Investment Funds 2021

Last Updated February 09, 2021

Cayman Islands

Law and Practice

Authors



Maples Group advises global financial, institutional, business and private clients on the laws of the British Virgin Islands, the Cayman Islands, Ireland, Jersey and Luxembourg through its leading international law firm, Maples and Calder. With offices in key jurisdictions around the world, the Maples Group has specific strengths in the areas of corporate commercial, finance, investment funds, litigation and trusts. Maintaining relationships with leading legal counsel, the Group leverages this local expertise to deliver an integrated service offering for global business initiatives.

The Cayman Islands is a popular domicile for globally managed private equity, hedge and hybrid funds due to its tax neutral status, its flexible structuring options and its established and experienced financial services sector and professional service providers. Additionally, the Cayman Islands is recognised as an attractive jurisdiction for investment funds due to its English-based legal system, established judiciary and absence of political or sovereign concerns.

In particular, the Cayman Islands is the jurisdiction of choice for US sponsors structuring funds for US tax-exempt investors and non-US investors. Cayman Islands trusts and other vehicles are frequently used as investment vehicles for investors in Asia, including China and Japan.

The majority of investment funds established in the Cayman Islands are private non-retail funds.

Entity options available for structuring investment funds include exempted limited partnerships, exempted companies, limited liability companies and trusts. Private equity funds are typically structured as exempted limited partnerships, and hedge funds make use of both exempted company and exempted limited partnership vehicles in standalone and master-feeder structures. Cayman Islands trusts and other vehicles are frequently used as investment vehicles for investors in Asia, including China and Japan. The limited liability company is becoming the vehicle of choice for general partner and/or management vehicles.

A key difference between an exempted limited partnership and an exempted company is that, notwithstanding registration, an exempted limited partnership is not a separate legal person distinct from its partners. An exempted limited partnership must act through its general partner, and all agreements and contracts must be entered into by or on behalf of the general partner (or any agent or delegate of the general partner) under general legal principles of agency on behalf of the exempted limited partnership. Any right or property of the exempted limited partnership that is conveyed to or vested in or held either on behalf of the general partner or in the name of the exempted limited partnership is an asset of the exempted limited partnership held upon trust in accordance with the terms of the relevant law.

Formation and registration processes in the Cayman Islands are streamlined and efficient. Exempted companies are formed upon the filing of a declaration and the memorandum and articles of association with the Registrar. Exempted limited partnerships and limited liability companies are formed upon the execution of the relevant operating agreement and the filing of a registration statement with the Registrar.

With limited exceptions, all open-ended funds must register with the Cayman Islands Monetary Authority (CIMA) under the Mutual Funds Act (2020 Revision) and all closed-ended funds must register with CIMA under the Private Funds Act, 2020.

To register an open-ended fund, the requisite application form and offering memorandum must be submitted to CIMA in advance of the fund launch and directors must be registered under the Director Registration and Licensing Law. The administrator and auditor of the fund must submit consent letters confirming responsibility for these important roles.

To register a closed-ended fund, the requisite application form and offering memorandum (or summary of terms) must be submitted to CIMA within 21 days of a fund accepting capital commitments or, if earlier, prior to the fund receiving any capital contributions for the purpose of investments. The administrator and auditor of the fund must submit consent letters confirming responsibility for these important roles.

The Cayman Islands legal system is based on well-recognised legal concepts founded in English law, including limited liability and separate corporate personality, which underpin the corporate, partnership and trust vehicles used as collective investment schemes, all of which have been tried and tested and found to be robust during the global financial crisis.

As a general rule, in the absence of a contractual arrangement to the contrary, the liability of a shareholder of a Cayman Islands company that has been incorporated with limited liability and with a share capital is limited to the amount from time to time unpaid in respect of the shares it holds. A Cayman Islands company has a legal personality separate from that of its shareholders, and is separately liable for its own debts due to third parties.

A Cayman Islands exempted limited partnership does not have a legal personality separate from its partners. General partners have unlimited liability for all the debts and obligations of such partnerships by virtue of the Cayman Islands Exempted Limited Partnership Law (2018 Revision). Fund investors typically subscribe for limited partnership interests on which their liability is generally limited to their contributed capital and outstanding capital commitment (if any).

However, there are limited circumstances under Cayman Islands law whereby if an investor takes part in the conduct of the business of the partnership and holds itself out as a general partner to third parties, it may assume unlimited liability for the debts and obligations of the partnership. Exempted limited partnerships are the most common type of Cayman Islands vehicle used in private equity fundraising and investors in such funds commonly seek Cayman Islands legal opinions in respect of, amongst other things, the limited liability nature of their partnership interest.

Every mutual fund registered with CIMA (unless that fund is a "master fund" as defined under the Mutual Funds Act) is required to issue an offering document that must describe the equity interests in all material respects and contain such other information as is necessary to enable a prospective investor to make an informed decision as to whether or not to invest in the fund. CIMA has issued rules regarding the content of offering documents for registered mutual funds and rules regarding the content of marketing materials for registered private funds.

All fund offering documents are subject to the pre-existing statutory obligations with regard to misrepresentation and the general common law duties with regard to proper disclosure of all material matters.

