The Cayman Islands is the leading jurisdiction for the offshore investment funds industry due to its combination of flexible and appropriate regulation, an approachable and effective regulator, professional service provider expertise, high reputation among investors and a tax neutral regime.
Investment funds established in the Cayman Islands fall into two broad categories: open-ended funds and closed-ended funds.
Open-ended funds are funds that provide investors with voluntary redemption or repurchase rights and closedended funds are funds that do not provide investors with voluntary redemption or repurchase rights. Typically the former will invest in liquid assets which can be readily realised to fund redemptions (for example, listed liquid tradable securities) and the latter will invest in non-liquid assets requiring time to liquidate/realise value (for example, real estate, unlisted growth companies).
Fund Vehicle Options
Exempted companies limited by shares are the most common form of entity used for the establishment of open-ended investment funds with an investor's liability being limited to the amount paid or agreed to be paid in respect of their shares.
Segregated Portfolio Companies
An exempted company may register as a segregated portfolio company (SPC). An SPC is akin to a segregated cell company in many other jurisdictions.
An SPC may establish any number of segregated portfolios. Assets and liabilities attributed to a particular segregated portfolio are legally separated from the assets and liabilities attributed to any other segregated portfolio. A creditor who is party to a contract involving a particular segregated portfolio will have restricted recourse and will be entitled to make its recovery only against assets attributed and credited to the specific segregated portfolio to which the contract is also attributed.
SPCs can be useful as multi-strategy vehicles and platform vehicles but savings by using multi-strategy SPCs are often not as great as anticipated and SPCs with multiple segregated portfolios do require a greater degree of care to ensure assets are properly segregated, contracts are entered into on behalf of the correct segregated portfolio and inadvertent cross-collateralisation does not occur.
Cayman Islands unit trusts are established under and governed by the Cayman Islands statute the Trusts Law and, save as modified under that law, generally applicable principles of English trust law. Under a unit trust investors contribute funds to a trustee which holds those funds on trust for the investors and each investor is directly entitled to a pro rata share in the trust's assets, its unit. Unit trusts are constituted under a trust deed
that provides the terms on which the trustee holds the trust's assets for unit holders. The use of Cayman Islands unit trusts is particularly popular in Japan.
Limited Liability Companies
Limited liability companies (LLCs) may be incorporated in the Cayman Islands in a form closely aligned to the Delaware LLC. LLCs may be used in investment fund structures going forward where a flexible structure akin to a limited partnership is required, but where the vehicle needs to be established as a body corporate distinct from its members. LLCs are regulated by their LLC agreement and the Limited Liability Companies Law.
Exempted Limited Partnerships
While an exempted limited partnership (ELP) is the most common vehicle for closed-ended funds including private equity, venture capital and real estate funds, they are also used for open-ended funds. An ELP has many similarities to its Delaware equivalent vehicle but an ELP is not a separate legal person and for this reason, it is popular with managers and investors in a number of jurisdictions. An ELP is managed by its general partner.
All of the above entities can be established on an expedited basis and no governmental or regulatory approvals are required.
Taxation of vehicles
All of the above vehicles are exempted from any Cayman Islands income or gains taxes and can obtain a tax undertaking certificate from the Cayman Islands government guaranteeing no change in their tax status for 20 years or more.
Liability of investors
All of the vehicles issue equity interests which typically limit investor liability to the amount paid or agreed to be paid in respect of their investment.
Management of Entities
An exempted company or SPC's management rests with its board of directors, a unit trust's with its trustee, an LLC's with its members or a separate manager or managers and an ELP's with its general partner and these are all referred to as `operators'. Typically investment management authority is delegated to an investment manager or adviser but the relevant operator will always be required under generally applicable law to maintain oversight of the investment manager's functions. In this regard, the Cayman Islands Monetary Authority (CIMA) has provided guidance as to the best practice for fund governance which should be followed by operators of all funds. See our Guide to Duties and Obligations of a Director of a Cayman Islands Fund for further details.
Standalone Fund (No U.S. taxable investors)
Typical Offshore Fund Structures Investors
(typically Cayman Company)
Non US Investors
Offshore Feeder Fund
US taxable Investors
(Limited Partnership) eg Delaware
Offshore Master Fund
Mutual fund regulation
Fund and securities regulation in the Cayman Islands
The Mutual Funds Law is the main legislation regulating investment funds in the Cayman Islands. Investment managers, broker dealers and others carrying on securities investment business from the Cayman Islands must comply with the Securities Investment Business Law (SIBL). All investment funds, investment managers and their service providers must comply with anti-money laundering and automatic exchange of information laws (aka FATCA) and regulations.
What is a `mutual fund'?
