James Williams, Hedgeweek

Corporate governance moves underscore commitment to global best practices

By James Williams – December 2013 proved to be a busy period for the Cayman Islands in terms of the development of its regulatory framework. On 6 December 2013, after a period of consultation with industry practitioners, the Cayman Islands Monetary Authority (CIMA) – the Islands’ financial regulator – released its Statement of Guidance for Regulated Mutual Funds (‘SoG-MF’). 

In essence, the SoG-MF codifies and sets guidance on the minimum corporate governance standards required by operators of regulated mutual funds (directors, general partners) and gives the operators a clear understanding of their primary duties. For example, the operators must ensure that the fund has a conflict of interest policy – this is undoubtedly in response to the Weavering case whose directors were related to the investment manager – and that the Governing Body should meet at least twice a year. 

“In general terms, the SoG is a welcome addition to the legislative and regulatory framework in Cayman. The SoG isn’t prescriptive, which is a relief as prescriptive regulation could easily drive down the quality of the provision of a key service to the industry. Prescriptive regulation establishes a floor and ceiling in terms of duty and obligation whereas a SoG, as a guide to best practice, permits the circumstances to dictate the relevant conduct required of the directors to meet their obligations. That offers funds and their investors the greatest protection and contribution from those charged with corporate governance responsibilities,” comments Colin MacKay, Group Director, Ogier Fund Services. 

In addition to the SoG-MF, December also saw the appointments of Christina Bodden and Colin Nicholson as co-directors of the Hedge Fund Association’s Cayman Islands Chapter. The HFA’s global mission is to increase transparency and foster greater trust in alternative investments. Bodden is a partner in the Investment Funds group at law firm Maples and Calder while Nicholson is a partner in KPMG’s Alternative Investments Practice. Their appointments are a further illustration of Cayman’s commitment to evolve in tandem with global regulation and remain as relevant as ever to investment managers and investors alike. 

The publication of the SoG-MF is part of an evolving narrative with respect to corporate governance as CIMA and the Cayman Islands Government work to enhance its regulatory and legislative framework. 

This is especially important given that the AIFM Directive has now been transposed into EU law – which has direct repercussions on how managers of Cayman funds market their products in Europe – and FATCA (Foreign Account Tax Compliance Act), the pervasive US tax regulation that seeks to ensure all US taxpayers pay their dues, comes into effect in 2014; Foreign Financial Institutions must finalise their registration with the IRS by 25th April 2014 and receive their Global Intermediary Identification Number, without which they will be unable to do business with their FATCA-compliant counterparts. 

The next expected step in Cayman’s evolution is the licensing of directors and a register of directors, which will be publicly accessible. Whether this a benefit or not remains open to debate, although one person who doubts the efficacy of such a register is Ian Gobin, Global Head of Funds at law firm Appleby.

“Apparently this [the register of directors] is something investors have been screaming for. On a wish list this just isn’t a high priority with the institutional investors we speak with. The correct place for disclosing information on directors remains in the private placement memorandum. That’s how you attract investors, through your PPM. If an investor has a particular issue or flashpoint with a director on a fund or they have a question to ask on who’s been selected as a director, they can raise it privately with the investment manager. But the public database is coming in one form or another and if it assists investors it should be seen as a positive change,” says Gobin.

One of the potential issues of having a public register is that investors might question the ability of a director who sits on a large number of funds. Making common knowledge the number of directorships is a sensitive issue. Nevertheless, in last year’s CIMA survey, two thirds (62 per cent) of respondents cited the number of directorships held by each director as important information for their corporate governance due diligence process. 

This might lead to CIMA applying heavier regulation by pre-approving and licensing directors who sit on more than six funds. The licensing process would be another step forward in Cayman demonstrating its commitment to improved transparency.

“The licensing process, which seems most likely to take the form of new legislation, will possibly apply globally to any director of a Cayman fund regardless of whether they are based in Cayman. Whilst this will require careful management and implementation, I consider this is a positive governance step for the jurisdiction. If an individual is acting as a fund director for financial compensation, then to have a form of licensing approval granted from the outset seems eminently possible. Once someone is licensed for one fund then that should suffice no matter how many additional funds the director sits on. It is of course another cost, but the overall concept is fine in my opinion,” comments Ashley Gunning, a partner in Walkers’ Global Investment Funds and Corporate Group in Cayman. 