The Cayman Islands is a popular domicile for globally managed private equity, hedge and hybrid funds due to its tax neutral status, its flexible structuring options and its established and experienced financial services sector and professional service providers. In particular, the Cayman Islands is the jurisdiction of choice for US sponsors structuring funds for US tax-exempt investors and non-US investors. Cayman Islands trusts and other vehicles are frequently used as investment vehicles for investors in Asia, including China and Japan.

Private equity investors tend to invest in unregulated private funds structured as exempted limited partnerships. Hedge or regulated fund investors typically invest through exempted company and/or exempted limited partnership structures. Cayman Islands trusts and other vehicles are frequently used as investment vehicles for investors in Asia, including China and Japan.

Unless a mutual fund is "licensed" or "administered" or was registered with CIMA prior to 14 November 2006, all investors investing into a CIMA-regulated fund are subject to an initial minimum investment amount of KYD80,000 (or its equivalent in another currency).

Investment funds that fall within the definition of either a "mutual fund" under the Mutual Funds Act or a "private fund" under the Private Funds Act are required to be regulated by CIMA.

A mutual fund is any company, unit trust or partnership (wherever established) that issues equity interests redeemable at the option of the investor, the purpose or effect of which is the pooling of investor funds with the aim of spreading investment risks and enabling investors to receive profits or gains from investments. Mutual funds that issue debt are excluded from regulation, even if the bonds or notes are convertible or have warrants attached.

There are four types of regulated mutual funds.

  • The "Licensed Mutual Fund" – a fund may obtain a licence from CIMA if CIMA considers that each promoter is of sound reputation, that the administration of the fund will be undertaken by persons who have sufficient expertise and are fit and proper to be directors (or, as the case may be, managers or officers in their respective positions), and that the business of the fund will be carried out in a proper way. The licensing process can take a few months and a fund must not commence operations until the licence has been granted. No regulatory minimum initial investment amount applies to this type of fund.
  • The "Administered Mutual Fund" – these funds are required to designate a principal office in the Cayman Islands at the office of a licensed mutual fund administrator (MFA). Instead of CIMA doing so, it is the MFA that is required to be satisfied that the promoter is of sound reputation, that the administration of the fund will be undertaken by persons who have sufficient expertise to administer the fund and are of sound reputation, and that the business of the mutual fund and the offer of equity interests will be carried out in a proper way. No regulatory minimum initial investment amount applies to this type of fund.
  • The "Registered Mutual Fund" – this type of fund is not subject to licensing nor is it required to have a principal office provided by an MFA. However, it must have either (i) a minimum initial investment amount of at least KYD80,000 (or its equivalent in another currency) per investor, thus making it suitable only for sophisticated investors, or (ii) its equity interests listed on a recognised stock exchange, making it therefore subject to additional regulation by such stock exchange.
  • The "Limited Investor Fund" – this type of fund must have no more than 15 investors, who must be capable of appointing and removing the operator(s). Prior to the admission of a sixteenth investor, a Limited Investor Fund will be required to re-register with CIMA under one of the other heads of regulation described above. Unlike a Registered Mutual Fund, a Limited Investor Fund is not subject to any statutory investment amount.

All mutual funds regulated by CIMA are required to file offering documents or a summary of terms upon registration, and must notify CIMA within 21 days of any material changes to service providers or the terms of the offering. In addition, all CIMA-regulated mutual funds must file audited accounts and a fund annual return within six months of their financial year-end.

A private fund is any company, unit trust or partnership (wherever established) that offers or issues or has issued investment interests, the purpose or effect of which is the pooling of investor funds with the aim of enabling investors to receive profits or gains from such entity’s acquisition, holding, management or disposal of investments, where:

  • the holders of investment interests do not have day-to-day control over the acquisition, holding, management or disposal of the investments; and
  • the investments are managed as a whole by or on behalf of the operator of the private fund, directly or indirectly, but this does not include certain licensed or registered persons or any non-fund arrangements.

CIMA has wide-ranging powers in respect of Cayman Islands entities that are regulated as mutual funds or private funds in the jurisdiction. CIMA has worked alongside overseas regulators in regulatory investigations involving investment funds, including the US Securities and Exchange Commission and the UK's Financial Conduct Authority.

There is no requirement for the investment manager or manager of a fund to be domiciled in the Cayman Islands or for a non-Cayman Islands manager or investment manager to be regulated in the Cayman Islands. Most fund managers are not domiciled in the Cayman Islands.

The Cayman Islands recently revised its regime for anti-money laundering (AML) and combatting terrorist financing, with the aim of aligning the regime more closely to Financial Action Task Force (FATF) recommendations and global practice. The regime covers a wider range of investment entities, including all types of investment funds (whether regulated or not) in the Cayman Islands. All investment entities are now required to appoint experienced risk and compliance professionals with specific knowledge of the Cayman Islands AML regime to the roles of anti-money laundering compliance officer (AMLCO), money laundering reporting officer (MLRO) and deputy MLRO. The AMLCO, in particular, will assist the investment entity in ensuring compliance with relevant requirements and, where the investment entity looks to rely upon a third party for carrying out AML/KYC checks on investors, the AMLCO will likely take a lead role in assessing the suitability of that third party. It is clear that CIMA expects the operators of investment entities, together with their AMLCO, to carry out a risk-based due diligence exercise when assessing the suitability of a service provider and that this exercise should be tailored to the risk profile of each investment entity (taking into account its investor base and its anticipated investment activities). This continues to be a rapidly evolving area and the importance of retaining specialist risk and compliance professionals continues to rise.

