I OVERVIEW OF RECENT ACTIVITY
Asset management vehicles established in the Cayman Islands can generally be divided into two distinct groups:
- regulated open-ended funds (predominantly hedge funds), for which there is an abundant supply of publicly available statistical information (although it lags behind the market, as is inevitably the case for information compiled by a regulator); and
- other asset management vehicles (including closed-ended and private equity funds), for which the available data is more limited.
A cornerstone to the success of the Cayman Islands' financial services sector is its strong legal and regulatory system, which equally benefits managers and institutional or other sophisticated investors. The jurisdiction is attentive and responsive to developing international trends, continually evolving to ensure it meets the requirements of finance sector participants, including governmental and regulatory authorities. Against this background, there have been a number of noteworthy developments, which are discussed in more detail below. The Cayman Islands continues to maintain its position as the leading jurisdiction for the registration of funds, with 10,559 funds regulated under the Mutual Funds Law (2015 Revision) (Mutual Funds Law) at the end of 2017 and 10,500 at the end of the first quarter of 2018.1 While the level of exceptional growth experienced in the years preceding the global financial crisis has ended, the industry has largely held its ground since the crisis. The industry's positive outlook is reflected in the Cayman Islands Monetary Authority's (CIMA) statistical digest for 2016, which shows growth in the net asset value of reporting funds up from US$3.575 trillion in 2015 to US$3.592 trillion in 2016.2
It is more difficult to obtain an accurate overview of the state of the Cayman Islands' asset management industry as a whole, which would necessarily include looking at the level of managed account activity and closed-ended fund activity. While single investor vehicles created as part of a managed account structure may involve registration of the relevant vehicle with the Cayman Islands registry, the vehicle will often not be required to register with CIMA because there is only one investor and therefore no pooling of investor funds (a requirement of the statutory definition of a mutual fund). There is also an exception to the need to register with CIMA for funds known as Section 4(4) funds, which are open-ended investment funds that pool the funds of 15 or fewer investors, a majority of whom are given the power to appoint and remove the fund's directors, managers (in the case of a limited liability company (LLC)), general partner or trustee, as applicable.
Closed-ended funds (i.e., funds that do not afford investors the option to withdraw all or part of their investment prior to the winding up of the fund) are not required to be registered or licensed by CIMA, so it is more difficult to gauge their numbers. The most useful indicator of the level of closed-ended fund activity (which generally includes funds investing in illiquid asset classes, such as private equity, real estate or infrastructure projects) is the number of registrations of Cayman Islands exempted limited partnerships (ELPs) and, more recently, LLCs. However, this is only a rough indicator based upon practitioners' experience that the majority of closed-ended fund structures are formed as ELPs. By contrast, CIMA's statistical digests show that only a small fraction of open-ended funds are formed as ELPs, highlighting that they are most prominent in the closed-ended sector. Figures released by the Cayman Islands Registrar of Exempted Limited Partnerships show that at the end of 2017, there were a total of 22,655 ELPs registered in the Cayman Islands. The years since the crisis have generally seen a consistent increase in the number of annual ELP registrations. In 2017, the figure for new ELPs formed stood at 3,872, compared with 3,356 in 2016, 3,377 in 2015 and 2,893 in 2014. At the end of May 2018, the figures for LLCs registered stood at 1,289. The introduction of this vehicle in July 2016 may account for the slight drop in ELP registrations in 2016, as the LLC provides similar flexibility to that which has made the ELP a popular vehicle for closed-ended structures.
ELPs are utilised for a variety of purposes within closed-ended structures. An ELP may well be the primary closed-ended fund vehicle, but often ELPs will also serve other purposes (e.g., ELPs may be used as a feeder into an onshore fund, an alternative investment vehicle, a parallel fund or a co-investment vehicle). Similarly, while still a relatively new vehicle in the Cayman Islands, experience has shown that LLCs are increasingly being used as general partners as well as feeder, blocker and aggregator vehicles in closed-ended fund structures. Changes in the rate of formation of ELPs and LLCs could, therefore, indicate fluctuations in the rate of new fundraising, but are just as likely to point to variations in the level of transactional activity by established closed-ended funds themselves.