To be categorised as a mutual fund under the Mutual Funds Law:
the fund must be issuing equity and not debt or contractual interests, in other words, shares, limited partnership interests, LLC interests or trust units;
the fund must be a collective investment vehicle effecting the pooling of investor funds;
the fund must issue equity interests which are redeemable or repurchasable at the option of the investors, so those funds where the fund operators have discretion to consent to redemptions or repurchases are exempt. However, funds with an initial but limited no redemption lock-up period (usually from six months to three years) are considered mutual funds for the purposes of the Mutual Funds Law; and
the fund must be established in the Cayman Islands or be a foreign fund and seek to make an offer or invitation to the public in the Cayman Islands to subscribe for its equity interests.
Exclusions or exemptions from regulation?
Some funds are not regulated and therefore are not required to be registered with, or licensed by, CIMA.
1. Single investor funds (which are not master funds) are not mutual funds, as there is no `pooling' of investor funds.
2. Closed-ended funds which do not permit the redemption or repurchase of investor equity, for example private equity funds, are not mutual funds.
3. Exempted funds are those funds (which are not master funds) which fall within the definition of a mutual fund, but the equity interests of which are held by not more than 15 investors, a majority of whom (in number and without reference to the number of shares or other equity interests held by each investor) are capable of appointing or removing the operator (ie the directors, trustee, LLC manager or general partner) of the fund.
4. Listed or otherwise regulated funds which are not incorporated or established in the Cayman Islands and which make invitations to the public in the Cayman Islands to subscribe for the fund's equity interests through a person licensed under SIBL, provided that the fund in question must be either:
a) listed on a stock exchange recognised for the purpose by CIMA; or
b) regulated in a category and by a regulator recognised for the purpose by CIMA.
There are currently three categories of regulated mutual funds:
1. registered funds (which includes master funds required to register);
2. administered funds; and
3. licensed funds.
This is the most common category of regulation under the Mutual Funds Law with approximately 70 per cent of Cayman Islands mutual funds registered under this category. To qualify for registration, a mutual fund must have either:
1. a minimum initial subscription amount of US$100,000, or its equivalent in any other currency (by far the most common); or
2. its equity interests listed on a recognised stock exchange approved by CIMA.
Master funds are a sub-category of registered funds. Approximately 26 per cent of Cayman Islands funds registered with CIMA are master funds.
A master fund is a vehicle that facilitates the investment by a regulated feeder fund (which is a mutual fund regulated by CIMA that conducts more than 51 per cent of its investing through a master fund) in the underlying assets pursuant to a particular investment strategy. A master fund does not benefit from the single investor exemption or fall within the exempted fund classification (15 or fewer investors).
For example, a typical master/feeder structure may involve a Cayman Islands feeder fund and a US feeder fund being set up to invest in a Cayman Islands master fund. If the Cayman Islands feeder fund were registered or licenced by CIMA then the master fund would have to register.
However, if the Cayman Islands feeder fund was not required to register with CIMA (for example, because it was a single investor fund or if it was an exempted fund) and the only other investor was the US feeder fund, the master fund would not have to register with CIMA and could be structured as an exempted fund.
Administered funds make up approximately 3 per cent of funds that are registered with CIMA.
Administered funds will generally be used if the promoter does not want to have a minimum initial investment amount for its investors. The mutual fund must designate a principal office in the Cayman Islands at the office of a Cayman Islands based licensed mutual fund administrator. The key difference to regulated funds is that
responsibility for regulatory oversight for Administered Funds is largely delegated to the licensed mutual fund administrator and therefore the administrator providing the fund's principal office must be satisfied that:
1. each promoter of the fund is of sound reputation;
2. the fund's administration will be undertaken by persons with sufficient expertise to administer the mutual fund and who are of sound reputation; and
3. the fund's business and any offering of its equity interests will be carried out in a proper way.
On an ongoing basis, the licensed fund administrator must notify 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, is insolvent or is otherwise acting in a manner that is prejudicial to its creditors or investors. There are also specific on-going obligations applicable to licensed mutual fund administrators.
This is the rarest category of Cayman Islands funds with fewer than 1 per cent of regulated funds being registered under this category.
Unless a mutual fund falls within one of the other categories described above, it must obtain a mutual fund licence. A fund promoter manager would usually choose to license a fund under section 5 of the Mutual Funds Law if the fund was intended to be a retail fund offered generally to the public outside the Cayman Islands, with its administrator and/or manager and other key service providers located outside the Cayman Islands.
