The Cayman Islands
The Cayman Islands is one of the world’s leading offshore jurisdictions for the establishment of investment funds. As at 31 March 2010, there were 9,370 funds (predominantly hedge funds) registered with the Cayman Island Monetary Authority (“CIMA”) under the Mutual Funds Law (the “Mutual Funds Law”). There are also significant numbers of private equity and other closed-ended alternative investment funds registered in the Cayman Islands but which are not required to register with CIMA.
Key features include:
The flexibility of the investment fund regime within a clear and effective regulatory environment.
The quality and experience of the legal, administrative and accounting service providers.
Ease of registration procedures.
No requirement to have Cayman-based directors or officers, managers, administrators or custodians.
No restriction on commercial matters such as investment objectives, trading strategies or leverage, trading or diversification limits. Such commercial matters are for the fund’s sponsor to determine provided that full disclosure of such matters (and all associated risk factors) is made in the offering document.
Regulation of investment funds
The Mutual Funds Law is the principal legislation relevant to the regulation of investment funds in the Cayman Islands. Investment managers based in the Cayman Islands will also need to comply with the Securities Investment Business Law, and all investment funds and service providers must also comply with relevant anti-money laundering legislation and regulation. CIMA is the regulatory body responsible for compliance with these regulations and has broad powers to ensure the protection of investors.
Definition of ‘mutual funds’
The Mutual Funds Law refers to investment funds as ‘mutual funds’ and as such defines a ‘mutual fund’ as a company, unit trust or partnership incorporated or otherwise carrying on business in the Cayman Islands that issues equity interests for the purpose of pooling investor funds, with the aim of spreading investment risk and enabling investors to receive profits or gains from investments.
Scope of the Mutual Funds Law
The following exclusions or exemptions from the Mutual Funds Law apply:
Funds with only one investor fall outside the definition of a ‘mutual fund’, as there is no pooling of investor funds.
Closed-ended funds or private equity vehicles which do not permit redemption or repurchase of interests also fall outside the definition of ‘mutual fund’.
Investment funds with fifteen investors or less, the majority of whom have the power to appoint or remove the operators of the investment fund (i.e. the directors, the general partner or the trustee, as the case may be), are exempt from the licensing and registration provisions of the Mutual Funds Law.
Categories of regulation
Three categories of mutual funds are regulated by the Mutual Funds Law, referred to in this briefing as: (a) the registered mutual fund, (b) the administered mutual fund and (c) the licensed mutual fund.
a) Registered mutual funds – this is the most common type of investment fund registered with CIMA and comprises those funds which have a minimum investment per investor of at least US$100,000 (or its equivalent in any other currency) or whose equity interests are listed on a recognised stock exchange. Registration under this route is straight forward as it does not involve any discretionary approval process on the part of CIMA. Specifically, CIMA does not conduct a prior review of the offering document and there is no discretion for CIMA to refuse to register a registered mutual fund provided that the fund qualifies for registration and the application is properly made.
b) Administered mutual funds – an alternative route is for the mutual fund to designate its principal office in the Cayman Islands at the office of a licensed mutual fund administrator. An administered mutual fund is the only type of regulated mutual fund which must appoint a mutual fund administrator based in the Cayman Islands. This type of mutual fund is favoured by investment managers who wish to have a minimum subscription per investor that is lower than US$100,000 but who do not wish to pursue the licensing route described below.
For an administered mutual fund, the selected administrator undertakes the responsibility of being satisfied of the same matters that CIMA considers for a licensed mutual fund (see below), and provides the principal office of the mutual fund at the 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 Mutual Funds Law or may be insolvent or is otherwise acting in a manner prejudicial to its creditors or investors.
c) Licensed mutual funds – the third alternative is to apply to CIMA for a license for the mutual fund that may be issued at CIMA’s discretion. This alternative would be appropriate for mutual funds wishing to accept subscription amounts below US$100,000 but which do not propose to appoint a Cayman Islands mutual fund administrator and are sponsored by reputable and well-known institutions.
Requirements under the Mutual Funds Law
All mutual funds must 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.
All regulated mutual funds are required to file their offering document with CIMA, together with the prescribed particulars. The ‘prescribed particulars’ are set out in forms which summarise certain details from the offering document, as follows:
a) Registered fund : Form MF1
b) Administered fund: Form MF2 and MF2A
c) Licensed fund: Form MF3
All regulated mutual funds must, so long as there is a continuing offering, update their offering documents within 21 days of any material change, and must re-file the updated offering document and the prescribed particulars with CIMA within such 21 days.
All regulated mutual funds must have their accounts audited annually, and such audited financial statements must be filed with CIMA within six months of the year end of the relevant mutual fund in electronic format, together with an annual return form including prescribed details, signed by a director.
