Cayman Islands: A Domicile of Choice for Private Equity Fund

According to EY's 2016 Global Private Equity Fund and Investor Survey, the private equity (PE) asset class continues to experience steady growth and sustained appeal to global investors. Fundraising has been strong in recent years, with high-net-worth individuals and family offices increasing their allocation to PE. Nonetheless, the growing success of the PE industry is not without its challenges. The global regulatory environment is ever evolving, with new rules and regulations imposed on managers. Additionally, the global financial crisis has bred a new awareness and sophistication among investors who are demanding more transparency and oversight.

Against this background, the choice of domicile for a private equity fund (PEF) is driven more than ever by an investor's need for tax-efficient and transparent structures, concurrently balanced with strong governance, reputation and access to top talent.

The Cayman Islands, as a premier international financial centre, excel at all of these criteria and has developed into a globally recognised centre of excellence for the domiciliation and servicing of PEFs and related structures, such as the general partner (GP), investment manager and special purpose vehicle (SPV). and servicing of PEFs and related structures, such as the general partner (GP), investment manager and special purpose vehicle (SPV).

REPUTATION

Cayman has an enviable reputation in the global asset management industry and a track record of developing robust, innovative regulations while preserving the highest standards of integrity, governance and transparency. The government, its regulator and professionally accredited service providers promote a vigorous compliance culture. Cayman has a modern and independent legal and judicial system, based on English common law, which enhances its reputation as a leading financial services centre.

The government has several decades of engagement with international initiatives around KYC, AML and ATF, and is actively engaged in a number of international tax transparency and exchange of information initiatives such as the Organisation for Economic Cooperation and Development (OECD) Convention on Mutual Administrative Assistance in Tax Matters, as well as UK and US FATCA. Cayman is on the OECD's "white list" and is one of the first jurisdictions to agree to implement the global automatic exchange of information under the OECD Common Reporting Standard by September 2017.

FLEXIBILITY AND INNOVATION

Cayman vehicles for PEF are industry-friendly and offer many advantages in terms of structuring and operational flexibility, tax-neutrality, fiscal transparency, investor protection, confidentiality, speed and simplicity, as well as cost-effectiveness.

The most common structure for a Cayman-domiciled PEF is an Exempted Limited Partnership (ELP). A Cayman-domiciled PEF can also be structured using an Exempted Company to meet investor preference, tax structuring and regulatory considerations.

Cayman continues to innovate and respond to the global asset management market needs. The government has recently introduced new Limited Liability Company (LLC) legislation modeled after Delaware's LLC legislation. An LLC is a hybrid between a partnership and a corporate entity, which offers structuring flexibility for the GP, investment manager and fund vehicles – in particular those investing in an illiquid asset class. An LLC is also widely used as an SPV for tax structuring to hold private equity investments.

In short, Cayman ELPs and LLCs are pass-through entities for US federal income tax purposes; investors in an ELP or LLC benefit from limited liability, and there is flexibility in drafting economic and governing arrangements in the Limited Partnership Agreement (LPA) or Member Agreement.

Cayman structures are widely used as global PE fund platforms facilitating cross-border investment flows and supporting the global economy.

For instance, Cayman-based global infrastructure funds invest in both developed and developing countries to build power plants, renewable energy and water treatment facilities, among many other projects, which are improving quality of life.

Moreover, special situations strategy PEFs invest in companies that need restructuring or turnaround, or are facing a liquidity crisis and heavily indebted. PEFs provide both financial and professional support to these distressed companies, promoting industrial growth and saving jobs. Cayman entities are used in a variety of fund structures: stand-alone fund, master-feeder, fund of funds, parallel structure, blocker companies, SPVs and holding companies. Increasingly, Cayman structures are used for bespoke solutions or special accounts, alongside commingled funds, for co-investments, deal-by-deal and managed accounts. PEFs are structured as closed-end investment vehicles. Closed-end PEFs are not regulated by the Cayman Islands Monetary Authority (CIMA) under the Mutual Funds Law.

There are no capital gains, income, withholding, estate or inheritance taxes in the Cayman Islands. ELPs/LLCs can apply for an undertaking from the government that no form of taxation that may be introduced in the Cayman will apply to the ELP/LLC for up to 50 years.