Licensed funds are rarely encountered in practice as retail investment funds are normally set up as onshore funds in accordance with the regulatory requirements of their relevant home jurisdictions. However, one of the main exceptions to this practice has been in Japan, where the use of licensed funds structured as Cayman Islands exempted unit trusts has been popular. This type of category is usually only chosen by well-known financial institutions.
EU Connected Funds
The Cayman Islands Government has passed legislation, which is expected to come into force in 2017, which will introduce the concept of `EU Connected Funds' to enable Cayman Islands funds to take advantage of the passport regime under the Alternative Investment Fund Managers Directive1 as and when it becomes available to Cayman Islands investment funds. Further secondary legislation is also expected to be passed setting out in detail how EU Connected Funds will be regulated. The EU Connected Fund regime under the Mutual Funds Law will allow both open-ended and closed-ended funds to apply to be registered or licensed with CIMA as EU Connected Funds and therefore enable them to benefit from the EU passport regime.
To register a registered fund with CIMA, the filing is done via CIMA's online registration system by filing:
1. the fund's offering document;
1 Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers and amending directives 2003/41/EC and 2009/65/EC and Regulations (EC) No 1060/2009 and (EU) No 1095/2010
2. the Form MF1;
3. consent letters from the fund's administrator and auditor (confirming that they act as such on behalf of the fund);
4. the CIMA Connect affidavit; and
5. payment of the relevant registration fee.
General provisions affecting Cayman Islands funds
The Cayman Islands open-ended fund model requires transparency and full disclosure in the offering document, an audit firm that has been vetted and approved by CIMA, regular reporting and a properly qualified independent administrator. It is a model that emphasises disclosure over arbitrary prescription and so there are no requirements as to leverage or asset allocation or investment strategies. The model has proved popular and has changed little over the years, giving investors and managers a certain platform for their agreements.
Mutual Funds Law requirements
1. All regulated mutual funds (other than master funds) must have a current offering document which describes the equity interests in all material respects and contains such other information as is necessary to enable a prospective investor in the mutual fund to make an informed decision as to whether or not to subscribe for or purchase the equity interests.
2. All regulated mutual funds (other than a master fund which has no offering document) must file their offering document with CIMA on registration or licensing together with certain prescribed particulars.
3. All regulated funds, as long as there is a continuing offering of equity, must inform CIMA of any change that materially affects any information in the offering document (or prescribed details of a master fund, where applicable) and must file with CIMA an amended offering document and the relevant CIMA form incorporating such changes within 21 days.
4. All regulated funds must appoint an auditor from a list of firms approved by CIMA (and the local Cayman office will need to sign off on audits) and submit audited financial statements to CIMA within six months of the end of the fund's financial year in electronic format together with a fund annual return form (FAR).
5. All regulated mutual funds must pay the applicable annual fee (currently US$4,268 and US$3,048 for master funds) by 15 January of each year. If an annual fee is not paid by 15 January of each year, a penalty of 1/12 of the annual fee will be payable for each month or part of a month during which the annual fee and any penalty remains unpaid.
6. Although not a Mutual Funds Law requirement, in practice CIMA requires regulated funds to appoint an independent administrator.
Under the Director Registration and Licensing Law (DRLL), all directors (including managers of LLCs), whether natural persons or corporate directors and whether resident in the Cayman Islands or elsewhere, who act as directors of regulated mutual funds (or manager where the regulated mutual fund is an LLC) must also be registered with, or in certain circumstances be licensed by, CIMA. An application fee is payable to CIMA together with annual fees, which must be paid by 15 January of each year. There are heavy penalties for noncompliance with the DRLL including significant fines and imprisonment.
All Cayman Islands exempted companies, exempted limited partnerships, LLCs and exempted unit trusts must have a registered office in the Cayman Islands provided by a person licensed under the Companies Management Law or the Banks and Trust Companies Law.
Location of service providers
Save for Administered Funds and the local auditor sign-off requirement, there is no requirement that a mutual fund's service providers be based in the Cayman Islands or in any prescribed jurisdiction.
Mutual funds are obliged to comply with Cayman Islands money laundering legislation. The simplest way of complying with the requirements is for the fund to delegate their anti-money laundering compliance to administrators based and regulated in a jurisdiction identified in Schedule 32 to the Guidance Notes on the Prevention and Detection of Money Laundering and Terrorist Financing in the Cayman Islands (the Guidance Notes). This means, in practical terms, that administrators of Cayman Islands mutual funds usually operate out of a Schedule 3 jurisdiction3.
The Guidance Notes provide that such delegation is acceptable, provided that:
1. details of the delegation agreement and written evidence of the suitability of the administrator (or its employees) to perform the relevant functions on behalf of the mutual fund are available to CIMA on request;
2. there is a clear understanding between the administrator and the mutual fund of the functions to be performed by the administrator;
3. the relevant customer information is readily available to CIMA on request and to the Financial Reporting Unit and other law enforcement authorities; and
4. the mutual fund satisfies itself on a regular basis as to the administrator's systems and procedures.
