Investment funds in the Cayman Islands

WHY THE CAYMAN ISLANDS?

The Cayman Islands is a British overseas territory and has a history of stable government. It enjoys one of the highest standards of living in the Caribbean.

Cayman Islands law derives from English common law, supplemented by local legislation. The court system is well developed and experienced. Major civil cases are heard in the Grand Court with appeals to the Cayman Islands Court of Appeal and ultimately to the Privy Council in London.

There are no exchange control restrictions or regulations in the Cayman Islands. Funds can be freely transferred in and out of the territory in unlimited amounts. The Cayman Islands dollar is tied to the US dollar and the latter is freely accepted and used within the local economy.

Many of the world’s leading banks have a presence in the Cayman Islands and all the leading accountancy firms are represented as well. Investors and asset managers doing business in the Cayman Islands also benefit from top quality professional service providers (legal counsels, fund administrators, trust companies, company managers, etc.) with extensive experience.

Today, the Cayman Islands is one of the world’s leading offshore jurisdictions and is particularly renowned for the establishment of investment funds. Cayman Islands entities are customarily used for transactions of all types, including equity, debt, insurance and capital markets transactions, in mergers and acquisitions and in joint ventures.

The Cayman Islands Monetary Authority (“CIMA”) supervises and regulates a wide range of financial services, including banking, insurance and investment management.

REGULATORY FRAMEWORK

The regulation of investment funds established under Cayman Islands law, or which are administered or managed in the Cayman Islands, is governed by the provisions of the Mutual Funds Law, as amended from time to time (the “MFL”).
The goal of the MFL is to apply an appropriate level of regulation to each mutual fund carrying on business in or from the Cayman Islands, depending on its circumstances and ultimate investor market. There are no prohibitive licensing and regulatory provisions or stringent measures calling for local custodians, managers or directors as the legislation recognizes that most service providers engaged in the industry are already licensed or regulated in their home jurisdiction.

The MFL defines a mutual fund as company, trust or partnership, incorporated or established in the Cayman Islands, or if outside the Cayman Islands, managed from the Cayman Islands, which issues equity interest redeemable at the option of the investor, the purpose 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. Therefore, closed-ended investment vehicles, whose equity interests are not redeemable at the option of the investor, fall outside the definition of a mutual fund and, accordingly, are not regulated under the MFL in any way. The MFL only applies to open-ended investment vehicles.
CIMA is charged with the supervision and regulation of mutual funds and mutual fund administrators.

All regulated investment funds must qualify under the MFL before starting business. To do so, it may either obtain its own license, appoint a licensed mutual fund administrator in the Cayman Islands to provide its principal office or be registered if the target is a sophisticated investor, i.e. with a minimum investment of USD 100,000 (or equivalent in any other currency) per investor.

All Cayman mutual funds, whether regulated or not, are subject to applicable anti-money laundering laws and regulations in the Cayman Islands. As such, these mutual funds need to appoint named individuals as Anti-Money Laundering Compliance Officer (“AMLCO”), Money Laundering Reporting Officer (“MLRO”) and Deputy Money Laundering Reporting Officer (“DMLRO”). The AMLCO can also be either the MLRO or the DMLRO (but the MLRO and DMLRO must be separate individuals).
Each mutual fund must have appropriate policies and procedures in place in line with the aforementioned laws and regulations. These policies and procedures must cover not only the flow of funds from an investor to the fund, but also from the fund to the investments. The AMLCO has general oversight of the fund’s compliance function. The MLRO and DMLRO are responsible, inter alia, for assessing suspicious activity in relation to money laundering and reporting such suspicious activity to the Cayman Islands Financial Reporting Authority.

Categories of regulated funds
Three categories of mutual funds are required by the terms of the MFL to subject themselves to regulation by CIMA. Such mutual funds are referred to in this briefing as: (a) the licensed mutual fund, (b) the administered mutual fund and (c) the registered mutual fund.

Licensed mutual funds – Section 4(1)(a) of the MFL
This is the least common type of regulated mutual fund. A licensed mutual fund may offer its equity interests to the general public without any minimum subscription amount. The licensing process is therefore the strictest of all regulated mutual funds.
In granting a license, CIMA will consider whether:
– .each promoter is of sound reputation;
– the administration of the mutual fund will be undertaken by persons who have sufficient expertise and who are fit and proper to be directors, managers or officers (as the case may be); and
– the business of the fund and the offer of equity interests will be carried out in a proper manner.

