Cayman Islands: Domiciling Investment Funds In The British Virgin Islands And Cayman Islands

The "sub-prime" crisis and the volatility of international markets in 2008 has reinforced the utility of "open-ended" funds as a refuge for investors with a clear increase in the number of 'special opportunities' and 'distressed opportunities' funds being launched. Open-ended funds such as 'hedge funds' enable the collective pool of funds to be diversely invested in multiple markets, thus spreading the total risk amongst the investment pool. Open-ended funds give investors the right to demand a redemption of their interest in a fund (i.e. an investor's shares), thereby appealing to investors who require liquidity in an investment. This compares with "closed-ended" funds such as private equity funds which are usually established for a fixed period (i.e. 5-10 years) and investors cannot demand a redemption of their interest in the fund until divestment (i.e. when the fund's assets are sold before getting a return on their investment).

For investment managers and legal advisers, the most important decision will be choosing whether to domicile the fund onshore or in an offshore jurisdiction. By power of numbers, the choice of domicile for most investment professionals will be the British Virgin Islands ("BVI") or the Cayman Islands. According to the Cayman Islands Monetary Authority ("CIMA") there were 10,037 active regulated funds in the Cayman Islands as at June 2008. The BVI also affirms its place as an alternate second choice of domicile with 3,338 active fund vehicles being regulated by the Financial Services Commission ("FSC") for the period ending March 2007.

This article outlines the similarities that the BVI and the Cayman Islands share as offshore jurisdictions for domiciling open-ended funds, and discusses the various categories of funds that can be established according to the legislation of those jurisdictions.

General Benefits

The advantages in choosing the BVI and the Cayman Islands as an offshore jurisdiction for domiciling a fund include:

• Nil imposition of direct taxes.

• No foreign currency exchange restrictions.

• No restrictions on investment strategies and objectives that are commonly imposed by onshore regulators in the name of consumer protection.

• Ease and speed of fund registration.

• Both jurisdictions are British Overseas Territories, with the Privy Council in London as the final court of appeal, with companies laws based upon internationally familiar English company law principles.
• Appropriate levels of regulation by governments that recognise the importance of working closely with the private sector to provide legislation which meets market needs.
• Proximity and closeness of time zones with markets in North America and Latin America.

• The BVI and the Cayman Islands are each a 'recognised jurisdiction' for the purposes of the Financial Action Task Force, with know-your-client standards equivalent to many onshore jurisdictions.

Basic legal form of the fund

A fund domiciled in the BVI or the Cayman Islands can either be formed as a company with limited liability, a limited partnership or a unit trust, offering, respectively, shares, limited partnership interests or units of beneficial interest to investors. The majority of funds are established using a company structure, which will entail the fund issuing to investors, multiple classes or series of redeemable shares without voting rights (except the right to vote in matters affecting the rights of such shares). The memorandum and articles of association may also be drafted to provide the directors of the fund with the power to make any such required amendments to the memorandum and articles of association (except those affecting class rights) without the need to seek the consent of the members of the fund.

There is no minimum authorised or issued company share capital requirements imposed in either jurisdiction, and the share capital of the fund may be denominated in any one or more currencies. Shares may be issued at no par value, or at a low par value (i.e. $0.01). The shares will then be issued for subscription at a high premium (i.e. excess of issue price over par value) to provide maximum flexibility for redemption. Monies paid in as share premium are available for distribution by way of dividend or to satisfy any premium on redemption. In addition, subject to a solvency requirement, shares may be redeemed from capital.

Regulatory Framework

BVI

The choice of the BVI as a domicile for a fund means that it will be regulated under the Mutual Funds Act, 1996 (the "BVI Act") and by the FSC. A mutual fund is defined under the BVI Act as a company, a partnership a unit trust or other similar body which:

1. collects and pools investor money for the purpose of collective investment; and
2. issues shares, interests or units which entitle the holder to receive on demand or within a specified period after demand an amount computed by reference to the value of a proportionate interest in the whole or part of the net assets of the fund.

Closed-ended funds and funds set up for investment by (i) one or more members of the same family or (ii) a single investor are exempt from the requirements of the BVI Act.

The BVI Act provides for three categories of funds:

• Professional Funds - are the most popular category of fund registered in the BVI, followed in second place by private funds (discussed below). By definition a professional fund is a fund whose shares are only made available to professional investors. A "professional investor" is a person whose ordinary business involves, whether for his or her own account or the accounts of others, the acquisition or disposal of property of the same kind as the property, or a substantial part of the property of the fund, or a person who has signed a declaration that he or she, whether individually or jointly with their spouse, has a net worth in excess of US$1,000,000 or its equivalent in any other currency and that they consent to being treated as a professional investor.

• Private Funds - A private fund is essentially a fund whose constitutional documents specify that it will have no more than fifty (50) investors and/or that the making of an invitation to investors to subscribe for shares in the fund is to be made on a private basis. Unlike a professional fund, there is no minimum investment or investor suitability requirement for a private fund. A private fund is required to apply to the FSC for recognition as a private fund, and it is an accepted practice to file an offering memorandum with the FSC, although it is not an express requirement under the BVI Act.

• Public Funds - A public fund is a category of fund which is not a private or professional fund and is required to be registered and be granted a license by the FSC as opposed to private and professional funds which only need to be "recognised" by the FSC. The regulatory requirements and licensing procedures for public funds are tighter than those required for private or professional funds, as public funds are usually only used where the shares or interests are intended to be offered to retail investors. A public fund is required to file with the FSC a copy of its offering memorandum, which must follow the requirements as set out in the BVI Act and its regulations. A public fund is also required to file audited accounts with the FSC which is not a requirement for professional and private funds.

