In July 2016 European politics were profoundly shaken when UK voters unexpectedly opted by a narrow margin in a referendum for the UK to "Brexit" the EU. It is too early to say whether a Brexit means the UK will completely leave the EU or retain some sort of affiliated membership (like the EEA countries). UK-EU negotiations will likely go on for a few years after the UK formally triggers the exit process under Article 50 of the Treaty of Lisbon so it will be quite some time before these details become clearer. The task of unbundling decades of legal, regulatory and tax integration is a complex and unprecedented undertaking.
CAYMAN AND BREXIT
Although the Cayman Islands is a British Overseas Territory, it is not a Member State of the EU so Cayman's own position will not be directly changed by Brexit. For the time being it will be business as usual for Cayman domiciled investment funds and companies with European focused activities.
Cayman is one of the largest domiciles for alternative investments funds and is home to many of the world's best hedge and private equity funds managed by the most well respected investment fund managers. As such, Cayman remains committed to servicing European clients and to be open for EU-based pension funds and other sophisticated investors to invest in these world class alternative investment funds. EU pension funds, in particular, need to invest in a diversified global portfolio of cost efficient tax neutral alternative investment funds, including many based in Cayman, if they are going to meet their pension fund obligations in this low and negative interest rate environment.
Depending on how Brexit finally looks, the UK could be in a similar position to other non-EU Third Countries (e.g. the US or Cayman) with respect to EU Directives like the Alternative Investment Fund Managers Directive (AIFMD) or in due course under the Markets in Financial Instruments Directive (MiFiD II) as to how UK based financial services firms can continue to do business across the whole EU under various EU-wide passports.
Currently, alternative investment funds based in Third Countries must be marketed in EU Member States under their individual national private placement rules (NPPRs) or may respond to reverse solicitation. The AIFMD for the first time introduced the possibility of an EU-wide marketing passport for Third Country alternative investment funds and their fund managers.
The AIFMD requires three threshold criteria for Third Countries to be considered eligible for the passport, namely: (a) cooperation agreements with EU regulators; (b) absence from any FATF blacklists; and (c) tax information exchange agreements with EU Member States. The European Securities and Markets Authority ("ESMA") was given the task of advising the EU Parliament, EU Council and the EU Commission (together, the "EU Authorities") on whether the Third Country passport should be activated and the NPPRs terminated. Until the final decision is made to activate the passport, the NPPRs will continue for qualifying Third Countries until at least 2018 (and now possibly well beyond that date). Cayman currently satisfies the basic criteria and Cayman funds qualify to be marketed under the NPPRs.
ESMA took a country-by-country approach to this passport review. In July 2016, ESMA delivered its latest advice to the EU Authorities including in respect of Cayman. ESMA has so far given unqualified positive advice in relation to only five of the 22 jurisdictions considered. Other Third Countries (including the US, Hong Kong, Singapore and Cayman) received qualified assessments. ESMA is still gathering information on a larger group of Third Countries.
ESMA advised that there were no significant obstacles regarding competition and market disruption impeding the application of the AIFMD passport to Cayman; but it could not provide its final advice in relation to the other aspects of Caymans eligibility until the implementation of: (a) final versions of the proposed AIFMD-like regime; (b) legislative amendments giving the Cayman regulator power to impose administrative fines directly for certain regulatory breaches; and (c) a macro-prudential policy framework to enhance systemic risk monitoring.
The Cayman government is well advanced in addressing ESMA's points and is confident that once these are addressed ESMA will give Cayman a positive assessment for the passport.
The EU Authorities will have ultimate discretion on how to implement ESMA's advice. Given that only five of the original 22 relevant jurisdictions identified have been unqualifiedly assessed by ESMA, it would seem sensible for the EU Authorities to delay activation of the passport for any Third Country until more jurisdictions have been positively assessed, as suggested by ESMA. In the meantime, Cayman Islands alternative investment funds can be marketed in the EU under the relevant NPPRs until at least 2018, when there will be a further consideration of whether the NPPRs should continue indefinitely or not.
As a result, there is still no one-size fits-all approach to AIFMD and the status quo will probably continue to apply for managers looking to access investors globally, with the fund's domicile chosen to match the relevant investors, expectations.
Therefore many managers will likely continue to operate parallel fund structures. If market access across the whole EU is critical, managers may opt to establish fund structures in AIFMD compliant EU jurisdictions that have a proven track record of EU management and marketing (e.g. Ireland). In parallel to that, managers will continue to establish Cayman funds to target investors in countries where Cayman remains the dominant fund domicile (such as North America, Asia and the Middle East), relying on the existing NPPRs for marketing in the EU or reverse solicitation where appropriate.
BLACKLISTS AND WHITELISTS
Perhaps surprisingly, given the recent introduction of tax information exchange arrangements, the EU has recently stated that it is currently drawing up criteria for the creation of a new tax haven blacklist. Cayman is neither a tax haven nor a secrecy jurisdiction and by any objective standards should not appear on this list. Cayman is a transparent and compliant jurisdiction and a good trading partner to EU Member States. It has introduced full anti-money laundering legislation and entered into tax information exchange agreements with most EU Member States. Since 2005 Cayman banks have automatically reported bank account information on EU residents to EU Member States. More recently Cayman has implemented the OECD's Common Reporting Standard for the automatic exchange of tax information. Cayman will also offer to EU Member States the chance to benefit from a new portal giving access to beneficial ownership information on Cayman companies.
Cayman simply provides a neutral, cost efficient platform for international stakeholders to pool and allocate assets. Cayman funds are good capital allocators and act as a global conduit to allow international capital investment to flow into EU based businesses, which in turn promotes economic activity in the EU and ultimately results in job creation and tax revenues being generated in the EU.
Encouragingly, the Italian government recently added Cayman to its own white list (which will allow Cayman companies to invest in Italian debt securities and be paid gross of withholding tax) and consequently hopes to attract much needed inward investment from Cayman investment funds. Hopefully other EU Member States will follow suit and similarly welcome business from Cayman investment funds, so they too can benefit from more global inward investment which will ultimately stimulate their domestic economies.
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