II GENERAL INTRODUCTION TO THE REGULATORY FRAMEWORK
As noted above, pooled investment funds in the Cayman Islands are either open-ended and subject to registration with or licensing by CIMA (unless falling within the Section 4(4) exception), or closed-ended and not currently required to register with or be licensed by CIMA. The primary statute regulating Cayman Islands pooled investment funds is the Mutual Funds Law. Subject to the Section 4(4) fund exception, a Cayman Islands investment fund qualifies as a mutual fund, and is, therefore, required to be regulated under the Mutual Funds Law if:
- it is a company, LLC, partnership (including ELPs) or unit trust;
- it issues equity interests to investors (i.e., shares, partnership and LLC interests or trust units that carry an entitlement to participate in profits or gains, and which may be redeemed or withdrawn at the option of those investors prior to winding-up); and
- its purpose or effect is the pooling of investor funds with the aim of spreading investment risks and enabling investors to receive profits or gains from investments. The key distinction between such an open-ended mutual fund and a closed-ended fund is the ability of investors to voluntarily redeem or withdraw some or all of their investment prior to winding-up, whether at will or on a specified period of notice. Where shares, partnership and LLC interests or trust units are subject to a lock-up period, Cayman Islands practitioners and CIMA generally consider that the lock-up period should be at least five years for an investment fund to be regarded as closed-ended at the outset. A fund with such a lock-up period will generally need to register with or be licensed by CIMA prior to the expiry of the relevant lock-up period.
Master funds are also potentially subject to registration with CIMA. A master fund in a multi-level fund structure will be deemed to be a mutual fund for the purposes of the Mutual Funds Law and, accordingly, will be required to be registered with CIMA, if it:
- is a Cayman Islands company, LLC, partnership (including ELPs) or unit trust;
- issues equity interests;
- holds investments and conducts trading activities for the principal purpose of implementing the overall investment strategy of a CIMA-regulated feeder fund; and
- has at least one CIMA-regulated feeder fund that conducts more than 50 per cent of its investment activity through the master fund, whether directly or indirectly via an intermediary entity.
Owing to the definition of master fund under the Mutual Funds Law, a master entity in a structure having only one investor (i.e., where there is, strictly speaking, no pooling element at the level of the master fund) will, nevertheless, constitute a mutual fund. The exact fund structure will, in each case, determine whether registration of a master entity, or any other entity, is necessary, although there are certain structural approaches that may allow such an entity to fall outside the scope of the master fund registration regime under the Mutual Funds Law. Where a fund is eligible for registration both as a feeder fund and as a master fund, CIMA has suggested that funds should generally opt for registration as a master fund, although there are certain circumstances in which this may not be appropriate.
Funds registered under Section 4(3) of the Mutual Funds Law account for approximately 96 per cent of all regulated investment funds in the Cayman Islands as of 31 December 2017.3 The straightforward requirements for registration and the absence of a pre-approval process contribute to this popularity. The basic requirements for registration under Section 4(3) (for both traditional mutual funds and master funds) are that the minimum initial investment per investor is at least US$100,000 (or its equivalent in another currency), or that the equity interests are listed on a recognised stock exchange. Registration involves completion of an online application form by a licensed corporate services provider in the Cayman Islands, together with the online filing of the fund's offering document and consent letters from its administrator and its Cayman Islands auditor. A separate offering document is not required for a regulated master fund. On an ongoing basis, the fund must file an amended offering document within 21 days of any material change that occurs while it is still offering its equity interests. It must also file annual audited accounts, a key data elements form and a fund annual return (all submitted electronically by the fund's auditor) with CIMA within six months of the end of each financial year.