The increasing compliance burden – not just in the Cayman Islands, but globally – has led to a sharp increase in outsourced administration among closed-ended investment entities. Outsourced service providers are increasingly acting as a "one-stop shop" for compliance solutions where expertise and scalable data can result in marked increases in compliance efficiency.

There is generally no requirement that non-local service providers be regulated in the Cayman Islands. However, all directors of companies regulated by CIMA as mutual funds under the Mutual Funds Act must be registered with, or licensed by, CIMA pursuant to the Directors Registration and Licensing Law.

There is generally no restriction on a fund manager from another jurisdiction managing a fund established as a Cayman Islands vehicle. However, if an overseas manager establishes a Cayman entity to act as the investment manager for a fund, such manager vehicle may be subject to licensing or registration with CIMA under the Cayman Islands Securities Investment Business Act (2020 Revision). Such Cayman Islands entities acting as a discretionary manager of an investment fund may also be subject to local substance requirements under the Cayman Islands International Tax Co-operation (Economic Substance) Act (2020 Revision).

Licensed Mutual Funds must apply to CIMA for a licence to operate. The licensing process can take a few months and a fund must not commence operations until the licence has been granted.

Administered Mutual Funds, Registered Mutual Funds and Limited Investor Funds must make an online filing with CIMA in the prescribed form and submit an offering document (or summary of terms), service provider consent letters and an application fee before the launch date.

Private funds must make an online filing with CIMA in the prescribed form and submit an offering document (or summary of terms), service provider consent letters and an application fee within 21 days of accepting capital commitments or, if earlier, prior to the fund receiving any capital contributions for the purpose of investments.

Marketing of investment funds in the Cayman Islands does not require specific regulatory approval.

Investment funds are typically established as either Cayman Islands exempted companies, exempted limited partnerships, limited liability companies or trusts. An exempted company that is not listed on the Cayman Islands Stock Exchange is prohibited from making any invitation to the public in the Cayman Islands to subscribe for any of its securities. Exempted limited partnerships and limited liability companies are prohibited from undertaking business with the public in the Cayman Islands other than so far as may be necessary for the carrying on of their business exterior to the Cayman Islands. If a trust is registered as an "exempted trust", investors must not – and must not be likely to – include any person resident or domiciled in the Cayman Islands (other than exempted and ordinary non-resident Cayman Islands companies or the object of a charitable trust or power).

The "public in the Cayman Islands" does not include:

  • any exempted or ordinary non-resident company registered under the Cayman Islands Companies Law;
  • a foreign company registered pursuant to Part IX of the Companies Law;
  • a foreign limited partnership registered under Section 42 of the Cayman Islands Exempted Limited Partnership Law;
  • any company acting as general partner of a partnership registered under the Exempted Limited Partnership Law; or
  • any director or officer of the same acting in such capacity or the trustee of any trust registered or capable of registration as an exempted trust under the Cayman Islands Trusts Law acting in such capacity.

There are no investor protection rules that restrict the ownership of fund interests to certain classes of investors, except that a Registered Mutual Fund must have a minimum initial investment amount of at least KYD80,000 (or its equivalent in another currency). Such a fund is geared toward more sophisticated investors and is subject to lighter-touch regulation by CIMA. A mutual fund that has a minimum initial investment amount of less than KYD80,000 (other than a Limited Investor Fund) is subject to increased regulation by having to obtain a licence or having a "principal office" provided by a CIMA-licensed mutual fund administrator.

CIMA is a well-respected and dynamic regulator that consistently evolves its practice and approach to reflect the changing regulatory environment. CIMA has well-established consultation processes that are mandated by statute and that allow for co-ordinated feedback from industry. CIMA has historically adopted a light-touch approach to enforcement, looking to assist in remedying breaches and minimising the chances of future errors rather than penalising regulatory oversights. However, there are signs that this approach is shifting, largely in response to external assessments, and the use of active enforcement to drive compliance is anticipated, particularly in the light of new powers granted to CIMA to impose administrative fines for regulatory breaches without recourse to the judicial system.

There are no restrictions imposed by legislation on the types of activity that may be undertaken by a Cayman Islands investment fund or the types of investments it may make. However, there are certain operational requirements imposed on mutual funds and private funds regulated by CIMA.

Mutual Funds

A regulated mutual fund needs to comply with the Net Asset Value (NAV) Calculation Rules and the Segregation Rules. The NAV Calculation Rules require a mutual fund to establish, implement and maintain pricing and valuation practices, policies and procedures (a NAV Calculation Policy) that ensure the fund's NAV is fair, complete, neutral, free from material error and verifiable.

The NAV of a mutual fund must be calculated by a service provider that is independent of the fund's investment manager/adviser and operators, who is competent, has the capability to value the Portfolio of the fund and is able to adhere to the NAV Calculation Policy. A mutual fund's investment manager/adviser or operators may calculate or assist in the calculation of the fund's NAV but only if this fact is explicitly detailed in the fund's offering document, together with an explanation why another Service Provider could not calculate the fund's NAV.

