Cayman Islands: Cayman 2011 - Alternative Investment Funds And The EU

Last Updated: 14 June 2013
Article by Dominic Lawton-Smith and Philippa-Lucy Robertson

Despite independent reports on the financial crisis, including the EU's own De Larosiere Report, absolving hedge funds of any blame in the recent financial crisis, the European Commission has still pushed through the Alternative Investment Fund Managers (AIFM) Directive.   e Directive includes measures to ensure that managers of alternative strategy funds increase disclosure to investors. It also sets out new rules on capital requirements and introduces a European 'passport' system to enable firms to market to investors across the continent.

One way in which fund managers have sought to improve demand for their products while keeping in step with the EU is by launching Undertakings for Collective Investment in Transferable Securities (Ucits), which are fast developing as a form of 'regulatory wrapper' for hedge funds as they are intended to offer greater transparency and are subject to greater regulatory scrutiny. Given the negative media and political attention that surrounded hedge funds following the financial crisis, Ucits appear to some as being able to offer a flexible alternative investment product, affording managers sufficient investment freedom to pursue alternative investment strategies while providing a variety of safeguards to protect a wide range of investors.


  e degree of regulation that Ucits require should, however, be very carefully considered in terms of two key issues. First, the Ucits structure is increasingly a means to circumvent established regulation by enabling retail investors into complex strategies; such investors may not have sufficient financial markets experience of the product or the wealth to withstand potential losses. One can only imagine the ways in which politicians will be able to defame and damage the industry further when vulnerable investors lose money in complex Ucits III & Ucits IV strategies that may (even in a small minority of cases) not have been appropriate in the first place. Second, Ucits structures require managers to make sacrifices, which can limit the strategy and its returns, while concurrently increasing the fund's operating costs.

Clearly there are enormous commercial advantages to the use of Ucits in the right context, but this must surely be considered as being for a separate breed of investment strategy.

As many people may be aware, the infamous Madoff used Ucits as feeders, proving that no level of regulation is 'fraud proof'. In at least one case, losses were compounded by the appearance that the intended responsibilities of the custodian were avoided by the heavily regulated bank concerned.   ere are many ways in which investor protection can be achieved beyond regulation through the fund industry's existing infrastructure. Using the Cayman Islands as a case in point, the following will indicate how better governance and oversight is a realistic goal.


Despite reports to the contrary, the Cayman Islands Monetary Authority (CIMA) has recently confirmed that the Cayman fund industry continues to flourish, growing by approximately 95 funds per month, with de-registrations remaining at a steady rate of around 5%, as has been typical over recent years. CIMA has also confirmed that a mere four funds have explained their fund termination in the Cayman Islands by a move to the EU.

  e Cayman Islands is thriving, and is aware that the reality of achieving increased investor protection is through better oversight and better disclosure, in addition to specific built-in safeguards such as the employment of independent directors and regulated fund administrators.


Investment funds structured as companies have directors to supervise business operations and ensure that the company's corporate policies (and of course the respective legislative provisions) are respected. Properly paid, qualified and empowered independent directors who can devote appropriate time to each of the companies for which they are responsible protect investors' interests.

Directors owe a fiduciary duty to investors, and in common law jurisdictions such as the Cayman Islands, fiduciary duty is governed by the legal principle of equity. Equity prevails over other areas of law to allow fairness in place of the technical application of codes in situations where the code's creator would not have intended such an outcome. Fiduciary duty exists in equity to protect investors from the risk of the directors causing harm to either the fund or its assets through fraud or mismanagement (see also Rights in Property, below). Investors' interests would likely be better protected if a more literal and consistent application of such fiduciary rules was enforced by the courts, more in line with those of a trustee.


The appointment of an independent and properly regulated fund administrator further mitigates risk of fraud and mismanagement. A third-party administrator provides the independent valuation of the shares and investor reporting key to investor protection. The administrator is regarded as a fiduciary agent and must act in shareholders' best interests.

Fund administration is unregulated in much of the EU and in locations where fund administration is regulated there are often limited capitalisation requirements (only Ireland and Luxembourg within the EU have similar requirements to the Cayman Islands).

Other points of independent oversight include parties such as the deposit bank, custodian, auditor, prime broker, and other brokers. In addition, the fund will likely appoint an external law firm to provide legal services such as the drafting and review of offering documents to ensure that everything is sufficiently transparent to allow investors to make their own, informed investment decision.


As above, common law jurisdictions are governed by the legal principles of equity and offer increased protection to investors when compared to Napoleonic- or Germanicbased legal systems. Where assets are lost as a result of a breach in fiduciary duty, the principles of equity enable the courts to grant powers to continue tracing and the recovery of assets even where unmingled cash cannot be identified. Trusts outside a code that recognises equity are contract-based arrangements without such protections. Thus where assets are still held, in whole or part, there is far more chance of their recovery where the governing law is that of a common law jurisdiction.

Managers should be aware that in non-common law jurisdictions across the EU, including Luxembourg, Switzerland or the Nordics, fund cash placed with banks belongs to the bank concerned, which in turn owes a debt to the fund. Should the bank fail, other than a guaranteed amount (a fairly standard CHF100,000 ($108,400) in Switzerland, for example, and subject to certain conditions), the fund would rank below employees and alongside other creditors, including other banks and even the utility companies providing services to the building. In common law systems, the money remains the property of the investor rather than the bank and so the investors (via the fund) may often be better protected.


The knee-jerk political reaction of the EU to push the AIFM Directive through last year may be regarded by some as the EU reacting to protect investors from the opaqueness of the fund industry. However, it may also be legitimately described as misdirected. Whether the utopian ideal of investor protection that the Directive seeks will materialise in the reality of the funds industry remains to be seen, though, as this article has illustrated, the extent of its success will likely be limited in practice.

Increasing investor protection cannot be achieved through regulation alone; regulators must understand that investors need:

  • fairness;
  • transparency;
  • effective, independent oversight;
  • true accountability;
  • security; and (as often seems forgotten by regulators)
  • to make a profit.

Whether planned AIFMD rules and Ucits IV (as used by the hedge fund and private equity community) will help or hinder in striking the right balance for the industry will be for time to tell. It may require a level of efficiency and agreement that has been absent so far. As a result of international and industry pressure, the EU will recognise the equivalency of other, high quality jurisdictions for the purposes of the AIFM Directive. Given that protectionism will not now be a feature of the Directive, there seems little reason to domicile a fund in the EU if greater cost and ineffective regulation are a factor.

Originally published in HFM WEEK.COM.

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.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions