With the introduction of the Cayman LLC, the EU Connected Fund in its final stages of approval and a general drive towards continued regulatory evolution, the Cayman Islands is putting itself just where it needs to be to support global fund managers in today’s regulatory environment.
The sign of any serious fund jurisdiction is its willingness to reflect on what it offers the global investment management community and find ways to evolve and bring new solutions to market. Whether they are regulatory changes, fund product changes or legal structuring developments, anything that demonstrates the willingness of a jurisdiction to respond to market dynamics is a fillip.
In this context, the Cayman Islands is moving in the right direction. The last 12 months have seen a number of developments that reflect its desire to adapt and remain the world's leading offshore fund jurisdiction.
AIFMD and third country passporting
Last summer, ESMA concluded that it would complete its assessment of the Cayman Islands when the Cayman Islands' New AIFMD Regime and other related steps had been implemented. This is now near completion.
The implementation of an AIFMD compliant regime provides a pragmatic opt-in solution for funds/managers who wish to avail themselves of, potentially, a more streamlined European distribution strategy.
"The forward-looking and pragmatic approach adopted by the Cayman Islands in this regard is just further evidence of its continuing position as the leading offshore jurisdiction, and its commitment to constant improvement and evolution regarding its product offering and regulatory regime in order to maintain its reputation as the pre-eminent offshore jurisdiction and the jurisdiction of choice for the funds industry.
"Our view is that the adaptations made to the funds law in the Cayman Islands to cater for this European option will be positively received by clients and intermediaries," comments Aaron Walker, Senior Associate at Stuarts Walker Hersant Humphries.
The Mutual Funds Law was revised primarily to introduce the concept of an "EU Connected Fund" to give such funds the option to be registered or licensed under the Mutual Funds Law and to extend CIMA's supervisory duties and powers to regulated EU Connected Funds (and "EU Connected Managers" – which concept was introduced pursuant to similar amendments made to the Securities Investments Business Law in 2015).
An 'EU Connected Fund' is either an open-ended or closed-ended fund, which is either managed from or marketed in a member state of the EEA.
"Further regulations to provide for the detailed compliance obligations to be imposed on EU Connected Funds, in a manner consistent with the AIFMD regime, have now been published and will come into force shortly," confirms Walker.
When the AIFMD Like Regime is formally introduced Cayman promoters will have the opportunity to have a registered EU Connected Fund or become an EU Connected Manager.
"My understanding is that the regulations that will implement the provisions that have been introduced into Mutual Funds Law and Securities Investment Business Law will flesh out what is required for categorisation of an EU Connected Fund or an EU Connected Manager," says Matt Mulry, Partner at Dillon Eustace. "It would be a more highly regulated product and manager than the existing Cayman Exempted Fund and Exempted Manager.
"The regulations were published on 20 December 2016 but will not come into force until later this year. The regulations under the Mutual Funds Law require a Cayman fund that is either marketed in Europe or that has appointed a manager in Europe to provide additional information and confirmations to the Cayman regulator. The regulations under the Securities Investment Business Law reflect similar requirements for Cayman managers who wish to market their funds across Europe to those imposed on European managers by the European AIFMD", says Mulry.
Private placement remains vital access route
One of the stated objectives of the AIFMD was to bring `onshore' funds that would typically be established in successful offshore jurisdictions like the Cayman Islands. However, the actual effect appears to be that the AIFMD has led to a trend towards fund managers establishing both offshore funds in the Cayman Islands and EU-based fund products in EU member states in order to have a comprehensive offering of products that investors in different jurisdictions can choose from.
From that perspective, the AIFMD has not particularly marred the attractiveness of the Cayman Islands as a funds jurisdiction. "Rather, in some respects it has enabled service providers to develop new product offerings to better serve their fund manager clients in respect of their relevant jurisdictions," says Walker. "It is also worth bearing in mind that the AIFMD has not hampered the ability of non-EU funds/managers to sell into the EU on a passive placement or reverse solicitation basis.
"However, the anticipated extension of the passport regime to the Cayman Islands will further ensure the continued attractiveness of Cayman as a jurisdiction for global fund managers as the ability to market their funds in the EU on the basis of a third country passport naturally provides a simpler platform from which they may actively distribute their fund products across the EU, rather than having to comply with national private placement regimes in respect of each jurisdiction in which they would like to market their products."
This might be true but there is no indication yet that Cayman managers will flock to opt in to the Cayman's AIFMD regime. Most likely the majority will chose not to, either because they view Europe as a less important market for capital raising compared to the US and Asia or are happy to continue pursuing private placement.
"I think Cayman will become stronger as a result of the granting of the passport. But it is equally, if not more important, to realise that access into Europe via NPRR is still the preferred choice.