The Segregation Rules require a regulated mutual fund to appoint a service provider with regard to ensuring the safekeeping of the fund's portfolio. A mutual fund's portfolio must be segregated and accounted for separately from any assets of any service provider. A mutual fund must ensure that none of its service providers uses the portfolio to finance their own or any other operations in any way.

The operators of a mutual fund must establish, implement and maintain (or oversee the establishment, implementation and maintenance of) strategies, policies, controls and procedures to ensure compliance with the Segregation Rules, consistent with the fund's offering document and appropriate for the size, complexity and nature of the fund's activities and investors.

Private Funds

The Private Funds Act contains certain operational requirements for a registered private fund, including provisions relating to the valuation of assets, the safekeeping of fund assets, cash monitoring and the identification of securities.

A private fund is required to establish, implement and maintain appropriate and consistent pricing and valuation practices, policies and procedures in order to properly value such private fund's assets and to ensure that valuations are conducted in accordance with the Private Funds Act.

A private fund is required to appoint a custodian unless it has notified CIMA and it is neither practical nor proportionate to do so having regard to the nature of the private fund and the type of assets it holds. If no custodian is appointed, a private fund must appoint an administrator or another independent third party or (subject to disclosing and managing any conflicts) the operator or investment manager/adviser to verify that the private fund holds title to its assets, and to maintain a record of those assets.

A private fund is required to monitor the cash flows, to ensure that all cash has been booked in cash accounts opened in the name, or for the account, of the private fund and to ensure that all payments made by investors in respect of investment interests have been received.

A private fund that regularly trades securities, or holds them on a consistent basis, is required to maintain a record of the identification codes of the securities in question.

The Cayman Islands is a leading fund finance jurisdiction where both Cayman Islands and non-Cayman Islands security packages are respected and recognised. Financing counterparties recognise the Cayman Islands as a "creditor-friendly" jurisdiction and are very familiar with, and comfortable lending to, all forms of Cayman Islands funds vehicles. Both subscription line facilities secured on investors' capital commitments and leveraged finance facilities secured by the relevant target group's assets are very common and well-established products in the Cayman market.

There are no restrictions, issues or requirements imposed by Cayman Islands legislation, and Cayman Islands vehicles are able to access the full range of debt finance options seen in the market. Restrictions or requirements in relation to borrowing may, however, be contained in the constitutional and organisational documents of the Cayman Islands vehicle(s). These are discussed and negotiated by the sponsor and investors at launch, and/or with the finance provider at the outset of a new borrowing transaction, in the usual way.

Cayman Islands vehicles may be subject to – and grant a wide range of – security packages that will vary depending on the deal type, other jurisdictions involved, and normal deal considerations and requirements. Cayman Islands vehicles are able to enter into both Cayman Islands and non-Cayman Islands security packages and documentation. All such arrangements will typically be recognised by the Cayman Islands courts, provided they are valid and enforceable under the laws of the relevant non-Cayman Islands legal system(s). As noted above, subscription line facilities secured on investors' capital commitments are particularly prevalent.

There are no significant issues in relation to fund finance transactions from a Cayman Islands legal perspective. As with any jurisdiction or deal, transaction participants should pay close attention to constitutional and organisational documents at the outset to ensure they are in a suitable form for the type of borrowing transaction and security package contemplated.

The Cayman Islands tax system is predominantly based on indirect taxes, with government revenues being derived from the imposition of fees on the financial services industry, customs duties, work permit fees and tourist accommodation charges. Under existing legislation, the government of the Cayman Islands does not impose any form of direct tax on profits, income, gains or appreciations or by way of withholding in whole or in part on the payment of dividends or other distributions of income or capital by investment funds established in the Cayman Islands.

The Cayman Islands is not party to any double tax treaties with any country that are applicable to any payments made to or by investment funds established in the Cayman Islands.

The Cayman Islands entered into a Model 1B (ie, non-reciprocal) inter-governmental agreement to improve international tax compliance and the automatic exchange of information with the USA on 29 November 2013 (the Cayman/US IGA). A Cayman Islands financial institution shall be treated as complying with, and not subject to withholding under, Section 1471 of the US Code, so long as the Cayman Islands financial institution complies with its obligations under the Cayman/US IGA and those contained in the Cayman Islands implementing legislation.

The Cayman Islands became a signatory to the Multilateral Competent Authority Agreement to implement the OECD Standard for Automatic Exchange of Financial Account Information – Common Reporting Standard (CRS) with effect from January 2016.

Cayman Islands regulations have been issued to give effect to the Cayman/US IGA and CRS (collectively, the AEOI Regulations). Pursuant to the AEOI Regulations, the Cayman Islands Tax Information Authority has also published guidance notes on the application of the Cayman/US IGA and CRS to financial institutions structured in the Cayman Islands.

All Cayman Islands "Financial Institutions" are required to comply with the registration, due diligence and reporting requirements of the AEOI Regulations.