Gunning points out that in respect to the number of fund directorships and the perceived potential issues, there have in fact been no major incidents of any Cayman-based directors embroiled in scandals. “CIMA is keen to stay ahead of the curve with respect to corporate governance. I think in this instance CIMA is making absolutely sure that it has its house completely in order. 

“This clearly demonstrates to the outside world that CIMA takes into account what people within the global hedge fund community are saying. It does seem that as a result of their industry survey a public register of directors of investment funds, in addition to some form of regulation and licensing of such directors, is a certainty,” says Gunning. 

“In the end I think we’ll end up with some sort of public database. It will indicate that Cayman is being proactive in terms of what investors want with respect to regulating directors,” adds Richard Addlestone, partner at Solomon Harris. 

Matt Mulry, a partner at Dillon Eustace agrees: “Having a register does enhance the oversight and regulatory power of CIMA so from a regulator’s viewpoint that’s got to be good. It’s not yet clear how far the requirements will go, however. There is talk that CIMA will require at least one Cayman resident director on each Cayman fund but we haven’t seen any concrete decision being made on that yet. The expectations are that draft regulations relating to the register will be circulated for industry consultation in early 2014.”

For some, CIMA could go further in terms of corporate governance. In the opinion of Mike Saville, Director, Recovery & Reorganisation for Grant Thornton Specialist Services (Cayman) Ltd, if CIMA wants to make a fundamental change they should look at restricting the indemnities that are provided to directors out of the assets of the funds. 

“If the director were at risk if something in the fund went wrong their whole attitude would change. The fact is the threshold is too high and until there’s been some further change in that respect I’m not sure how dramatic new corporate governance rules will be in terms of changing behaviour,” says Saville. 

Gunning adds that possibly the most contentious point that came out of CIMA’s review was the proposal to amend the Mutual Funds Law such that CIMA would be able to intervene in the operation of the fund if the SoG on corporate governance were not adhered to. 

“There are various ways CIMA can intervene in the operation of a fund today, but the concept of amending the law to enable CIMA to intervene if someone did not comply with the Statement of Guidance, was seen as potentially contentious as the SoG is meant to be nothing more than guidance. CIMA have indicated they will delay a decision until the Cayman Islands Government has pronounced on the issue and so we will have to wait and see how that develops,” states Gunning.

Beyond Cayman, the big regulatory development affecting investment managers of Cayman funds is the AIFM Directive in Europe. Now that the directive has been transposed, non-EU managers have a lot of work to do understanding the cost benefits of continuing to market their funds into Europe under national private placement regimes and how each Member State is adapting their NPPR rules. 

CIMA has worked closely and established cooperation agreements with many of Europe’s leading markets, meaning that Cayman managers can continue to avail themselves of private placement. Crucially, in December 2013, CIMA signed a Memorandum of Understanding with Germany’s financial regulator, Bafin; the 27th MoU that CIMA has signed with European counterparts. 

“The plan has always been for Cayman to sign MoUs with all EU Member States. Germany hasn’t always been the biggest fan of offshore jurisdictions so the fact that it has signed the MoU could be taken as a sign that it is formally recognising Cayman and that’s a helpful development,” says Addlestone.

Michael Padarin of Walkers believes that because of Germany’s importance at the heart of Europe’s financial markets it is perhaps more significant than other MoUs that CIMA has signed. 

“It’s considered quite a landmark achievement for Cayman. It sends out a strong and positive message to the global investment community about CIMA’s commitment to removing barriers to entry for Cayman funds into the EU,” says Padarin. In his view, CIMA has done everything it can do in terms of complying with the requirements of the directive. However, he adds that it remains to be seen how things will play out given that different countries have differing private placement regimes and political agendas “which are out of CIMA’s control”. 

“Cayman satisfies all the main prerequisites to permit Cayman funds to be marketed in the EU by both EU and non-EU managers. They include Cayman not being on the OECD blacklist, and entering into co-operation agreements with almost all EU and wider EEA regulators. There are only four EU regulators Cayman doesn’t have these agreements with, two of which include Italy and Spain. 

“In addition, Cayman has entered into or negotiated tax information exchange agreements (TIEAs) with a significant number of EU jurisdictions, which will be required as a prerequisite for the next stage of the directive; namely non-EU managers obtaining EU passports to permit distribution of their Cayman fund products on a pan-European basis,” says Padarin. 