Few investment funds are fully licensed under the Mutual Funds Law, since this is generally only applicable to retail funds, while the majority of investment funds formed in the Cayman Islands are intended for institutional or high-net-worth investors. Of the total number of 10,559 regulated investment funds at the end of 2017, only 81 were fully licensed by CIMA under the Mutual Funds Law.4
An alternative to obtaining a full licence under Section 4(1)(a) of the Mutual Funds Law is to be regulated as an administered fund under Section 4(1)(b) of the Mutual Funds Law. As of 31 December 2017, there were only 33 administered funds.5
Administered funds have steadily declined in popularity in recent years (from 435 in 2010 to 331 in 2017),6 perhaps because the administrators who originally saw them as a source of higher fees came to realise that the higher fees were counterbalanced by higher risks. Registration as an administered fund is achieved by designating a Cayman Islands licensed mutual fund administrator as the fund's principal office. The administrator must satisfy itself that the promoters of the fund are of sound reputation, that the fund's administration will be undertaken by persons with sufficient expertise who are also of sound reputation, and that the fund's business and its offering of equity interests will be carried out in a proper manner. The administrator is obliged to report to CIMA any suspected infringements by the fund of the Mutual Funds Law (or any other law), or any suspicion that the fund may be insolvent or may otherwise be acting in any manner prejudicial to its creditors or investors. This imposes a role of quasi-regulator and compliance monitor on the administrator themselves, potentially a burdensome task to carry out effectively.
There are no local service provider requirements for CIMA-registered investment funds, save that they are required to appoint an approved local auditor and, in the case of an administered fund, a Cayman Islands licensed mutual fund administrator.
The corporate governance regulatory framework for funds is an area of consistent focus for CIMA. Partly in response to industry trends and stakeholder requests, CIMA issued a Statement of Guidance on Corporate Governance for Regulated Mutual Funds (SOG) on 13 January 2014. The SOG is relevant to all CIMA-registered and licensed mutual funds, their individual operators and their governing bodies. It does not extend to the banking and insurance sector. The purpose of the SOG is to provide individual operators and governing bodies of funds with guidance on CIMA's minimum expectations for the sound and prudent governance of mutual funds. While the SOG is not intended to be exhaustive and is not directly enforceable by CIMA, CIMA may look to the SOG should it need to consider whether the direction and management of a CIMA-registered and licensed mutual fund has been conducted in a 'fit and proper manner'.
The Directors Registration and Licensing Law, 2014 (DRL Law) entered into force in June 2014 to assist CIMA in verifying and maintaining key information on directors of companies regulated by CIMA as mutual funds under the Mutual Funds Law and companies registered with CIMA as 'excluded persons' under certain heads of the Securities Investment Business Law (2015 Revision), usually because of such companies' involvement as the investment manager in a fund structure (together, covered entities). This step was taken both for CIMA's own purposes and to assist CIMA with overseas regulator requests and, since the availability of the LLC, also extends to any manager of an LLC that is a covered entity. The DRL Law requires the directors (or, in the case of LLCs, the managers) of covered entities to be, themselves, registered with or licensed by CIMA, and allows CIMA to regulate 'professional directors' and 'corporate directors' of covered entities. The DRL Law will be relevant to any person who is, or who intends to become, a director of a company (or a manager of an LLC) that is or will be a covered entity, whether that person is resident in the Cayman Islands or elsewhere. Under the DRL Law, it is unlawful to be appointed as a director (or, in the case of an LLC, as a manager) of a covered entity without first being registered or licensed with CIMA.
The Cayman Islands has signed two intergovernmental agreements to improve international tax compliance and the exchange of information – one with the United States (US IGA) and one with the United Kingdom (UK IGA). The Cayman Islands has also signed, along with over 90 other countries, a multilateral competent authority agreement to implement the Organisation for Economic Co-operation and Development (OECD) Standard for Automatic Exchange of Financial Account Information – Common Reporting Standard (CRS). Cayman Islands regulations have been issued to give effect to the US IGA, the UK IGA and CRS (collectively, the AEOI Regulations). Pursuant to the AEOI Regulations, the Cayman Islands Tax Information Authority has published guidance notes on the application of the US and UK IGAs and the CRS. These developments are supported by a network of bilateral tax information exchange agreements (according to the OECD, as of 5 April 2018, there are over 2,700 bilateral exchange relationships activated with respect to more than 80 jurisdictions committed to the CRS), and adherence to multilateral conventions such as the OECD and Council of Europe Convention on Mutual Assistance in Tax Matters.
These initiatives further strengthen Cayman's regulatory reputation on cooperation matters and align its regulatory framework with a trend towards automatic exchange of information on tax.
1 Figures taken from the Mutual Funds and Mutual Fund Administrators (Annual and Quarterly) in the Investment Fund Statistics and Regulated Entities section of the CIMA website: www.cimoney.com.ky.
2 CIMA: Investments Statistical Digest 2016.
3 Op. cit. 2.
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