Such audited financial statements must be signed-off by an approved Cayman Islands-based auditor. In practice this causes little difficulty because all of the main accounting firms have offices in Cayman. The bulk of the preparatory work will invariably be done by the audit firm in the place in which the fund’s records are physically located (usually the office of the manager or administrator) and then the Cayman audit firm will sign-off on the audited financial statements.
All regulated mutual funds must pay an application fee and an annual fee each year in January, currently US$3,660.
A Cayman Islands investment fund may be open-ended, closed-ended or a hybrid of the two. In open-ended funds, the equity interest issued is capable of redemption at the option of the investor. A closed-ended fund or private equity fund will either have no redemption or repurchase rights or only restricted rights and will be used when the underlying assets of the fund cannot be easily realised or liquidated to meet redemption requests. A hybrid fund might begin life as a closed-ended fund but, following a liquidity event or a passage of time, may convert to an open-ended fund.
Structures that are commonly used for open-ended investment funds include single class, multi-class (umbrella), master/feeder and side-by-side funds.
Types of fund vehicle
A Cayman Islands investment fund may be established as a company, a unit trust or a limited partnership. It is important to note that only a company enjoys separate legal personality, distinct from its investors.
Companies are the most common vehicle for open-ended investment funds. Companies are invariably incorporated with limited liability although, under Cayman Islands law, it is possible to form companies with unlimited liability or with limited liability by guarantee. The majority of Cayman Islands companies issue shares of a stated par value (although no par value shares are permitted). Cayman Islands law permits dividends or other distributions to be paid out of share premium account, subject to a solvency test, even if no profits are available. Shares in a Cayman Islands company may also be redeemed or repurchased out of capital, again subject to solvency considerations.
Cayman Islands companies are invariably registered as exempted companies and can be incorporated on a same day basis and are subject to minimal local requirements. There must be a registered office in the Cayman Islands at which a register of directors and a register of mortgages and charges must be maintained. A register of shareholders must also be maintained although this can be kept either in or outside the Cayman Islands. None of these registers is open to public inspection.
An exempted company may be registered as a segregated portfolio company (“SPC”). An SPC allows a number of segregated portfolios to be operated with the benefit of statutory segregation of assets and liabilities between segregated portfolios. A liability in respect of a particular segregated portfolio entitles a creditor to have recourse only to the assets attributable to that portfolio and not the assets of other segregated portfolios.
Cayman Islands trust law is based on English common law and therefore interpreted according to English case law, as modified by any Cayman case law. Under a unit trust arrangement investors (or unit holders) 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 trust’s assets.
A unit trust is often used for investors in jurisdictions (such as Japan) where participations in a unit trust are more acceptable or tax-effective than shares in a company.
The trust deed regulates the rights and obligations of unit holders and will usually give unit holders the right to redeem their units and to purchase further units. The trustee of a unit trust fund is invariably a licensed Cayman Islands trust company.
Limited partnerships are the most common vehicle for closed-ended funds or private equity funds. They are also sometimes used in master-feeder structures. Cayman limited partnerships are governed by a combination of equitable and common law rules (based on English common law) and also statutory provisions, pursuant to the Exempted Limited Partnership Law.
An exempted limited partnership requires at least one general partner and at least one limited partner. There is no requirement for a capital contribution by a general partner. In most cases, the general partner is either a Cayman Islands company or an overseas company registered here as a foreign company although may be another Cayman Islands exempted limited partnership.
There are no statutory restrictions on distribution of profits and returns of the partnership so long as it remains solvent.
The Cayman Islands has no direct taxation of any kind. There are no income, corporation, capital gains or withholding taxes or death duties. Under the terms of relevant legislation it is possible for all types of fund vehicles - the company, the unit trust and the limited partnership – to apply to the government of the Cayman Islands for a written undertaking that they will not be subject to various descriptions of direct taxation, for a minimum period, which in the case of a company is currently twenty years and, in the case of a unit trust and limited partnership, fifty years.
Cayman investment funds and their service providers must comply with relevant anti-money laundering legislation. In Cayman the relevant provisions are contained in the Proceeds of Crime Law, the Money Laundering Regulations and CIMA’s Guidance Notes on the subject.
The Cayman Islands Stock Exchange (“CSX”) has become an important offshore listing facility and exchange for investment funds, specialist debt securities and warrants. The CSX is recognised by the London Stock Exchange and the UK Inland Revenue and is also an affiliate member of IOSCO and a full member of AIMA. The CSX has developed a set of listing rules specifically tailored to meet the needs of investment funds of all types.
The Cayman Islands has long established itself both as a jurisdiction where hedge funds and other alternative investment vehicles can be set up on a tax-neutral basis and as a jurisdiction which, although well regulated, offers sufficient flexibility for setting-up fund structures suitable for institutional and sophisticated investors. This is the Cayman Islands niche and, although significant onshore regulatory changes are now regarded as inevitable, the Cayman Islands is expected to retain its position as one of the leading jurisdictions for offshore alternative investment funds.
By James Wauchope, Partner, Mourant Ozannes