Administered mutual funds – Section 4(1)(b
of the MFL
Instead of applying for its own license, a mutual fund may seek to rely on the existing license of a licensed mutual fund administrator based in the Cayman Islands. This type of mutual fund is favored by investment managers who wish to have a minimum initial subscription per investor that is lower than USD 100,000, but who prefer not to go through the approval process outlined above.
An administered mutual fund is the only type of regulated mutual fund, which must appoint a mutual fund administrator based in the Cayman Islands; licensed mutual funds and registered mutual funds may appoint an administrator in any jurisdiction.
For an administered mutual fund, the selected administrator undertakes the responsibility of being satisfied of the same matters that CIMA considers for a licensed fund and provides the principal office of the mutual fund at that administrator’s office in the Cayman Islands. A licensed administrator must report to CIMA if it has reason to believe that a fund for which it provides the principal office is acting in breach of the MFL or may be insolvent or is otherwise acting in a manner prejudicial to its creditors or investors.

Registered mutual funds – Section 4(3) of the MFL
This is the most common type of investment fund registered with CIMA. Registered mutual funds are exempt from the requirement to be licensed or administered locally on the basis that either (i) each investor must subscribe for equity interests in an amount not less than USD 100,000 (or the equivalent in any other currency) or (ii) the equity interests of the fund are listed on a stock exchange recognised by CIMA.

General requirements for regulated mutual funds
All regulated mutual funds are required to:
• have a current offering document, which must describe the equity interests of the mutual fund in all material respects and must contain all material information to enable a prospective investor to make an informed decision as to whether or not to subscribe;
• file their offering document with CIMA, together with the prescribed particulars, whereby the ‘prescribed particulars’ are set out in forms which summarize certain details from the offering document, as follows:
a. Licensed fund: Form MF3
b. Administered fund: Form MF2 and MF2A
c. Registered fund: Form MF1
d. Registered master fund: Form MF4
• update, so long as there is a continuing offering, their offering documents and/or prescribed particulars (in case of a master fund) within 21 days of any material change, and re-file the updated offering document and/or prescribed particulars with CIMA within such 21 day period;
• have their accounts audited annually and to file such audited financial statements with CIMA;
• pay an application fee and an annual fee each year in January.

CIMA has released a Statement of Guidance which establishes key principles of good governance which must be observed by each regulated mutual fund.

Exempted funds
Not all investment funds are regulated under the MFL. Exempt from regulation subject to sub-section 4(4) of the MFL are funds with equity interests (i.e. shares, partnership interests or units) held by no more than 15 investors who by majority are capable of appointing or removing the operators of the fund (i.e. directors, general partners and trustees). In order to meet this requirement, the power to appoint and remove directors etc. must be vested in a majority in number of investors, rather than a majority in terms of the value of the equity interests.

INVESTMENT FUND VEHICLES

The three vehicles commonly used for operating mutual funds are the exempted company, the exempted limited partnership and the unit trust.

Exempted company
The most popular form of company for offshore operations is the exempted company. Cayman Islands exempted companies have distinct legal personality and have a substantial degree of flexibility. They only need to have one shareholder and there is no minimum capital requirement. Shares can be issued in any currency and denomination. There is no minimum or maximum amount prescribed for authorized, issued or paid up share capital. The exempted company may redeem its shares and may therefore operate as an open-ended fund. Closed-ended funds can also be established using the exempted company, but this is less common. The company’s board of directors is responsible for the company’s general management, on the terms of its constitutional documents.
An exempted company can also be registered as an exempted segregated portfolio company (“SPC”) with protected cells or portfolios. Once registered as an SPC, a number of segregated portfolios can be operated by the company, which each have the benefit of statutory segregation of their respective assets and liabilities. Such structures can be used for multi-class, umbrella and master-feeder mutual fund structures, as well as for multi-issuance platforms allowing single managers to establish funds with different profiles within a single structure or allowing sponsors to employ a single vehicle into which they bring multiple managers to manage distinct funds.

Exempted limited partnership
The exempted limited partnership can be formed as easily as the exempted company or the unit trust. Limited partnerships are the most common vehicle for closed-ended funds, such as private equity or real estate funds. A partnership registered as an exempted limited partnership (ELP) must have at least one general partner, that is based in Cayman. The general partner is responsible for the conduct of the ELP’s business and is liable for the partnership’s debts and obligations. An ELP does not have any separate legal personality distinct from its partners and therefore any property of the ELP will be deemed to be held on trust by the general partner as an asset of the ELP. Limited partners have a liability, which is limited to the amount of capital committed to the partnership, unless they would actively take part in the conduct of the business of an ELP. In such case, they will risk to become liable for the debts and obligations of the ELP in case the ELP becomes insolvent.

Unit trust
The Cayman Islands has a well-established and flexible trust regime allowing for privacy and asset protection, both in the commercial and private wealth spheres. Under a unit trust arrangement, investors contribute funds to a trustee which holds those funds on trust for the unit holders and each unit holder is directly entitled to share pro-rata in the trusts’ assets.

