Reflection after the tumult

By A Paris – In what has been a rollercoaster year from all perspectives, 2020 saw the Cayman Islands being first placed on the European Union blacklist in February, followed by its removal from said list in October, after it made improvements to its tax framework. 

The jurisdiction, best known as a domicile of choice for hedge funds and alternative investments, has introduced a spectacular 19 new pieces of legislation in its steadfast endeavour to strengthen oversight and ensure the Cayman Islands industry is aligned with global standards.

Elemental to Cayman’s removal from the EU blacklist was the enhancement of its framework on collective investment funds. The jurisdiction also introduced new economic substance rules in 2019 and passed new legislation in January 2020 to further enhance its regime for private funds.

“Following consultation in which both the Cayman Islands and the EU Commission gained better appreciation for our respective regimes, the Cayman Islands made certain enhancements to our funds framework. The most prominent changes include that all Cayman Islands-based investment funds are now required to be registered, valued independently, and have their accounts audited annually by a recognised auditor. 

“Funds are also now required to have their cash flows monitored by an independent third party, and to make additional arrangements for safekeeping fund assets,” outlines Tara Rivers, Minister of Financial Services and Home Affairs in the Cayman Islands Government, in a sponsored article.

In a statement reacting to the repeal of the blacklisting, Jude Scott, CEO of Cayman Finance, says: “The EU’s recognition of the Cayman Islands as cooperative on both transparency and fair taxation is an important validation of Cayman’s commitment to a responsible policy of tax neutrality that poses no harm to other countries.  

“The EU now joins many other respected international entities like the OECD in identifying the Cayman Islands as a transparent jurisdiction without harmful tax regimes. We greatly appreciate the Cayman Islands Government’s cooperation and working relationship with the EU over many years that helped produce this outcome.”

Ronan Guilfoyle, AIMA Cayman Chairman, also comments: “This action by the EU acknowledges that the regimes established by the Cayman Islands for fund regulation and the wider economic substance requirement, as well as those for the exchange of tax and financial information, anti-money laundering and related measures are fully in line with international standards.”

The removal from the EU blacklist came as a relief after Nordic pension funds publicly shunned new investments in Cayman-based entities earlier in the year. Some MEPs in Europe remain unconvinced, calling on the EU to change the system used to draw up the list of tax havens, deeming the current method ‘confusing and ineffective’. In a press release detailing the resolution prepared by the Subcommittee on Tax Matters and adopted by the Economic and Monetary Affairs Committee, the MEPs say the criteria to judge if a country’s tax system is fair or not needs to be widened. They also declare that removal from the blacklist should not be the result of only “token tweaks” and that the list has to be formalised through a legally binding instrument. “The fact that the Cayman Islands has just been removed from the blacklist, while running a 0% tax rate policy, is proof enough of this,” MEPs claim.

Rivers responds to this in her article, writing: “The Cayman Islands imposes no corporate and income taxes, nor do we have any double tax treaties which facilitate the choice of tax domicile and the minimisation of taxes owed and payable by the use of stated versus effective rates. We do, however, levy taxes on a consumption basis, similar to the EU’s VAT tax system, and our taxes equate to about 25% of our GDP. Therefore, the Cayman Islands is not “tax free” nor a “zero tax jurisdiction,” and our system of taxation raises roughly the equivalent as those of many OECD countries.

“Cayman considers these discussions as central to our decades-long commitment to participating in initiatives that foster mutual understanding and strengthen international regulatory standards. We look forward to collaborating with our counterparts in the EU and its Member States on global taxation reforms that are currently being developed at the OECD level.”

Following this period of re-dress and swathes of new rules, several industry players say it is now time for the sector to re-group and ensure the new regulations are implemented in a robust manner.

Impact opportunity

Beyond tax considerations, an aspect of good governance which is rising in importance is sustainability. Institutional investors the world over are now focusing on environmental, social and governance (ESG) factors when investing and so are the investment management players active in the Cayman Islands.

A report by the Cayman Islands practice of KPMG, released in February 2020 found institutional investors are driving the ESG agenda. “Until fairly recently, these investors have been mostly focused on uncorrelated absolute returns. They now want their investments to target double bottomline benefits: do well financially by doing good socially and environmentally, while promoting high standards of governance and avoiding reputational risk….Thus, the traditional risk–return equation is being rewritten to include ESG factors. This, in the belief that it is now becoming material to investment returns, as our societies tackle environmental and social challenges such as climate change, water scarcity and loss of biodiversity,” the report outlines.

According to Patrick Henry, US Investment Management practice leader at Deloitte and Jim Eckenrode,Managing director at the firm’s Centre for Financial Services, the opportunity for hedge funds in particular lies in the impact investing space.

“The lack of a clear hedge fund leader in impact investing suggests there may be open space for early movers to gain a competitive advantage. The biggest value proposition for this strategy is that a growing class of investors wants to see these types of products within their suite of investment options. 

“The value-add to managers is not only about interest in a specific fund, but also about how this creates opportunity to bring in new clients and deepen relationships with existing clients. Competition is fierce and any opportunity to show responsiveness to investor demands while being first in an untapped market is key,” they advise.

In May 2020, the UN PRI (Principles for Responsible Investment) published a technical guide for ESG incorporation in hedge funds. “With respect to client demand, although ESG funds have been growing in the long-only market for some years, institutional investors are becoming increasingly interested how hedge fund managers are applying ESG factors in their portfolios. With regards to how regulatory environments may differ between funds and strategies and an analysis of materiality, the PRI has created various materials to support asset owners and hedge fund managers in broadening their understanding,” the guide declares.

Given the Cayman Islands remains one of the most popular domiciles for hedge funds, the jurisdiction can expect to see a broader application of this guidance across its shores. n

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