Matthew Feargrieve works in Mourant du Feu & Jeune's London Office
The Cayman Islands are the world's leading offshore jurisdiction, in terms of the volume of business booked through the islands in 2008 and the number of investment funds domiciled there.
The number of funds registered with the Cayman Islands Monetary Authority ("CIMA"), the jurisdiction's financial services regulator, contracted somewhat in the 4 months to 31 January 2009, but the statistics speak both to the islands' market dominance and the difficulties experienced by hedge fund managers in financial centres worldwide. The number of funds registered with CIMA fell from 10,271 at 30 November 2008 to 9,870 at 31 December 2008; but that figure represents an increase of 457 on the number for 31 December 2007. Around 90% of these funds can be categorised as hedge funds, and together they represent some 85% of hedge funds globally. Fund start-ups in the islands over 2008 declined 18% on 2007, to 1,650, but this figure still leaves other offshore domiciles trailing. Fund terminations over 2008 totalled 1,093, an increase of 29% on 2007. CIMA has reported that, as at 31 January 2009, 123 funds had suspended redemptions, 90 had suspended NAV calculations and 2 had suspended subscriptions. The numbers are growing.
What these statistics do not reflect are the thousands of private equity vehicles registered in Cayman and which, being closed-ended, are not required to register with CIMA. Whilst closed-ended funds with traditionally illiquid portfolios have not been unaffected by the financial turbulence, the numbers available at 31 December 2008 suggest that the Cayman Islands remained the leading offshore jurisdiction for private equity funds.
The Cayman Islands Government has ensured that the jurisdiction has remained in step with global economic, political and regulatory developments over the past 25 years, and is acutely aware of the challenges that the islands face on the advent of a new administration in the US and the emergence of a new financial world order. In this paper we look at the ways in which the Cayman Islands are responding to these challenges.
Mourant du Feu & Jeune's Cayman funds advisory team, based in London and the Cayman Islands, has provided extensive advice to fund managers seeking to manage liquidity and deal with difficult-to-value assets by means of legal techniques like side pocketing, gating, lock-in periods, suspension of dealings, restructuring and, ultimately, liquidating. The team has also worked closely with CIMA and other members of Cayman's financial services community as the jurisdiction formulates a collective response to the challenges posed by the financial turmoil, and the team is well placed to advise managers or prospective managers on the continuing advantages of the Cayman Islands as a domicile for hedge funds.
Obama and the Stop Tax Haven Abuse Act
Much has been made of the Stop Tax Haven Abuse Act co-sponsored by Barack Obama while still a Senator in 2007 and his oblique reference to the office of a well known firm of Cayman Islands attorneys housing "12,000 US-based corporations", which, he observed, is "either the biggest building in the world or the biggest tax scam in the world. And I think we know which one it is". This is an emotive remark that has been much quoted, but the rhetoric cannot wholly conceal the inconvenient truth that the registering of legal entities in the Cayman Islands (or, for that matter, any other offshore jurisdiction) is no materially different from the functionality provided by Delaware to the rest of the US.
There are already meaningful indications that the Act, which has lapsed twice already in the Congressional agenda and awaits another hearing some time in 2009, has lost much of its initial momentum. In 2007 the US General Accounting Office was delegated to examine the activities of the Cayman attorneys to which Obama had obliquely referred. The report that ensued was markedly pro-Cayman, opining that the dynamics driving US corporates to Cayman were the jurisdiction's legal stability and the well established support infrastructure and skills base, rather than a blatant desire to avoid or evade US tax. The report challenged the popular image in the US of Cayman being a "secrecy" jurisdiction, emphasising the fact that the islands have several information-sharing protocols with the US and have been consistently cooperative in sharing information with US authorities on suspicious financial activities. The GAO cited the views of the Caribbean Financial Action Task Force that the islands have a culture of "strong compliance" in matters requiring cooperation to combat terrorism and international money laundering, and acknowledged the view of the International Monetary Fund that Cayman's regulatory regime is broadly consistent with its recommended standards.