The EU passport is expected to be made available to non-EU managers in 2015. 

“What we have seen in Cayman and Ireland is managers setting up Irish funds in parallel with their existing Cayman funds in response to investor requirements. It may well be that we will now see managers establishing AIFMD-compliant funds, whether in Cayman, Ireland or elsewhere, for their European investors and separate funds for non-European investors,” posits Mulry. 

The extent to which managers of non-EU funds choose to continue with private placement as opposed to establishing an onshore presence as an AIFM will depend on how regulation in each European jurisdiction is implemented and what the resultant cost impact will be.

“Investment managers may find that the Cayman fund complying with the AIFMD’s filing and disclosure requirements under relevant private placement rules is a more straightforward option in terms of time and cost than it is to launch an EU-domiciled AIF, but a cost-benefit analysis is required to establish what the best option is,” adds Mulry.

Gobin continues this point by stating that if a US investment manager decides that Europe is strategic for them, they’ll need to set-up a regulated investment management operation in Europe and market an EU fund. With such a strategy, it is the end investors that bear the brunt of the AIFM’s capital expenditure costs. 

“There’s almost a competitive advantage to being a non-EU manager of a non-EU fund. That’s the irony and precisely what the Directive was trying to avoid,” says Gobin. “Europe is still in the doldrums and remains a challenge for investment managers trying to raise capital and seeking assets. I would estimate that maybe 20 to 30 per cent of US investment managers are interested in developing a strategy around Europe but those that actually set up investment management operations in the EU and set-up EU funds will be much smaller.”

“With many clients taking very different approaches to AIFMD, investors and managers seem content to continue to structure through Cayman for non-EU capital raising and non-EU investing,” adds Ogier’s MacKay. 

Another important legislative development that has slipped under the radar to a certain extent is preparation for AIFMD by CIMA to enable it to obtain orders for the collection of information from all different types of investment funds, including unregulated closed-ended funds for which they previously had limited remit. 

Amendments have been made to the Monetary Authority Law, the piece of legislation that establishes CIMA and gives it its powers. 

As Padarin explains: “These amendments permit CIMA to obtain a range of court orders to assist overseas regulators to obtain information and take other actions in connection with cross-border supervision of Cayman funds. That’s an important development because in addition to regulated funds, it also covers closed-ended funds which CIMA previously hadn’t had much power over, as they are largely unregulated vehicles.” 

The third key regulatory development for Cayman hedge fund managers to be aware of is FATCA and the Model 1 Inter-governmental Agreement (IGA) that the Cayman Islands Government signed with the US Treasury Department on 29th November 2013. At the same time a new tax information exchange agreement (TIEA) was signed outlining the legal channels through which information will be automatically exchanged between the Cayman Islands Tax Information Authority (TIA) and the IRS. The previous TIEA had been in place for 12 years. 

The Model 1 IGA will authorise Foreign Financial Institutions (FFIs) under FATCA to collate information in relation to US taxpayers that have financial interests in the Caymans and report that information to the Cayman Islands TIA. That information will then be released to the IRS under the terms of the IGA. Annual reporting to the TIA is set to commence in 2015 and will include data for both 2013 and 2014. 

“This Model 1 IGA simplifies the process from the viewpoint of the FFI. It means that instead of reporting directly to the IRS they can report locally to the TIA which makes it easier for Cayman fund managers,” notes Jonathan Fitzgibbons, partner at Solomon Harris.

“Now that the Model 1 IGA is in place, we continue to provide advice and support to clients as they assess the impact on their Cayman structures, something that will continue with the advent of Cayman enforcement legislation early in 2014 and clarity around the GIIN registration process and the local reporting requirements for foreign financial institutions. With Cayman also having signed up to the UK’s version of FATCA, advising on issues of transparency and tax reporting seem destined to continue well into 2014,” says MacKay. 

This Model 1 IGA is just the latest example of Cayman embracing the new world order and opening its arms to greater transparency. 

“State Side, the market has yet to focus on what they need to do in Cayman – that’s been the missing link. The issue is ‘Who’s going to be the FATCA Responsible Officer (FRO)? It’s likely to be either a fund director or officer or an officer/director of the investment manager,” says Gobin. “That’s one of the open points right now. Some clients will want our assistance with providing these services, others will want to provide the services in-house. As a Cayman Islands law firm, FATCA and AIFMD are the two highest priorities for our clients right now.” 

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