From an investor's perspective, while the Cayman Islands adds no additional tax layer to the structuring of their global financial transactions, investee entities as well as investors are still subject to their home jurisdictions' relevant taxes and are responsible for complying with such obligations. As noted above, the Cayman Islands has in place globally accepted standards for transparency and cross-border co-operation with foreign tax authorities and law enforcement agencies, and automatically exchanges information with more than 100 worldwide revenue authorities annually, pursuant to the Cayman/US IGA and CRS (among other annual automatic exchange of information regimes).

The majority of investment funds established in the Cayman Islands are private non-retail funds. Indeed, a Cayman Islands company that is not listed on the Cayman Islands Stock Exchange is prohibited from making any invitation to the public in the Cayman Islands to subscribe for any of its securities, and exempted limited partnerships are prohibited from undertaking business with the "public in the Cayman Islands" other than so far as may be necessary for the carrying on of the business of the partnership exterior to the Cayman Islands.

For these purposes, "public in the Cayman Islands" does not include any exempted or ordinary non-resident company registered under the Cayman Islands Companies Act (2021 Revision), a foreign company registered pursuant to Part IX of the Companies Act, a foreign limited partnership registered under Section 42 of the Cayman Islands Exempted Limited Partnership Act (2018 Revision), any company acting as general partner of a partnership registered under the Exempted Limited Partnership Act or any director or officer of the same acting in such capacity or the trustee of any trust registered or capable of registration as an exempted trust under the Cayman Islands Trusts Act (2020 Revision) acting in such capacity.

Investors in an exempted trust registered under Part VI of the Trusts Law must not and must not be likely to include any person resident or domiciled in the Cayman Islands (other than exempted and ordinary non-resident Cayman Islands companies or the object of a charitable trust or power).

Subject to the above restrictions, certain categories of regulated open-ended mutual funds may be established without a statutory minimum investment requirement and therefore could be established as retail funds, although they are not common in the Cayman Islands.

There are four types of regulated open-ended "mutual funds" under the Mutual Funds Act.

  • The "Licensed Mutual Fund" – a fund may obtain a licence from CIMA if CIMA considers that each promoter of the fund is of sound reputation, that the administration of the fund will be undertaken by persons who have sufficient expertise and are fit and proper to be directors (or, as the case may be, managers or officers in their respective positions), and that the business of the fund will be carried out in a proper way. Funds that have obtained a licence from CIMA are not subject to a minimum initial investment amount.
  • The "Administered Mutual Fund" – this type of fund is not subject to a minimum initial investment; however, instead of going through the licensing process, the fund is required to designate a "principal office" in the Cayman Islands at the office of a CIMA-licensed mutual fund administrator.
  • The "Registered Mutual Fund" – this type of fund must have either (i) a minimum initial investment amount of at least KYD80,000 (or its equivalent in another currency), which will render it therefore not suitable as a retail fund, or (ii) its equity interests listed on a recognised stock exchange.
  • The "Limited Investor Fund" – this type of fund must have no more than 15 investors, who must be capable of appointing and removing the operator(s). Prior to the admission of a sixteenth investor, a Limited Investor Fund will be required to re-register with CIMA under one of the other heads of regulation described above. Unlike a Registered Mutual Fund, a Limited Investor Fund is not subject to any statutory investment amount.

See 3.1.1 Retail Fund Structures.

See 3.1.1 Retail Fund Structures.

See 3.1.1 Retail Fund Structures.

See 3.1.1 Retail Fund Structures.

See 3.1.1 Retail Fund Structures.

See 3.1.1 Retail Fund Structures.

See 3.1.1 Retail Fund Structures.

See 3.1.1 Retail Fund Structures.

See 3.1.1 Retail Fund Structures.

See 3.1.1 Retail Fund Structures.

See 3.1.1 Retail Fund Structures.

See 3.1.1 Retail Fund Structures.

See 3.1.1 Retail Fund Structures.

See 3.1.1 Retail Fund Structures.

See 3.1.1 Retail Fund Structures.

See 3.1.1 Retail Fund Structures.

See 3.1.1 Retail Fund Structures.

In addition to offences for non-compliance set out in the Mutual Funds Act and the Private Funds Act, CIMA now also has the power to impose administrative fines for breaches of prescribed provisions of such Acts committed by entities and individuals.

Breaches of prescribed provisions are categorised as being "minor", "serious" or "very serious". There is a sliding scale of fines, as follows:

  • a fixed fine of KYD5,000 for minor breaches;
  • up to KYD50,000 for individuals or KYD100,000 for entities for serious breaches; and
  • up to KYD100,000 for individuals or KYD1 million for entities for very serious breaches.

Upon determination of a breach, CIMA will provide a breach notice to a relevant party. There will be a 30-day opportunity to reply to the breach notice and to rectify a minor breach to the Authority's satisfaction.

The introduction of the administrative fines regime reinforces the need for all operators of regulated investment funds to understand their obligations under the Acts and to ensure that they maintain appropriate systems and controls to meet these obligations, as failure to do so could now potentially result in the imposition of significant fines.