Filing requirements for recognition of private/professional mutual funds.

The following documents are required to be filed with the FSC in order to be recognised as a private or professional fund:

• A certified copy of the fund's certificate of incorporation, and memorandum and articles of association.

• A copy of the fund's offering memorandum.

• For professional funds - a copy of the subscription agreement together with a professional investor declaration.

• Completion of the prescribed application form for recognition.

• A notice containing details of the fund's places of business and address for service in the BVI, and the fund's registered agent in the BVI.

• Payment of the prescribed application fee (discussed below).

Once the FSC is satisfied that the requirements of the BVI Act have been met, a Certificate of Recognition as a fund will be issued.

Ongoing FSC requirements

The FSC maintains a register of funds which must contain up-to-date address details of the fund. A change in such details must be filed with the FSC within 21 days. If a fund wishes to change a manager, administrator, investment advisor or custodian, it must first obtain the prior written consent of the FSC.

The fund will be required to pay a registration fee of US$350 to the FSC if the fund is registered prior to June 30, and a fee of US$175 if the fund is registered after 1 July. Thereafter the annual fee is US$350.

Cayman Islands

Funds in the Cayman Islands are required pursuant to the Mutual Funds Law (Revised) of the Cayman Islands (the "Cayman Law") to be licensed or registered as a mutual fund with CIMA before they commence carrying on business unless they are exempt from such requirements.

A "mutual fund" is defined as any company, trust or partnership either incorporated or established in the Cayman Islands, or if outside the Cayman Islands, managed or administered from the Cayman Islands, which issues equity interests redeemable at the option of the investors, the purpose or effect of which is the pooling of investors' funds with the aim of spreading investment risk and enabling investors to receive profits or gains from investments (i.e. an open-ended fund).

A fund will be exempt from the requirements to be registered if the equity interests are held by not more than 15 investors, the majority of whom are capable of appointing or removing the operator. For this purpose, there is no examination of the beneficial owners, as the term 'investor' is defined as the investor of record. If, therefore, all the equity interests are issued to a single institutional nominee or custodian, the fund will fall outside the scope of the Cayman Law. Closed-ended funds and those funds which only issue debt instruments are outside the scope of the Cayman Law.

Unless exempt, a Cayman Islands fund must comply with one of the following three alternatives prescribed by the Cayman Law:

• The Section 4(3) Mutual Fund - this category is appropriate if the minimum aggregate equity interest which may be purchased by a prospective investor is at least US$100,000 (or its equivalent in another currency), or if the equity interests are listed on a recognised stock exchange. This category of fund is popular with investment managers of hedge funds. The filing requirements below focus on this fund category.

• The Licensed Mutual Fund - this option is generally suited for funds accepting initial investor subscriptions below the US$100,000 minimum threshold (i.e. retail funds) and requires an application to CIMA for a Mutual Fund License, and a registered office for the fund in the Cayman Islands to be established.

• The Administered Mutual Fund - is appropriate where the fund designates its principal office at the office of a mutual fund administrator licensed in the Cayman Islands. This category is also suited for retail funds accepting initial investor subscriptions below the US$100,000 minimum threshold.

Filing requirements for registration of a Section 4(3) mutual fund

The following documents are required to be filed with CIMA in order to register a Section 4(3) mutual fund and be issued a Certificate of Registration:

• a registry certified copy of the fund's Certification of Incorporation;

• a completed Form MF1 application;

• a current offering memorandum describing the equity interests in all material respects and containing such other information as is necessary to enable a prospective investor to make an informed decision as to whether or not to subscribe for or purchase the equity interests;

• consent letters from the fund's administrator and auditor; and

• payment of a registration fee of US$3,050.

A fund may begin to market its offering to investors upon filing the required documents with CIMA, but may not receive subscription monies until such time that the fund has received its Certificate of Registration from CIMA.

Ongoing CIMA requirements

Once a Section 4(3) mutual fund has been registered with CIMA, its obligations under the Cayman Law are to:

• file with CIMA within 21 days, a copy of any amendments to its current offering document, and any changes to the fund's registered or principal office;

• have its accounts audited annually by an auditor approved by CIMA and to file those accounts with CIMA within 6 months of the end of the fund's financial year; and

• pay the prescribed annual license fee (currently US$3,050) on or before 15 January in each year.

Selection of Jurisdiction - BVI or Cayman Islands?

BVI advantages

• Cheaper regulatory and annual fees (US$350 - compared with US$3,050 in the Cayman Islands).

• No requirement for an auditor to be appointed.

• Professional funds may operate for 14 days before receiving its grant of recognition from the FSC.

• The FSC is an ordinary member of the International Organization of Securities Commissions (IOSCO) in recognition of the BVI's "robust international cooperation framework and its long-standing commitment to comply fully with international standards".

Cayman Islands advantages

• Strong market recognition as a leading domicile for offshore funds.

• Ability for a fund to market its offering to investors (but not accept subscription monies) upon filing the relevant documents with CIMA.

• Exemption from the registration requirements of the Cayman Law if the fund has less than 16 investors.

• The Cayman Islands operates its own stock exchange

• The Cayman Islands has a sovereign credit rating from Moody's.

Quick Reference Table

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.