Cayman LLC should offer a ‘cleaner’ vehicle for PE managers
It's safe to say that the Cayman Island Government's in-tray is probably rather full at the turn of the year. Two major developments are in train, both of which are set to further enhance the jurisdiction's reputation. The first of these developments is the impending introduction of a new legal vehicle – the Cayman Islands limited liability company ("LLC"), which is expected to be brought into force in early 2016 (likely March or April).
The second development is the introduction of an AIFMD opt-in regime, with the hope that come the end of 2016, Cayman will be on ESMA's Third Country recommendation list of non-EU countries to qualify for AIFMD passporting; something that Jersey, Guernsey and Switzerland recently achieved.
Susan Lock, Partner at Campbells, is also part of a four-person sub-committee of the Financial Services Legislative Committee, which is assisting the Cayman Government and Cayman Islands regulator, CIMA, in drafting the law to introduce the new Cayman LLC. Broadly based on the Delaware LLC model, the Cayman LLC should provide some synergies with onshore vehicles, and potential efficiencies in respect to documentation, administration and governance.
"Cayman Islands exempted companies are corporate bodies with their own legal status but they have the rigidity of having to maintain share capital and issue shares that represent the underlying investments," comments Lock. "Conversely, the exempted limited partnership may have more contractual and capital accounting flexibility but it does not have a separate legal personality and needs to be operated by a separate general partner, which can be administratively cumbersome.
"But the Cayman LLC will be a hybrid between the two: it will have a separate legal personality and will also have substantial contractual flexibility to structure many aspects of its business how its members choose."
Where a closed ended fund requires separate legal personality, a Cayman Islands exempted company can be cumbersome in the operation of capital call and default mechanisms – an LLC may be ideally suited to such a scenario and as such should be welcome news to global private equity managers.
Indeed, the US commercial and corporate world has long been pushing for the introduction of a Cayman LLC given that the Delaware LLC is so popular.
"Many of our clients are based in the US and always look for familiarity of structures. We've been asking for a Cayman LLC for the last decade or so. It's good news that the Government is proposing to enact this in 2016. We think it will benefit Cayman because if US managers using a Delaware LLC decide to establish an offshore vehicle, they'll be able to choose a Cayman LLC," comments Melissa Lim, partner at Walkers (Cayman).
Currently, the only offshore jurisdictions that offer LLCs are the Marshall Islands and Anguilla.
"If managers are using a Delaware feeder structure it will become easier to mirror that in Cayman because they'll be able to "Caymanise" the Delaware LLC agreement. It effectively means that there won't be many changes to mirror the Delaware LLC in a Cayman structure," adds Lim.
Having a corporate vehicle that allows the members to decide between themselves on the flexibility of capital commitments, capital calls etc., should be a huge benefit to Cayman.
Michael Padarin is a partner in the Investment Funds Group at Walkers (Cayman). He notes that as private equity sponsors become increasingly global, it means that their senior managers commonly receive a portion of the fund's carry in the US, a portion in the UK and Europe, and a portion in Asia.
"They wouldn't necessarily want to receive their carry interests through a Delaware LLC because of the US tax consequences. I imagine that the Cayman LLC will be a useful vehicle to use in place of a Cayman exempted company or partnership. It should be a cleaner vehicle to use for some of the carry mechanics that apply to closed-ended PE funds," explains Padarin.
Salient features & advantages
Fund promoters often prefer to have a Delaware LLC registered as a foreign company in Cayman, in order for the Delaware LLC to be able to act as the sole general partner of a Cayman Islands exempted limited partnership.
"Offering a Cayman LLC solution might better suit promoters' needs in this respect," according to Chris Humphries, Managing Director, Stewarts Walker Hersant Humphries. He adds that the new LLC law includes the following salient features:
a) An LLC will be a body corporate with limited liability;
b) An LLC may be formed for any lawful business, purpose or activity;
c) An LLC will require at least one member;
d) Registration is effected by payment of a fee and filing a certificate of formation;
e) An LLC will have the ability to be member managed or managed by a manager or managers.
f) Members are free to agree amongst themselves the internal workings of the LLC, with appropriate minimum safeguards;
g) The law seeks to take into account existing Cayman Islands laws and considerations, including preserving the rules of equity and common law and addressing minimum statutory duties in the context of members and managers; and
h) Exempted companies may merge into LLCs, and foreign LLCs may merge or migrate into Cayman.
Susan Lock thinks the benefits of a Cayman LLC will be threefold.
Firstly, the draft LLC law is based on the Delaware LLC meaning there should be clear synergies between the Cayman LLC and an onshore vehicle.
"When we advise clients on a typical master/feeder structure – a Cayman feeder and a Cayman master with a Delaware onshore feeder – it could be a closer match of the legal framework between the onshore and offshore feeder funds, which should assist US managers with only having to grapple with one legal concept. It should also assist in the drafting of documentation.
"Secondly, LLC entities could allow for simplified and flexible fund administration. It will be easier to track each member's investment and calculate the fund's NAV rather than having to go back and adapt a flexible fund structure into a more rigid share capital and share class structure.
"Thirdly, it might allow for more flexible corporate governance. That doesn't mean to say there will be a waiving of governance; there are still going to be fiduciary duties involved for the fund sponsor but an LLC won't need a separate board of directors/separate general partner, and the manager may or may not be a member," explains Lock.
Expanding on the governance point, Matt Mulry, Partner, Financial Services, Dillon Eustace (Cayman), adds: "If a Cayman LLC is to be used as a registered fund it will require at least two managers who will need to be registered or licensed under the recent Directors Registration & Licensing Law, 2014."