The GAO's report has gone some way to dispel the popular image in the US of the islands as a secrecy jurisdiction into which US individuals and corporates can salt away tax dollars. A great deal of ignorance still persists, though, and the recent populist rhetoric of politicians and press alike on the subject of "tax havens" makes that much clear. The hope amongst Cayman's professional services community is that Obama's views towards Cayman will be tempered by the counsel of advisors and industry insiders, and that the Stop Tax Haven Abuse Act will eventually run out of steam. For the moment, there is considerable uncertainty about the administration's priorities, and Cayman's financial services community remains alert to the need to respond pro-actively to any changes the administration may make to inland revenue rules that could impact business sourced by Cayman from the US.
Onshore Regulatory Changes
Although most hedge fund managers in the US are not required to register their firms with the SEC, almost half of them have obtained registration anyway, most recently in response to the prevailing feeling of nervousness about what, if any, new regulation may be forthcoming from the US regulators.
Hedge fund managers in London share the concerns of their US counterparts, and all eyes are on the UK Government and the FSA in anticipation of new regulations. But additional regulation of the onshore manager will not necessarily mean regulation of the offshore pooling vehicle, and the Cayman Government has responded calmly to the prospect of increased onshore regulation, viewing it primarily as a response by the SEC and FSA to the breakdown of the banking systems in the US and the UK.
In its pre-budget report in November 2008, the UK Government announced its intention to commission an independent review of British offshore financial centres, their role in the global economy and their long-term business strategies. This review is headed by a former managing director of the FSA, Michael Foot, and representatives of the Cayman Government will be meeting with Foot over February and March 2009 with a view to sharing perspectives on financial supervision and transparency, financial crisis management and international cooperation. The review will also focus on Crown Dependencies and Oversees Territories including Jersey, Guernsey, the British Virgin Islands and the Isle of Man. An interim set of findings is scheduled to be provided in time for the Budget (April 2009), with fuller conclusions to follow. The Cayman Government has clearly signalled its willingness to actively participate in this review.
The stance of the Cayman Government on the matters highlighted at the G20 Group meeting in November 2008 has been markedly pro-active, and the jurisdiction has both a mindset and a regulatory framework that will enable it to deliver a measured and considered response to the policies the G20 nations formulate at their April 2009 Summit in London.
CIMA published a notice in December 2008 to the effect that no entities managed by Madoff or being part of the Madoff structure had been registered in the Cayman Islands, and stated that no Madoff entity was providing direct services to any Cayman fund. CIMA also made clear that it was ready to provide any assistance requested by the SEC.
This position was updated in January 2009 to the effect that 34 funds registered with CIMA had reported direct exposure to the Madoff fraud and that CIMA was in the course of seeking further information on the position from funds and licensed fund administrators in Cayman in order to understand the effects of Madoff being felt by their investors and clients.
In contrast with the lack of proper audit of the Madoff entities, it is pertinent to note that auditors of CIMAregistered funds, together with CIMA-licensed administrators, banks and trust companies, have been required since 2006 to notify CIMA if, in the course of audit, information is obtained to the effect, or it suspects, that the fund or licensee (i) is insolvent or likely to become so, (ii) is operating or winding up in a manner prejudicial to investors/creditors, (iii) is not keeping adequate accounting records or (iv) is operating in a fraudulent or criminal manner or in breach of applicable Cayman laws. The reporting regime applicable to CIMA-registered or licensed entities therefore contains built-in protection against frauds of the Madoff type.
AIMA and IOSCO
CIMA has launched an initiative with the Cayman Islands chapter of the Alternative Investment Management Association ("AIMA") to codify a body of regulatory guidelines, standards and practices applicable to Cayman service providers like fund administrators and professional independent directors. CIMA has resolved to take active measures to ensure that the regulatory regime in the Cayman Islands in 2009 stays abreast of developing trends and changes in best practice touching service providers. The guidelines will be intended to represent current best practice and will no doubt be influenced by the threefold trends of US managers appointing independent administrators (moving away from their historical model of self-administration), calls for greater transparency in portfolio valuations and the growing number of managers on both sides of the Atlantic desirous of appointing truly independent and competent directors to the fund's board. Additionally, the Association of Independent Directors in Cayman has drawn up a code of conduct for the regulation of its members broadly along the lines already articulated by AIMA in the UK.