Maples Group

Ugland House
South Church Street
PO Box 309
Grand Cayman KY1-1104
Cayman Islands

+1 345 949 8066

+1 345 949 8080

info@maples.com www.maples.com
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Trends and Developments


Author



Mourant is a leading offshore law firm with expertise in Cayman Islands, British Virgin Islands, Jersey and Guernsey law. Through Mourant Governance Services, it delivers a complementary range of fiduciary, administration and governance services. The firm's clients include many of the world's leading financial institutions, corporations, public organisations, private equity houses and investment funds, as well as ultra high net worth individuals and family offices. The firm routinely works in partnership with the most prestigious international legal and accountancy firms. Mourant was named Offshore Law Firm of the Year 2020 at The Lawyer Awards and awarded Offshore Law Firm of the Year 2020 at the Hong Kong Asian Legal Business Awards.

The Cayman Islands investment funds market has, against a number of odds, not least the COVID-19 pandemic, been very resilient over the past year. Despite significant practical challenges, investment business has largely continued to succeed, with managers pivoting to grasp opportunities presented by social, economic, political and regulatory change.

For its part, the Cayman Islands has proved responsive to and adaptable in the face of turbulent global events. Its steadfast commitment to aligning it's legislative and regulatory framework with evolving global standards and best practices has been with a view to retaining its position as the pre-eminent offshore jurisdiction for investment fund formation.

The COVID-19 Pandemic

The spread of COVID-19 and the subsequent containment measures – including quarantine, lockdown and travel restrictions – have created an unprecedented set of challenges globally.

While the overall impact of the COVID-19 pandemic is not yet fully understood, it is apparent that it has affected and continues to affect Cayman Islands investment funds at every stage in their life cycle.

Fundraising

With travel restrictions applying globally, and much of the world in lockdown since March 2020 with face-to-face meetings being abandoned as a matter of course, it appeared that the initial period of hardship caused by the COVID-19 pandemic was felt most keenly by managers who were "on the road", whether for the first time or for successor fundraising. 

However, based on the author's experience and activity levels in Cayman, a significant number of investment funds were still able to overcome this predicament, including those managed by large global managers with established reputations and investor relationships, as well as those with strategies designed to capitalise on market dislocation.

Driven in part by the desire to lock in commitments before investors reduced allocations to the sector, to cement terms for drawing down capital (in order to mitigate concerns around potential investor defaults) and to ensure the availability of sufficient capital for opportunistic deployment, a number of investment funds closed or launched mid-pandemic on highly accelerated timetables.

With its ease and speed of entity incorporation and registration procedures, the Cayman Islands was and is well positioned to facilitate expedited fund closings and launches.

Cayman Islands legislation is also conducive to handling remote closings. For example, the Electronic Transactions Act (as amended) generally recognises electronic signatures as legally valid, binding and enforceable where the signatory intends to sign the relevant document and the electronic signature is as reliable as is appropriate for the purposes for which the document is generated.

Impact on existing investment funds

In the author's view, the COVID-19 pandemic has had a profound impact on the day-to-day operation of investment funds. For example, the following have been observed.

  • For closed-end investment funds, portfolio company health has been brought into sharp focus. "Doing the right thing" by portfolio companies and their employees during the COVID-19 pandemic is widely thought to be of critical importance to institutional investors. Managers have been encouraged to be proactive in sharing information regarding the manner in which they are dealing with the impact of the pandemic on their portfolios. There is a sense that how managers responded may have a significant impact on their future fundraising ability. 
  • In some corners of the closed-end investment funds space, capital calls have risen with managers engaging in anticipatory drawdowns. Increasingly, managers appear to be telegraphing capital calls by giving greater notice than they are contractually obliged to give under the fund documentation.
  • In the open-end space, some investment funds have been faced with an increase in redemption requests, requiring them to review the availability of, and in some cases employ, liquidity tools, such as gates, side pockets, in-kind distributions and suspensions. Due to lessons learned from the previous financial crisis, current fund documentation is more likely than pre-crisis documentation to contain clear disclosure regarding use of these tools.

Opportunities

Although the COVID-19 pandemic continues to have a significant negative impact on economies and markets around the globe, it has inevitably created opportunities. Many of the most successful investment funds were raised during the previous financial crisis, a fact not lost on managers or investors, who will not want to miss out on opportunities this time around. Some of these opportunities may include the following.

  • Special situation funds – given the potential availability of under-priced distressed assets, investment funds specifically focused on this asset class may have significant investment opportunities and be more likely than investment funds focused on other asset classes to generate investor traction.
  • Credit funds – the reduction in bank finance to the SME sector by mainstream banks and the increased appetite for distressed debt opportunities has, in recent years, driven a shift towards credit funds, with investors continuing to seek a reliable income/yield with an appropriate balance of risk and return. A COVID-19 pandemic-driven market downturn could amplify these factors and lead to an increase in this asset class.
  • Secondaries – there is likely to be an increase in GP-led secondary transactions, including single-asset deals, "stapled" transactions, preferred equity transactions and restructurings of groups of funds or assets. These would allow managers and investors to attempt to manage liquidity in otherwise illiquid asset classes.
  • Niche strategies – the restrictions imposed on the general population giving rise to the "new normal" has also created room for niche strategies such as telecommunications infrastructure. This could not only create a strong basis for future investment strategies, but also provide for more favourable immediate returns.

At a time of great uncertainty, when investors are loath to take unnecessary structural risks, the Cayman Islands – with its clear and effective regulatory environment, established and respected legal system, and high-quality professional service providers – provides a tried and tested solution for seizing these opportunities.