"The Cayman Islands currently has more than 11,000 registered funds and approximately 75 per cent of these are managed by US managers or US affiliated groups so the nexus between Cayman and the US cannot be understated. The discussion around passporting has to include both the US and Cayman in terms of the US having eligibility as well.
"There is still a strong preference among managers to utilise the private placement avenue to access European investors. I believe until NPRR disappears altogether Cayman/US managers will take their time considering EU Connected Funds and availing of the passport," comments Alex Brainis, Partner at Appleby (Cayman).
The Brexit dilemma
One potential spanner in the works is the small issue of Brexit. When the UK voted to leave the EU last June it threw serious doubt over how the UK's financial services market would interact with the EU. The vote to leave meant that overnight the UK was put on track to became a third country in its own right, and outside of the purview of AIFMD. This won't manifest officially until Article 50 has been negotiated.
"The UK is currently the most important market in Europe for Cayman funds and its departure from Europe may have a big impact in Cayman. When there is an uncoupling from EU regulation in the UK it is unlikely that there will be a massive change in financial services regulation; the UK will likely maintain equivalence with EU regulation which will mean these new regulations are likely to remain relevant to the UK at least in the short term," suggests Mulry.
"It's difficult at this stage to understand what the effect of Brexit might have on Cayman," cautions Giorgio Subiotto, Partner at Ogier. "It raises a whole raft of new issues. One of the biggest markets in Europe for Cayman fund managers is the UK, it is where the majority of Cayman funds are distributed so what happens to the UK following the completion of Article 50 will have a big impact.
"The other big issue regarding the third country passport is what impact that will have on turning off the NPPR option. A lot of our clients are quite comfortable with National Private Placement Regimes because they know which markets in which they want to raise capital. I think they've taken this option very much in their stride and a number of European-based fund managers also go down this route. To the extent that third country passporting will bring an end to private placement rules it will need to be properly coordinated to ensure some third countries are not treated any differently to others. That could create potential regulatory arbitrage."
There are many implications to Brexit. The UK could, theoretically, become a competitor. There is talk of reducing the corporate tax rate, which could lead to a scenario where the UK becomes a low tax offshore jurisdiction and a funds centre in its own right, suggests Subiotto.
"We view the AIFMD opt-in regime as an additional tool for managers – it will be additive not subtractive. The US remains the most important market for capital raising. I don't therefore expect to see too many managers choosing to opt in to the regime. The cost of setting up and maintain structures here will continue to be lower than in Europe, there's less tax here and these are important factors. Cayman will always maintain that advantage over European jurisdictions," says Subiotto.
Cayman LLC takes off
Aside from the EU Connected Fund and AIFMD opt-in developments, another significant introduction to the Cayman Islands is the Cayman LLC vehicle, which became available last July.
This is the first new vehicle in Cayman since the SPC and adds a further structuring option for fund managers.
"I think the beauty of the LLC is its flexibility. For example, it allows for a broad range of fiduciary standards to be imprinted onto the LLC, at the higher end where fiduciary duties or standards of care could be set to be akin to an exempted company used in a funds context, or at the lower end where it is used as a blocker or tailored for a joint venture vehicle. It can deliver the bespoke fiduciary obligations and standards of care that the parties may want.
"It's likely to serve a role for downstream structuring given that it's a cost-efficient vehicle. I don't expect it to be a vehicle that the investor community encounters given their market preference for exempted limited partnerships and exempted companies," explains Jonathan Green, head of the Cayman Islands Investment Funds team at Maples and Calder.
The demand to create a Cayman LLC came from the US; principally US counsel and promoters familiar with the Delaware vehicle. This took hold and was the genesis of how Cayman initially ended up with exempted limited partnerships to respond to the US and provide a degree of symmetry with promoters' onshore vehicles.
"Our thinking with the LLC was very similar. It also resonates well with some of the vehicles used in the Asia market but it was predominantly in response to requests from the US market," says Green. "The Cayman LLC takes its inspiration from the Delaware LLC and in addition draws upon the principals and concepts that stakeholders will be familiar with from our existing Cayman vehicles."
Amongst the key benefits of the LLC are that it provides a hybrid vehicle offering the best characteristics of a limited liability company together with those of a limited partnership – including separate legal personality and limited liability, not to mention a greater degree of flexibility as to the management and internal workings of the LLC. This is because most of the features can be determined as a matter of contract between its members as opposed to being prescribed by the law.
In accordance with OECD commitments, the LLC must maintain: (a) a register of members; (b) a register of managers; and (c) a register of mortgages and charges. In a funds context, the Cayman LLC will allow closer alignment of the offshore fund structure with the onshore fund structure, making for easier and more cost-effective structuring and administration of the fund group.
