum number and value of shares, units or other interests that may be issued - although increasing such limits is in the ordinary course not a complicated or lengthy process. While there are no published rules under COBO, certain minimum disclosure requirements and ongoing disclosure obligations apply, and annual reports must be filed with the GFSC. There are few other reporting requirements.
POI Law applies to open-ended funds (that is, investment funds where investors are entitled to redeem their holdings at a price related to the value of the underlying assets). Application is made to the GFSC for authorisation under three categories: Class A, Class B or Class Q.
Class A Schemes are governed by the Class A Rules. It is possible for a Class A Scheme to be a futures and options fund but generally uncovered exposure must not exceed 20% of the value of the scheme property. A Class A Scheme would be subject to a heavier level of regulation in its operations than a Class B or Class Q Scheme. However, Class A Schemes may be marketed more widely in certain jurisdictions (for example, they are eligible for recognition by the UK Financial Services Authority for sale to the public in the United Kingdom).
Class B Schemes are governed by the Class B Rules, which are designed to be as flexible as possible, with reliance placed on disclosure. There are no investment restrictions set out in the Class B Rules although the principle of risk spreading applies. The GFSC has the power to derogate from the requirements of any of the rules and will consider all levels of disclosure and investment restrictions in light of the proposed investor basically and will consider the totality of the circumstances in each dividend case.
Class Q Schemes are governed by the Class Q Rules which provide for the regulation of professional investor funds. Greater discretion is permitted in respect of investments with the emphasis again on disclosure. Holdings in Class Q Schemes may only be held by 'qualified professional investors' which are:
(a) government, local or public authorities;
(b) trustees of trust with net assets of greater than £2,000,000(or currency equivalent); or
(c) body corporates or limited partnerships if they (or any holding company or subsidiary) have net assets of greater than £2,000,000 (or currency equivalent); or
(d) individuals who (together with any spouse) have a minimum net worth (excluding main residence and household goods) of greater than £500,000.
Qualifying Investor Funds ('QIFS')
In respect of funds for which either COBO consent or a POI Law authorisation is required, the GFSC will permit a fast track application, where a locally licensed administrator conducts appropriate due diligence and confirms the same to the GFSC. Funds that use this procedure are called QIFs. Other requirements apply. Principally the investors in the fund must be restricted to:
(a) government, local or public authorities;
(b) professional investors;
(c) affiliates of the fund (that is, financial services business or professionals associated with the operation of the fund);
(d) individuals who make an initial investment of greater than US$100,000;
(e) experienced investors who are able to understand the nature of the risks involved; or
(f) employees of the fund or consultants appointed by the fund.
In addition to the QIF regime the GFSC has introduced a Registered Fund regime which is short allows an applicant to take advantage of the fast track application process but which does not contain the QIF Regime instructions as to investors.
The Registered Fund regime is available only to closed-ended funds whereas QIFs can be open or closed-ended.
Please note the requirements for investors in a QIF and a Class Q Scheme are not the same and must be considered separately.
A Guernsey resident administrator (or designated manager) will be required for all Guernsey funds. A Guernsey resident custodian will generally be required for all open-ended funds authorised under the POI Law. For hedge funds, however, a prime broker, regulated in an acceptable jurisdiction and having substantial net worth, may be appointed without the need for a Guernsey custodian.
(a) The establishment and regulation of investment funds in Jersey is governed by the Borrowing (Control) (Jersey) Law, 1947 (the 'Borrowing Law') and the Collective Investment Funds (Jersey) Law, 1988 (the 'Funds Law') together with the regulations made thereunder. Although the scope of the two statutes overlaps, in practice an investment fund with a limited number of investors which is not to be listed will be governed by the Borrowing Law whereas a more widely distributed or listed fund will be regulated under the Funds Law.
