The regulatory landscape facing the alternative investment community in Asia has changed dramatically over recent years. The implementation of FATCA and The Alternative Investment Fund Managers Directive ("AIFMD") and the introduction of other reporting and compliance rules in various jurisdictions have meant that managers and investors alike are now operating in an increasingly regulated environment. Cayman structures have retained their popularity through these changes. This is because the Cayman Islands government has implemented and refined the rules regulating Cayman funds and managers. The changes have been intended to ensure funds are structured and operate in a manner that complies with the tax and securities laws applicable to banks, businesses, managers and investors in multiple onshore jurisdictions, dovetail the offshore structure with onshore offerings but keep the entities tax neutral. In summary, whether you are a manager or investor, the regulatory system in the Cayman Islands is driven by industry best practice.
How a Cayman Islands fund is regulated depends on the kind of fund. Broadly speaking, fund vehicles established in Cayman fall into two categories: (i) open-ended funds, and (ii) closed-ended funds, where withdrawals are not permitted.
The majority of open-ended funds are structured as companies or trusts (refer to the following chapter on Trusts).
Where a Cayman Islands fund permits the redemption of an equity interest at the option of investors (i.e. it is open-ended), unless limited exemptions apply, it should be a "mutual fund" and subject to the Mutual Funds Law (2015 Revision) (the "MF Law"). Accordingly, it will be subject to regulation by the Cayman Islands Monetary Authority ("CIMA").
Funds regulated under the MF Law fall into three categories: Licensed Mutual Funds, Administered Mutual Funds and Registered Mutual Funds. Each category of fund must file a prospectus with CIMA describing the fund's equity interests in all material respects. Common law principles regarding disclosure also apply in relation to offering materials and updates identifying any changes must be filed. The funds must pay application and annual fees, file a form including certain prescribed information and satisfy various other requirements.
All regulated mutual funds must appoint auditors approved by CIMA in the Cayman Islands and file annual audited accounts. The auditors also have reporting duties. In addition there are specific and different rules that apply to each category.
Compliance with the MF Law is generally regarded as simple for most funds as their managers are sophisticated, professional and already set up to comply with the regulations of their home, onshore jurisdiction.
The result is that managers over the world find Cayman entities cost effective, simple and efficient, with the added benefit of enjoying significant familiarity to investors.
In order to ensure that Cayman structures complement onshore regulatory regimes, the Cayman government has also implemented jurisdiction-specific regulation. For example, the Cayman Islands have a specific set of rules to ensure appropriate governance of funds offered to the public in Japan. The Retail Mutual Funds (Japan) Regulations ("Japan Regulations") ensure that Cayman funds offered to the public in Japan comply with the Japanese Investment Trust Association rules which mirror the local Japanese Securities Dealers Association Rules. These Japan Regulations also facilitate compliance with the current Japanese Ministry of Finance Prospectus requirements.
Closed-ended fund vehicles on the other hand, fall outside the operation of the MF Law. Although these can also be structured using companies or trusts, the most common structure for such funds is the exempted limited partnership ("ELP"). The legislation governing ELPs comprises, primarily, the Exempted Limited Partnership Law, 2014 ("ELP Law"). The ELP Law provides that rules of common law and equity apply to ELPs except where they are inconsistent with the express provisions of the statute. ELPs are not separate legal entities and the maintenance of capital doctrine does not apply to them. However, limited partners generally enjoy limited liability.
The ELP Law has been refined on various occasions (most recently in 2014), after consultation with industry participants, to provide symmetry with corresponding onshore laws (particularly those of Delaware) and developments in market practice. The rules have been designed and updated to provide flexibility for the fundraising and ongoing investment activities of private equity, venture capital and real estate funds while ensuring that limited partners retain the protection of limited liability.
In an ELP, limited partners are passive and do not take part in the conduct of the business of the ELP. The conduct of the business is the sole responsibility of the general partner(s) (at least one of which must have a specified nexus with the Cayman Islands). Each general partner has unlimited liability for the debts and obligations of the ELP to the extent that its assets are inadequate. This gives limited partners in an ELP the best of both worlds: certainty about one's maximum financial exposure to the ELP coupled with an almost unfettered ability to receive a return of capital subject only to the terms of the limited partnership agreement.
RECENT DEVELOPMENTS IN REGULATION
In addition to the various laws that regulate fund vehicles, recently additional regulations have been introduced to ensure that the Cayman Islands continues its role as the jurisdiction of choice for the alternative investment community.
Tax Information Exchange and AML
For some time now, all Cayman Islands entities have been subject to legislation and regulations that implement both rules in relation to the Foreign Account Tax Compliance Act of the US and its UK equivalent (together "FATCA"). On 16 October 2015 the Cayman Islands Government passed regulations to give effect to the OECD's Common Reporting Standard for Automatic Exchange of Financial Information in Tax Matters ("CRS"). The implementation of the CRS will mean that, as with FATCA, there is an obligation for financial institutions (which will include most funds) to register with the Cayman Islands Tax Information Authority and to report specified information on a regular basis. The CRS represents a significant step towards the global automatic exchange of information ("AEOI") and further strengthens Cayman's regulatory reputation in relation to cooperation regarding disclosure. AEOI implementation is supported by a network of bilateral tax information exchange agreements (currently in excess of 30, with further agreements being negotiated) and adherence to multi-lateral conventions such as the OECD/Council of Europe on Mutual Assistance in Tax Matters.
Obligations in relation to exchange of tax information are supported by the application of robust anti-money laundering rules to Cayman Islands that apply to fund managers and funds.
Cayman implemented rules in 2014 to enhance the regulatory oversight of directors of funds and fund managers. The Director's Registration and Licensing Law requires all directors of Cayman Islands mutual funds and certain fund managers, which are not required to be licensed with CIMA, to be either registered with CIMA or licensed. The registration and licensing requirements essentially impose a screening process to ensure that persons who may not be suitable to act as directors of mutual funds or managers are prohibited from acting as such.
LOOKING TO THE FUTURE
The recent developments in funds regulation in the Cayman Islands are anticipated to continue in a manner that further supports the alternative investment industry.
On 30 July 2015, the European Securities and Markets Authority recommended the extension of passports under AIFMD to non- EU alternative investment fund managers and non-EU alternative investment funds. The passport enables such managers and funds to be marketed across the EU.
Cayman has already entered into the requisite co-operation arrangements with the major EU investment securities regulators and the necessary tax information exchange agreements with EU governments as required by AIFMD. In addition, the government has been developing rules for an opt-in regime to ensure that it can meet the needs of Cayman managers who want to market funds into the EU under the passport regime.
Cayman also expects to introduce the Exempted Limited Liability Company ("ELLC") as a new fund vehicle. The ELLC should, essentially, be a hybrid vehicle combining characteristics of a company and an ELP. The ELLC draws its inspiration from the Delaware LLC but with certain modifications to fit with Cayman laws. ELLCs should have separate legal personality whilst ensuring the liability of members is limited, and is expected to have no share capital but that members will have capital accounts and can agree amongst themselves how profits and losses are allocated and distributed.
The Cayman Islands have consistently adapted their legal system to meet the demands of the alternative investment sector and international best practice. As a result of regular dialogue between government and the private sector, there will inevitably be further regulatory developments in future as the Cayman Islands seek to maintain its role as the preeminent investment funds centre.