Expanding on the hybrid point referred to above, Mulry remarks: "On the company side, it has a separate legal personality and it has its own obligations and liabilities distinct from those of its members. On the partnership side, it operates capital accounting mechanisms for assessing the value of an investor's interests and the law offers wide ranging flexibility to negotiate the relationships between the members themselves and between members and managers.
"This means that administration costs may be lower for LLC funds as NAV and performance fee calculations can be more straightforward."
One useful feature of the LLC is that it is more streamlined in the sense that one doesn't need to appoint a board of directors and trading companies can be set up with minimal footprint.
"The other advantage it brings to the table," says Subiotto, "is the ability to really tailor the management of the LLC. You can have one manager managing one class of the LLC, another manager responsible for manager a second class, which is difficult to achieve in an exempted limited company where a board of directors has responsibility for the company as a whole."
Converting existing vehicles into an LLC
Currently, it is possible to convert an existing Cayman exempted company into an LLC as both structures avail of a separate legal personality. Exempted limited partnerships do not have this feature and therefore there is no mechanism to flip them into an LLC.
That might change in the future. As Green explains: "Separate legal personality for Cayman exempted limited partnerships is still at the `think tank' stage. Should it come to pass, and an exempted limited partnership chose to opt in to separate legal personality, then it might be possible to allow it to convert into an LLC. We have already seen a number of people considering converting LLCs from elsewhere into a Cayman LLC (e.g. from Delaware and lesser known jurisdictions such as the Marshall Islands)."
Green thinks it is unlikely that promoters or investors will want to convert all their exempted companies into LLCs, however.
"I don't see a big drive to change what already works well in the funds context, unless perhaps it involves a hybrid deal or something unusual, say a fund holding a mix of liquid and illiquid assets that intends to operate as a hybrid PE/hedge fund vehicle. It is these more exotic situations where an LLC might be a more flexible offering. I do not envisage the LLC displacing the jurisdiction's established vehicles for run-of-the-mill structures."
No authorised share capital
The big step forward with the LLC is that Cayman has created a vehicle that allows a company to have a separate legal personality but does not have authorised share capital. That provides much more flexibility in terms of how members are admitted and the vehicle is administered. Companies with share capital can lead to people incorrectly issuing or exceeding their authorised share capital and it is rather an archaic concept.
"This constraint means that people could foot fault. It becomes very convoluted and a cumbersome structure. Dispensing with this really allows LLCs to become the vehicle of the future. They aren't constrained around some of the more archaic constructs of company law. That's where some of the cost-efficiency of an LLC comes from," adds Green.
SPCs proving useful
A third area of continued growth and innovation is the use of the Segregated Portfolio Company in Cayman. Before the SPC was available, in certain situations investors would insist on separate standalone funds to pursue separate strategies, particularly where there was leverage involved in one of the strategies; investors in the non-leveraged fund did not want to be exposed to the leveraged fund. Using an SPC, the manager can set up individual sub-funds with separate share classes within the same company.
"Investors understand that the assets and liabilities of each segregated portfolio are segregated or "ring-fenced" from other portfolios, and their investment will only be deployed in respect of a designated portfolio. If one of the other portfolios does not succeed, or has exposure to non-performing or problematic investments, this will not affect their investment", comments Richard Spencer, Partner at law firm Campbells.
In terms of having separate objectives and strategies across multiple portfolios, it is possible for there to be a mixture of open-ended and closed-ended portfolios. But as Spencer points out, managers should be mindful that notifications must be made to CIMA and fees paid in respect of newly created closed-ended portfolios of existing CIMA-registered SPC fund structures, notwithstanding that closed-ended standalone funds are not subject to any registration or filing requirements. Once a manager has made the decision to set up an offshore fund there are a variety of options.
"The key Cayman Islands investment fund vehicles are exempted companies, unit trusts and limited partnerships, and of course LLCs are also now available. One of the advantages of choosing an SPC fund structure is the ability to bolt on new portfolios as and when desired. The creation of a new portfolio is a straightforward and inexpensive process," adds Spencer.
Also, it allows investors to switch between strategies (if the documents allow for it). There are tax advantages to doing this as it doesn't require the investor to realise gains in the fund strategy they are rotating out of.
Conclusion
All told, there are significant developments taking in place to keep Cayman vital as a jurisdiction. Chris Humphries, Managing Director, Stuarts Walker Hersant Humphries, concludes on the following optimistic note: "Cayman is a pragmatic and business-friendly jurisdiction. It seeks constant improvement in its product offering and the government, with industry, recognises the need to keep its laws under constant review to maintain a competitive edge and a level of regulation and compliance, which is compliant with all applicable international standards.
"The introduction of the Cayman LLC and the EU Connected Fund developments are just recent examples of how these aspirations are put into practice and we believe that Cayman will continue to be best placed amongst the international financial centers to serve the needs of the global alternative funds industry."