(b) In general, if shares, units or limited partnership interests are to be offered to 50 or fewer persons and are not to be listed it is necessary only to obtain consent of the Jersey Financial Services Commission ('JFSC') under the Borrowing Law. If, on the other hand, shares, units or limited partnership interests are to be offered to more than 50 persons or are to be listed, permits under the Funds Law will also be required. It is important to note that for these purposes it is the number of offers made which dictates whether a fund is to be regulated under the Borrowing Law or the Funds Law. Accordingly, it is possible for a 'red-herring' offering document to be distributed to more than 50 prospective investors without this giving rise to regulation under the Funds Law provided the red-herring document makes it clear that it is not intended to constitute an offer of shares, units or limited partnership interests. Where permits are granted under the Funds Law, any Borrowing Law consents which are required will be issued automatically.
(c) Jersey has recently adopted a streamlined approval process for Expert Funds. An Expert Fund will be subject to a very light degree of regulation. In particular, the promoter of an Expert Fund will not be subject to any regulatory review or approval and an Expert Fund will not be required to adopt any prescribed investment restrictions or risk diversification strategy. Self-certification as to compliance with the Expert Fund Requirements means that an Expert Fund can be approved by the JFSC within three days.
(d) A Jersey Expert Fund must appoint a Jersey resident administrator, manager or (in the case of a closed-end unit trust) trustee. A Jersey open-ended Expert Fund must appoint a Jersey resident custodian (unless it is a hedge fund, in which case a prime broker with a credit rating of A1/P1 is required). A Jersey open-ended fund (not being an Expert Fund) must appoint a Jersey resident manager and a Jersey resident custodian.
- Selection Of Investment Structure
a) The prospective investor at whom the investment product is targeted will be an important consideration in determining the selection of the appropriate form of investment vehicle. Where, for example, a retail fund is to be offered to the public in the United Kingdom or to Japanese investors a unit trust may be the most familiar structure, whereas if the fund is to be marketed in Europe or in the United States, an open-ended investment fund company may be the appropriate form. For a complex investment product having a high minimum investment threshold which is to be offered to investment institutions, a limited partnership may be the appropriate form.
b) While regulatory and marketing considerations are important in selecting whether the corporate, unit trust or limited partnership form is used, the fiscal implications for investors will generally be the determining factor. The promoters of the investment fund will generally wish to ensure that, at the least, the investment fund achieves tax neutrality, whereby an investor will be in the same tax position whether he makes his investment directly in the underlying assets or through the medium of the investment fund.
c) In most tax jurisdictions the corporate form, by virtue of being a separate legal entity, is treated as being fiscally non-transparent, the fund's tax position being determined without regard to its shareholders. However, it has been possible to structure companies as entities which satisfy the relevant conditions within other jurisdictions for fiscal transparency. A limited partnership on the other hand will for tax purposes generally be treated as being transparent and the total tax take will be determined by the partners' individual circumstances. For fiscal purposes a unit trust has mixed tax characteristics. In certain jurisdictions it may be treated as being transparent for income and non-transparent for capital gains distributions. The revenue authorities may regard income in the hands of the trustee as the income of the unitholder.
d) Accordingly, for certain types of investments in certain jurisdictions it may be advantageous for investors to use a trust vehicle. However, by virtue of the greater flexibility provided by the corporate form for listing on stock exchanges and the wider acceptability of companies for marketing purposes, the majority of the investment funds established in BVI, Cayman, Guernsey and Jersey in recent years have been open-ended investment companies.
e) Master-feeder structures are also frequently used and enable both onshore investors and offshore investors to participate in the same investment programmes. Using the US as an example, this is normally achieved by having the US taxable investors invest directly in a limited partnership domiciled in the US and having the offshore investors and US tax exempt investors investing in an offshore company (or, occasionally, a limited partnership). Each feeder will then invest all of its assets in the master fund, which is typically an offshore company which has elected to be treated as a partnership for US tax purposes under the 'check the box' rules. The investment manager will then manage the portfolio at master fund level. One of the advantages of the structure is administrative ease, since the investment manager will only need to maintain one set of books for the investments at master fund level.
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.