The Cayman Islands response

The Cayman Islands has proven to be highly responsive to, and adaptable in the face of, the COVID-19 pandemic, for the following reasons.

  • In March 2020, the Cayman Islands closed its borders and imposed an island-wide lockdown in an effort to prevent widespread community transmission of COVID-19. The Cayman Islands investment funds community – including government and regulatory agencies, and professional service providers – transitioned seamlessly to remote working. This was made possible in part by the Cayman Islands' state-of-the-art telecommunications facilities and robust business continuity plans.
  • In view of the practical hurdles resulting from various COVID-19 containment measures globally, the Cayman Islands government and the Cayman Islands Monetary Authority (CIMA) adapted their requirements with respect to a number of corporate and regulatory filings. For example:
    1. the Cayman Islands government began accepting affidavits and other documents that had been notarised or certified online, or utilising audio-video technology, together with introducing regulations that gave Cayman Islands notaries the ability to notarise documents virtually;
    2. CIMA began accepting written confirmations in lieu of notarised affidavits in connection with investment fund registration applications and uncertified copies of resolutions in lieu of certified copies of resolutions in connection with investment fund de-registration applications; and
    3. a number of filing and payment deadlines were temporarily extended, including in respect of 2020 annual returns and annual fees, economic substance notifications, beneficial ownership submissions and filings in connection with changes to companies' directors and officers and constitutional documents.
  • The Cayman Islands government and CIMA accelerated their development and upgrade of various digital platforms for corporate and regulatory submissions, including beneficial ownership register submissions.
  • The Judicial Administration of the Cayman Islands implemented measures to ensure vital continued access to the administration of justice, while minimising risks to the health of court users and staff. For example, the established procedure for applications to be determined administratively (where appropriate) on the papers and without a hearing continued and the conducting of hearings via videoconferencing and teleconferencing was encouraged. The Secretary of State for Foreign Affairs consented to Grand Court judges presiding from the UK for trials in Cayman by way of video-link and the use of electronic bundles was encouraged.

Regulatory Evolution

The Cayman Islands is one of the world's leading offshore jurisdictions for the establishment of investment funds. The success of the jurisdiction has, to a large extent, been based on the sophistication of its legal and regulatory regime, which has constantly evolved to keep pace with the global regulatory environment and the demands of its key stakeholders.

Regulation of private funds and mutual funds

The most notable recent regulatory development with respect to Cayman Islands investment funds has been the enactment of the Private Funds Act, 2020 (the Private Funds Act) and the Mutual Funds (Amendment) Act, 2020 (the MFA Amendment) in February 2020, which introduced new regulation for closed-end Cayman Islands investment funds and previously unregulated open-end Cayman Islands investment funds respectively.

The Private Funds Act requires closed-end Cayman Islands investment funds to apply for registration with CIMA prior to accepting capital contributions from investors for the purposes of investments and to comply with certain ongoing obligations (including continuous disclosure and an annual audit). Over 12,100 existing closed-end investment funds and other structures were registered before the expiry of the transitional period in August 2020.

The MFA Amendment removed the exemption from regulation for open-end Cayman Islands investment funds where the equity interests in the fund are held by 15 or fewer investors and a majority of those investors have the power to appoint or remove the investment fund's operator (Section 4(4) funds). Section 4(4) funds are now required to register with CIMA under the Mutual Funds Act (as amended) (the Mutual Funds Act) and comply with certain ongoing obligations (including continuous disclosure and an annual audit). As of September 2020, there were over 11,690 open-end investment funds (including Section 4(4) funds) registered with CIMA under the Mutual Funds Act.

Shortly after the enactment of the Private Funds Act and the MFA Amendment, the Cayman Islands government introduced amendments to its administrative fines regime, which had the effect of expanding the list of regulatory breaches for which CIMA may impose administrative fines to include breaches of the Private Funds Act and the Mutual Funds Act.

These legislative changes, which were closely co-ordinated with the European Union, introduce a balanced and proportionate regulatory environment for investment funds based on international standards and best practices. This was affirmed when the EU removed the Cayman Islands from its Annex I list of non-cooperative jurisdictions for tax purposes in October 2020.

AML/CFT

In line with recommendations of the Financial Action Task Force, the Cayman Islands substantially revised its anti-money laundering (AML) and countering the financing of terrorism (CFT) legislation in late 2017. The key changes included the extension of the definition of "relevant financial business" to bring certain unregulated businesses (including closed-end investment funds and structured finance vehicles) within the scope of the Cayman Islands AML/CFT regime and requirements, together with the introduction of the requirement for each investment fund to designate a natural person to act as its AML compliance officer, money laundering reporting officer and deputy money laundering reporting officer. The AML/CFT regime was most recently amended in 2020 to, among other things, enhance requirements relating to eligible introducer arrangements and country risk assessments.

Beneficial ownership

Since 2017, Cayman Islands companies and limited liability companies (LLCs), unless exempt, have been required to maintain a register of beneficial ownership information containing the required particulars of its beneficial owners and relevant legal entities (BOR). The BOR is maintained by the company's or LLC's corporate service provider and uploaded to a centralised electronic BOR platform, which the Cayman Islands government established to facilitate the unrestricted mutual exchange of beneficial ownership information between the respective law enforcement and tax authorities of the Cayman Islands and the UK.