The Cayman Islands Government worked extensively throughout 2007 and 2008 with the International Organisation of Securities Commissions ("IOSCO") as part of Cayman's application for IOSCO membership. IOSCO has indicated that it has no concerns about Cayman's capacity to cooperate with IOSCO member jurisdictions on information sharing. CIMA is "cautiously optimistic" of a positive outcome to the application, and a decision is expected in May 2009.
IMF, OECD and FATF
The Cayman Islands are currently preparing for an IMF visit scheduled for March 2009. The Cayman Government has already clearly signalled its intention to work actively with the IMF and to implement its recommendations, having accepted most of the recommendations contained in the IMF's 2005 assessment report of the islands (to the extent that they were considered appropriate for the islands). Indeed, the existing anti-terrorism financing and antimoney laundering laws and regulations currently in place in Cayman materially exceed similar measures enacted by EU countries (the UK and France among them) and the US.
The Cayman Islands were removed from the FATF's black list in 2000 (and have avoided altogether being blacklisted by the OECD) and are undertaking active measures to ensure that they will be on the OECD's "green" list of jurisdictions deemed to have acceptable international protocols for sharing of tax information. To this end, the Tax Information Authority (Amendment) Law 2008 was enacted in December 2008 to amend the existing law (passed in 2005) to enhance the provision by Cayman to other jurisdictions of tax information, and makes specific provision for the "parallel" mechanisms envisaged by the OECD's green list regime.
The Caribbean Financial Action Task Force (a subsidiary of FATF) visited the Cayman Islands in June 2007, the outcome of which was a favourable report, released in December 2007, in which Cayman was rated as being compliant with 38 of the 40 FATF recommendations on anti-money laundering and anti-financing of terrorism measures.
Since its inception in 1997 under the Monetary Authority Law ("MAL") of the Cayman Islands, one of CIMA's four primary functions has been the provision of assistance to overseas regulatory authorities. Such international cooperation takes place through the exchange of information, as provided for in the MAL and facilitated through memoranda of understanding ("MoUs") with overseas regulators, as well as through CIMA's active participation in international forums. Enhancements to the MAL were enacted in 2008.
The G20 Group meeting in November 2008 made clear its view that international cooperation on information sharing would be a key protection against future financial turmoil and a means of stabilising the current turbulence, and CIMA has resolved to treat information sharing as a priority for 2009.
Cayman currently has MoUs with 11 overseas regulatory authorities, including leading regulators such as the FSA, in addition to one regional MoU on cooperation on banking supervision and two "cooperation undertakings" with the SEC and the CFTC. An MoU with the securities regulator in Brazil (CVM) is awaiting Cabinet approval.
In December 2008, CIMA submitted an application to sign the multi-lateral MoU tabled by the International Association of Insurance Supervisors ("IAIS"), reflecting its cooperation and dialogue with the IAIS over many years.
The Cayman Government expects to sign around 10 additional cooperation agreements with various European countries over the course of 2009.
The Cayman Islands are working towards the implementation of the new Basel II framework between 2010 and 2012, following an "impact study" conducted in collaboration with PricewaterhouseCoopers in 2007. CIMA considers that Basel II implementation will be beneficial for the Cayman Islands and the implementation of Pillar I by the end of 2010, with a staged implementation of Pillars II and III between 2010 and 2012, will place the Cayman Islands amongst the "first wave" of implementing countries.
CIMA anticipates, and is ready for, some changes being made to the Basel II framework in light of the financial crisis, and has indicated that it will assess and, if it deems necessary, incorporate such changes in its implementation plans for the islands.