TOP TALENT

Cayman has an extraordinary concentration of top talent. The financial services community in Cayman is characterised by trusted and mutually beneficial commercial and professional relationships, whereby local service providers collaborate to offer integrated and complementary services to their clients at fair and competitive fees, with speed-to-market.

Responsive and talented professionals, including fund administrators, lawyers, accountants and tax advisors, in Cayman have a long history of servicing clients from start-ups to multi-ibillion-dollar, global PEF managers. Our highly credentialed professionals are adept at working closely with their counterparts in major financial centres in North America, Europe and the Far East, as well as emerging markets, to help PEF sponsors to achieve business success by providing the best advice and support from a PEF's launch to future expansion and growth.

Cayman is populated with fund administrators who provide high-quality customised client service, which is a prerequisite for a PEF, in a controlled environment. In fact, Cayman-based fund administrators are well-positioned to benefit from the increasing demand from investors for outsourcing of back-office activities and independent third-party oversight. Moreover, local fund administrators are differentiating themselves by offering value-added solutions to alleviate the burden on PEF managers of the ever-increasing regulatory changes.

In response to investor demand, fund administrators are enhancing their middle-office and data aggregation and reporting capabilities by investing in best-in-class technology.

The major accounting firms in Cayman provide assurance, tax and advisory services and have in-depth experience dealing with complex structures and strategies, valuation, capital account or LPA, reporting and tax issues for PEFs of all sizes.

Legal firms in Cayman have expertise in advising on fund formation, structuring and transactions, including complex, cross-border PE deals, financing, M&A and IPOs.

Cayman has an exceptional pool of highly experienced, independent directors who can provide "mind and management," evidence of substance of activities, and independent, objective oversight over the activities of the GP and investment manager.

There is currently no statutory requirement or investor pressure to have independent board oversight in a PEF. However, from an investor's vantage point, it is certainly beneficial to have independent members on a PEF advisory board or committee to reinforce governance and oversight.

Independent board members would provide objective guidance and sound judgment in matters relating to ongoing fund operations, governance, legal and accounting issues.

Cayman's professional firms of independent directorship services offer a unique value proposition to the global PE industry beyond governance and oversight. Professionals acting as independent members on a PEF's advisory board or committee bring a wealth of experience and industry benchmarking, sharing insights and leading practices with their clients.

PRIVATE EQUITY INVESTMENT IN FINTECH

The evolving needs of a tech-savvy population and the drive for efficiency are boosting significant investments in companies developing innovative and disruptive technologies, making FinTech one of the most important sectors for investing. Investors are taking notice and are asking the right questions about FinTech to assess the potential opportunities and help them better understand the risk/reward trade-off when making investment decisions. Is the business model sustainable and providing good value for money to customers?

FinTech, well-known to be backed by venture funds, is now attracting significant interest from PE investors. According to the PitchBook Platform, PE investors in 2015 closed a record 95 deals involving FinTech companies. Cayman service providers are well-positioned to service FinTech strategy start-ups and middle market managers.

PEF MANAGERS LAUNCHING

FinTech strategy structures will need to face investors and inspire confidence in the robustness of their risk management framework. PEF managers can trust their Cayman service providers to help them to launch structures that demonstrate sound governance, by also helping the managers in offering independent third-party oversight, transparency and strong reporting capabilities.

About the Authors

Baron is a partner in the Financial Services Organization of EY in the Bahamas, Bermuda, British Virgin Islands and Cayman Islands. He has over 18 years of accounting experience, including 16 years in the Cayman Islands and 2 years working in EY's San Francisco office, where he focused on providing audit services to complex onshore investment vehicles including hedge funds and venture capital companies. Baron serves a variety of financial services clients including alternative investment fund managers, hedge funds, fund administrators, multinational banks and trust companies.

Jeff is a partner and the sector leader for Wealth & Asset Management in the Financial Services Organization of EY in the Bahamas, Bermuda, British Virgin Islands and Cayman Islands. He has over 20 years of experience with Ernst & Young the majority of which have been in the Cayman Islands office. Jeff is dedicated to serving asset managers, hedge funds and private equity funds. His clients encompass start-ups to global multibillion dollar complexes.

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.

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