Hayden Isbister, Partner at Mourant Ozannes (Cayman), is in no doubt that a Cayman LLC will strengthen Cayman's position as a leading offshore funds jurisdiction.
"The Cayman LLC will be able to be used not only by the funds industry but also in the structuring of corporate deals.
"One of the most common questions we get asked by clients is whether the Cayman LLC will have a series concept; different series within the structure where the assets and liabilities are segregated. We already have a Segregated Portfolio Company structure available in Cayman so initially we won't have the series concept as exists in the Delaware LLC.
"It is something that could be introduced further down the line, however," comments Isbister.
AIFMD opt-in regime
There has been a lot of hot air regarding the freezing out of Cayman from `fortress Europe' in respect to AIFMD. However, the reality is that the European Securities and Markets Authority (ESMA) has yet to make a decision on whether to include Cayman, or indeed a raft of other non-EU jurisdictions, on its approved list of `third countries' to qualify for an AIFMD passport.
Crucially, the Cayman Islands Government is firmly focused on amending its regulations in order to establish an AIFMD opt-in regime, so as to present as strong a case to ESMA as possible. In an article on CNS Business on 2nd October 2015, Richard Addlestone, partner at Solomon Harris, was quoted as saying: "Cayman is the world's leading domicile for alternative investment funds and the EU market is estimated at USD2.25trillionº In an era of limited investment returns, European institutions and pension funds will need access to Cayman investment vehicles and investment structures just as much as Cayman funds need access to European investors."
At the start of last summer, a working group was formed composed of representatives from the Ministry of Finance & Economic Development, Cayman Islands Monetary Authority (CIMA), and industry professionals under the guise of Cayman Finance (comprising Big 4 accounting firms and law firms).
"The idea was that we would work collaboratively on the legislation with the intention to create, in effect, a two-track regime where managers of Cayman Islands funds could continue to take advantage of the private placement regimes in Europe if they wish, or they could opt in to the regulated regime under AIFMD to distribute their fund(s) to European investors using the passport," explains Padarin.
"There was a need to update some of the principal legislation in Cayman, particularly the Mutual Funds Law that relates to funds and the Securities Investment Business Law that relates to investment managers. Those principal laws were amended a couple of months back to set the framework. They are now in a near-final form as the working group continues to liaise closely with the government on the detailed implementing regulations, which are in a near-final form. We expect the framework to be finalised sometime in Q1 this year."
Commenting on the timeframe, Mulry points out that the initial report from ESMA indicated that the amount of information ESMA needed to sift through in order to conduct their assessment for a jurisdiction like Cayman was so large "that they simply needed more time. Cayman provided all the documentation requested by ESMA for the purposes of their assessment but it appears that the documentation was so extensive that there wasn't enough time for Cayman to be included in that first wave of recommendations."
The amendments establish an opt-in regulatory regime for Cayman-domiciled investment funds that are managed within, or marketed into, the EU, to be known as "regulated EU connected funds"; and for Cayman-domiciled fund managers managing or marketing such regulated EU connected funds.
"The election to be treated as a "regulated EU connected fund" would be available to both open-ended funds and closed-ended funds, which are currently outside the scope of the MF Law," confirms Humphries.
The amendments to the MF Law specify the enforcement powers of CIMA in relation to such "regulated EU connected funds". Humphries adds: "The amendments should easily allow those funds already registered as mutual funds under the MF Law to transition and become "regulated EU connected funds". To fall within this, the relevant fund must be either (i) managed by an EU-based manager (including EEA jurisdictions in which the AIFMD has been implemented), or (ii) marketed to investors in EEA jurisdictions in accordance with relevant local law requirements."
Padarin thinks the opt-in regime will be particularly important is for those managers based in the UK. He notes that given the large number of regulated UK managers that use Cayman structures, the ability to distribute Cayman products on a passported basis "would be incredibly important. Investors are familiar with the Cayman fund product, and not only that, it is a more cost-effective option than having to set up an EU regulated fund structure.
"The Cayman Government is taking this very seriously and attaching great priority to the process. It doesn't want to find itself in a position where neighbouring jurisdictions receive ESMA's approval and Cayman does not, as this would put us at a competitive disadvantage," stresses Padarin.
Amendments to the SIB Law have been made in order to allow Cayman-domiciled fund managers managing or marketing regulated EU connected funds to apply to CIMA for a license to conduct regulated management activities pursuant to the SIB Law.
As with the amendments to the MF Law, revisions have also been made to grant CIMA appropriate powers of enforcements for such EU connected managers.
The opt-in regime will not necessarily benefit all who use the Cayman Islands. After all, there are plenty of US-focused funds that generally do not seek investment from European investors and are untouched by AIFMD. Nevertheless, the extension of the passporting regime to Cayman will be welcome and, could, in Humphries' view, lead to further growth for the Cayman Islands as a leading jurisdiction for funds. "The period of time since the introduction of the AIFMD has perhaps not been as damaging as some commentators would have initially thought," suggests Humphries.
It would, therefore, appear to be a case of `when' not `if' Cayman receives third country recommendation from ESMA, although from a timing perspective, this may not transpire until the fourth quarter of 2016.
"There is a Memorandum of Understanding in place between Cayman and European Member States that provides for the requisite mutual assistance between regulators, which is a key element to the extension of a third country passport regime to Cayman.
"Once we see the draft regulations we'll have a clearer idea of what will be required for Cayman funds and managers to be considered equivalent and benefit from the AIFMD passport," concludes Mulry