INVESTMENTS

The MFL does not impose any restrictions on investment objectives, risks, target rates of return, leveraging or other commercial matters, given the institutional and sophisticated nature of the investors in Cayman funds. However, the MFL requires that a fund’s offering memorandum describes comprehensively the equity interests and contains sufficient information to enable an investor to make an informed decision.

TAXATION

The Cayman Islands has no direct taxes of any kind. There are no corporate, capital gains, income, profits or withholding taxes. Under the terms of the relevant legislation, it is possible for exempted companies, unit trusts and limited partnerships to register with and apply to the Cayman Islands government for a written undertaking that they will remain tax-free for a minimum period (20 years in the case of exempted companies and 50 years in the case of unit trusts and limited partnerships).

Relevant legal entities carrying out relevant activities need to comply with economic substance requirements. These requirements have been introduced to ascertain that such legal entities have sufficient economic substance in the jurisdiction in which they are tax resident (which jurisdiction often subjects corporate profits to a (near) zero tax rate, such as the Cayman Islands). The most significant relevant entities in scope of the requirements are exempted companies (including SPCs). Exempted limited partnerships are not regarded as relevant entities. Investment funds in general are not relevant entities and therefore normally do not need to comply with the economic substance requirements, unless they perform other relevant activities. Investment managers usually will be relevant entities though and fund management business is a relevant activity. Therefore, an investment manager must satisfy the economic substance test, whereby it must (i) conduct Cayman Islands core income generating activities, (ii) be directed and managed in an appropriate manner in the Cayman Islands and (iii) have sufficient substance (as further detailed in the International Tax Co-operation (Economic Substance) Law) in the Cayman Islands. Depending on whether or not an entity is a relevant legal entity and whether or not it performs a relevant activity, certain information needs to be reported to the applicable tax authority.

KEY SERVICE PROVIDERS

Cayman funds, regulated under the MFL, will generally appoint the following functionaries, some of them compulsorily:

Investment manager
The primary service provider appointed by a fund is its investment manager or investment adviser. Its precise role will vary depending on the terms of the contract pursuant to which the investment manager or investment adviser is appointed and can range from managing the fund’s assets to simply acting in an advisory capacity and leaving all investment decisions ultimately to the directors.
There is no requirement that the investment manager is Cayman Islands based. In case of a Cayman Islands based investment manager, such a manager needs to have either a full license under the Securities and Investment Business Law or must register as a registered person.

Administrator
For most mutual funds established in the Cayman Islands, there is no requirement that the fund appoints a Cayman Islands based administrator. Where the fund is a regulated mutual fund, CIMA will require the administrator to file a consent letter confirming to CIMA the specific functions for which the administrator will be responsible.

Custodian
A custodian is appointed by a fund to act as guardian of its assets pursuant to the terms of the relevant custodian agreement. A custodian will hold in custody all of the securities and cash of the fund. It may also collect dividends and other payments due in respect of the fund’s assets. There is no requirement that a custodian be based in the Cayman Islands. If the custodian is based in the Cayman Islands, it may need to be regulated pursuant to the Mutual Funds Law if it has control of all or substantially all the assets of the mutual fund.

Auditor
Mutual funds usually appoint an auditor and, in the case of funds regulated by CIMA, are obliged to do so. A regulated mutual fund must file accounts audited by an approved auditor, based in the Cayman Islands, within six months of its financial year-end. Additionally, a regulated mutual fund is also obliged to file a Fund Annual Return with CIMA together with its audited accounts.
In practice, the requirement for a local sign-off in Cayman Islands causes little difficulty because all of the main accounting firms have offices in Cayman. The bulk of the preparatory work will be done by the audit firm in the place in which the fund’s records are physically located (usually the office of the investment manager or administrator) and subsequently the Cayman audit firm will sign-off on the audited financial statements.

Directors
The MFL imposes on regulated mutual funds to appoint at least two directors. Generally, these should be individuals, although CIMA will permit a corporation to act as a director under certain circumstances.
The directors are responsible for the day-to-day oversight of the fund and must act in accordance with the Statement of Guidance on key principles of good governance.
Directors of mutual funds are not personally liable for the debts, liabilities or obligations of the company except for those debts, liabilities or obligations which arise out of the negligence, fraud or breach of fiduciary duty on the part of an individual director, or an action not within his authority and not ratified by the company.

In addition, under the Cayman Islands Directors Registration and Licensing Law 2014, directors of (a) mutual funds regulated under the MFL and (b) companies registered as registered persons under the Cayman Islands Securities Investment Business Law must register with, or obtain a license from, CIMA.

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