Revision of Insolvency Regime
The Companies (Amendment) Law 2007 was introduced to modernise and streamline the Cayman insolvency regime by providing processes specifically suited to Cayman requirements, in particular the requirements of CIMA-registered funds. An Insolvency Rules Committee has prepared a set of Insolvency Rules (to be called the Companies Winding-Up Rules), which will come into effect on 1 March 2009. This new regime will remove the grey areas that previously existed between Cayman's insolvency laws and the UK Insolvency Rules 1986 (which applied in Cayman subject to any law to the contrary).
The new regime should help to reinforce Cayman's reputation as an investor- and creditor- friendly jurisdiction. For the first time, a contingent or prospective creditor will have standing to present a winding-up petition, as will a director, where permitted by the fund's constitutional documents. The new law codifies the liquidator's investigatory powers and imposes duties on former officers, employees and professional service providers to cooperate with the liquidator. It also introduces four new offences of fraud in relation to winding-up and the concept of shadow directorship. Whilst not adopting the UNCITRAL Model Law on Cross- Border Insolvency, the new regime provides for international cooperation, for the recognition of foreign insolvency representatives and for protocols in matters involving parallel insolvency proceedings.
Amendment of Companies Law and Partnership Law
Draft amendments to the Companies Law (2007 Revision) of the Cayman Islands are currently being discussed in committee. The principal object of the tabled changes is to amend the Companies Law to make provision for mergers and consolidations between Cayman companies and between Cayman companies and non-Cayman companies, similar in effect to the merger provisions of the UK Companies Act. In order to protect Cayman's credentials as a creditor-friendly jurisdiction, the consent of secured creditors will be required for a merger/consolidation, while unsecured creditors will be protected by the directors of the merging companies being required to make a statutory declaration that unsecured creditors will not be prejudiced by the arrangements.
The changes will complement the current Companies Law which contains "arrangements and reconstructions" provisions (similar to those enshrined in s. 425 of the UK Companies Act 1985, or Part 26 of the new 2006 Act) but no merger/consolidation provisions. The new provisions are expected to be enacted during the course of 2009.
Amendments to the Exempted Limited Partnership Law (2007 Revision) are also being drafted, principally to amplify the statutory "safe harbours" of activities in which a limited partner may engage without risk of losing its limited liability status in the event of the partnership' insolvency, and to bring the dissolution provisions of the current law in line with the winding up provisions of the Companies Law. In particular, a Cayman exempted limited partnership will no longer be deemed to have been dissolved by the withdrawal or retirement of the sole or last remaining general partner. The new provisions are expected to be enacted during the course of 2009.
The global financial system has changed radically over 2007 and 2008, with a focus now crystallising on issues such as liquidity management, risk management, transparency, failure resolution and cooperation between regulators. The Cayman Islands Government, CIMA and the financial services community in the islands are actively addressing these issues with a view to enhancing the existing regulatory and legal framework in Cayman to ensure Cayman's continuing development as a worldleading offshore financial centre. There is an awareness in Cayman that the new financial order now emerging is both a challenge and an opportunity for the jurisdiction to change itself. The Cayman Government and CIMA are keen to ensure that the misnomers traditionally applied to the Cayman regulatory regime - "flexible" and "light touch"- are consigned firmly to history, as they strive to preserve and consolidate the jurisdiction's pre-eminence in global offshore financial services and as an attractive offshore regime for alternative funds.
CIMA has always been active in swapping ideas with foreign regulators, and its clear objective for 2009 is to reinforce its international reputation as a robust regulator. It will be seeking over the course of the year to increase its involvement with regulators and policy makers to ensure that it remains a leading contributor to multi-national discussions and decision-making. The Cayman Government is already looking at ways of consolidating and protecting the principal sources of the jurisdiction's business, notably the US, the UK, the Middle East and the Far East, and has always been adept at winning business in new markets, with road shows being planned in India, China, Hong Kong and Singapore.
Through a combination of its dominance of the market in offshore alternative funds, its long history as a leading offshore financial centre and the efforts of a pro-active government, regulator and financial services community (spread worldwide), together with its cordial relations with regulators in developed nations and with bodies like AIMA and IOSCO, the OECD and FATF, the outlook for the Cayman Islands is - deservedly - positive.
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