In exercise of its authority under the Monetary Authority Law (as amended) (the "Monetary Authority Law"), the Cayman Islands Monetary Authority ("CIMA") has published a Rule on the segregation of assets (the "Rule"). All funds regulated or licensed under the Mutual Funds Law (as amended) (the "Mutual Funds Law")1 are obliged to appoint a service provider with regard to ensuring the safekeeping of the fund's assets.2 The primary intention of the Rule reinforces standard industry practice by reiterating that no operator (director/general partner/trustee), investment manager, administrator, custodian or other service provider to a mutual fund (the "Service Provider") is able to use the portfolio investments or investor funds of the fund to finance its own or any other operations in any way. In most cases, we do not expect that funds will need to make significant changes to their existing arrangements.
In order to comply with the Rule, a mutual fund's portfolio investments and investor funds must be segregated and accounted for separately from any assets of the Service Provider. The operator of the fund is required to establish, implement and maintain strategies, policies, controls and procedures to ensure compliance with the Rule, consistent with the fund's offering document and as determined by reference to the size, complexity and nature of the mutual fund, its portfolio assets and its investor base.
The Rule sets out certain activities that will not be deemed to constitute the financing of the operations of the Service Provider. In particular, the Rule specifies that the transfer and reuse, or rehypothecation, of assets by the Service Provider is not in contravention of the Rule, provided that:
- such transfer and reuse is consented to by or on behalf of the mutual fund;
- a description of the arrangements entered into with the Service Provider allowing for the possibility of transfer and reuse (and the maximum permitted level of transfer and reuse) is disclosed in the offering documents or otherwise disclosed to investors before they invest; and
- any material changes thereto are also disclosed to investors.
CIMA has confirmed that the Rule does not prohibit prime brokerage/custody arrangements that allow, in accordance with established and accepted industry practice, a custodian/sub-custodian to hold all client assets in a commingled client omnibus account along with the assets of other clients.
The operator of a mutual fund must ensure that verification that a mutual fund holds title to fund assets, based on information provided by the fund and on available external information, together with the maintenance of a record of those assets, is carried out either by:
- an administrator or other independent third party; or
- the manager, operator or person who has a control relationship with the manager or operator, provided that such function is carried out independently from the portfolio management function or that potential conflicts of interest are properly identified, managed, monitored and disclosed to the investors of the mutual fund.
1. Excluding those funds to which the Retail Mutual Funds (Japan) Regulations (as amended) apply.
2. There are additional obligations for funds licensed under the Mutual Funds Law.
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.