The beneficial ownership regime has also been extended to Cayman Islands limited liability partnerships (LLPs).

CRS and FATCA

The Cayman Islands has adopted legislation implementing the Common Reporting Standard (CRS) and the Foreign Account Tax Compliance Act (FATCA) automatic exchange of information regimes. Cayman Islands vehicles classified as "Cayman Reporting Financial Institutions" and/or "Reporting Financial Institutions" under CRS and FATCA, respectively, are subject to registration, reporting, due diligence and administrative obligations. Reports are made to the Cayman Islands Tax Information Authority, which in turn provides account information automatically to the tax authorities of over 100 jurisdictions.

Data protection

The Cayman Islands introduced the Data Protection Act, 2017 (as amended) (DPA) in late 2019, which aims to protect individuals' rights in relation to their personal data. The DPA is based upon, and is intended to provide equivalent protection to, the EU General Data Protection Regulation.

Economic substance

The International Tax Co-operation (Economic Substance) Act (as amended) (the ES Act) imposes economic substance requirements on companies and LLCs in the Cayman Islands. The ES Act was introduced in response to concerns of the EU Code of Conduct Group regarding favourable tax regimes facilitating offshore structures that generate profits without real economic activity. The ES Act also reflects the Cayman Islands' commitment as a member of the Organisation for Economic Co-operation and Development's Inclusive Framework on Base Erosion and Profit Shifting (BEPS) and, in particular, BEPS Action 5.

Under the ES Act, a "relevant entity" that carries on a "relevant activity" is required to satisfy the economic substance test in relation to that relevant activity. Investment funds (which includes any entity through which an investment fund directly or indirectly invests or operates but not an entity that is itself the ultimate investment held) do not fall within the definition of "relevant entity" for purposes of the ES Act and will not be required to meet any economic substance requirements. However, each Cayman company, LLC and LLP is required to make an annual notification for economic substance purposes as a prerequisite to filing its annual return.

Additional transparency measures

Recent amendments to the Companies Act (as amended) require additional information with respect to each company to be recorded on the register of companies maintained by the Registrar of Companies, including the amount of capital of the company (and the number of shares into which it is divided), the name and address of each subscriber to its memorandum of association and the number of shares taken by each subscriber, the date of execution and filing of its memorandum of association, the nature of its business and the date of its financial year end. This register is open to inspection by any person.

Similarly, pursuant to amendments to the Limited Liability Companies Act (as amended), the Registrar of Limited Liability Companies is required to make certain information from a Cayman LLC's registration statement available for inspection by the public. Equivalent amendments were made to the Limited Liability Partnership Act (as amended) for LLPs.

Regulatory priorities going forward

The Cayman Islands government continually reviews and enhances its legislative and regulatory environment to ensure it is in line with evolving global standards and best practices. It has identified a number of key financial services regulatory initiatives – broadly related to tax transparency, AML, CTF and countering proliferation financing – on which it will focus in 2021. These include:

  • with respect to AML/CFT, exploring the effectiveness of accessing information on trusts and legal arrangements and any necessary enhancements to improve the Cayman Islands' overall framework for transparency and co-operation;
  • refining legislation and systems in order to meet its commitment to introduce a public register of beneficial ownership information (as it becomes the global standard);
  • analysing all types of partnerships in the Cayman Islands, the rationale for their initial exclusion from the Cayman Islands economic substance rules and the outcomes of applying economic substance requirements to partnerships; and
  • consulting with stakeholders on the implementation of mandatory disclosure rules, which were introduced by the EU Code of Conduct as a further transparency measure for certain jurisdictions.

With its clear and effective regulatory environment, its commitment to maintain the highest global standards and best practices, its reliable legal system, its high-quality professional service providers and its responsiveness and willingness to adapt in the face of turbulent global events, the Cayman Islands is well placed to retain its position as the leading offshore jurisdiction for the establishment of investment funds.

Mourant

94 Solaris Avenue, 4th Floor
Camana Bay
Grand Cayman
Cayman Islands, KY1-1108

+1 345 949 4123

+1 345 949 4647

catherine.pham@mourant.com www.mourant.com
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Law and Practice

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Maples Group advises global financial, institutional, business and private clients on the laws of the British Virgin Islands, the Cayman Islands, Ireland, Jersey and Luxembourg through its leading international law firm, Maples and Calder. With offices in key jurisdictions around the world, the Maples Group has specific strengths in the areas of corporate commercial, finance, investment funds, litigation and trusts. Maintaining relationships with leading legal counsel, the Group leverages this local expertise to deliver an integrated service offering for global business initiatives.

Trends and Development

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Mourant is a leading offshore law firm with expertise in Cayman Islands, British Virgin Islands, Jersey and Guernsey law. Through Mourant Governance Services, it delivers a complementary range of fiduciary, administration and governance services. The firm's clients include many of the world's leading financial institutions, corporations, public organisations, private equity houses and investment funds, as well as ultra high net worth individuals and family offices. The firm routinely works in partnership with the most prestigious international legal and accountancy firms. Mourant was named Offshore Law Firm of the Year 2020 at The Lawyer Awards and awarded Offshore Law Firm of the Year 2020 at the Hong Kong Asian Legal Business Awards.

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