2 Current Schedule 3 jurisdictions are Argentina, Australia, Austria, Bahamas, Bahrain, Barbados, Belgium, Bermuda, Brazil, British Virgin Islands, Canada, Cyprus, Denmark, Finland, France, Germany, Gibraltar, Greece, Guernsey, Hong Kong, Iceland, India, Ireland, Isle of Man, Israel, Italy, Japan, Jersey, Liechtenstein, Luxembourg, Malta, Mexico, Netherlands, New Zealand, Norway, Panama, People's Republic of China, Portugal, Singapore, Spain, Sweden, Switzerland, Turkey, United Arab Emirates, United Kingdom and United States of America. 3 It should be noted that administrators based in the US are not generally `subject to' regulation in the US. As such specific additional provisions should be included in agreements with US-based administrators.
As a result it is crucial for the relevant administration agreement to contain provisions to this effect.
Automatic Exchange of Information Obligations
Cayman Islands funds are not directly subject to the US Foreign Account Tax Compliance Act (FATCA), however the Cayman Islands has introduced legislation implementing FATCA requirements for `financial institutions' to identify and report certain US accounts to the Cayman Islands Tax Information Authority (TIA) on an annual basis.
The Cayman Islands has also enacted regulations (CRS Regulations) to implement the OECD common reporting standard on automatic exchange of information (CRS) into Cayman Islands law. Under the CRS Regulations, Cayman Islands `reporting financial institutions' will have to report information on the holders of `reportable accounts' which are tax resident in `reportable jurisdictions'.
The Cayman Islands currently has an intergovernmental agreement with the United Kingdom (UK FATCA) which sets out similar due diligence and reporting obligations for `financial institutions' to identify and report certain UK accounts, without imposing a withholding tax regime for non-compliance (as applies under FATCA). However, UK FATCA will be phased out in 2017 as the Cayman Islands, the United Kingdom and all other British Overseas Territories and Crown Dependencies have undertaken to adopt the CRS.
The majority of Cayman Islands mutual funds fall within the definition of an `investment entity' and are generally classed as a `financial institution' for FATCA, UK FATCA and CRS purposes. As a result, those funds will have information gathering and reporting obligations to report the relevant information to the TIA on an annual basis and that information will then be sent automatically to the relevant home tax jurisdiction of the relevant account holders.
For further details of applicable FATCA, UK FATCA and CRS requirements, please contact your usual Harneys contact who would be happy to assist or see our Guide on Automatic Exchange of Information Obligations for Cayman Islands Investment Funds.
There is no restriction on the location of the investment manager of a regulated mutual fund and many managers decide to set up a Cayman Islands vehicle as the investment manager or adviser to the fund.
SIBL regulates the advisory and management services of investment managers and investment advisers incorporated, registered or with a place of business in the Cayman Islands. Cayman Islands managers managing regulated mutual funds will be exempted from regulation under SIBL and save for retail funds typically exemptions will also be available for managers managing unregulated funds.
Investment managers and advisers who are exempt from the requirement to be licensed under SIBL must, however, file an annual declaration with CIMA to confirm their exempt status and pay the prescribed exemption fee. Further details on investment managers and advisors and SIBL can be found in our Guide to the Securities Investment Business Law.
Supervision and enforcement CIMA can require a special audit of a regulated mutual fund. Regulated funds must also provide CIMA with such information and access to such records as CIMA requires. CIMA may apply to court to preserve the assets of a regulated mutual fund. CIMA has power in relation to a regulated mutual fund to revoke its registration, impose conditions upon it, require the substitution of a promoter or management, appoint advisers or persons to assume control of the affairs of the mutual fund or require the reorganisation or winding up of the mutual fund. The auditor of a regulated mutual fund must immediately give written notice to CIMA if the mutual fund is, or is likely to become, unable to meet its obligations as they fall due, is carrying on or attempting to carry on business in a manner prejudicial to investors or creditors or is maintaining insufficient accounting records to allow its accounts to be properly audited. For more information and key contacts please visit www.harneys.com/funds.
Harneys, September 2016 - KY:1535063_2
Harneys is a leading international offshore law firm. We provide the world's top law firms, financial institutions and corporations with legal services relating to British Virgin Islands, Cayman Islands, Bermuda, Cyprus and Anguilla law, from more than 12 offices around the globe. For more information about Harneys please visit www.harneys.com or contact us at firstname.lastname@example.org. This Legal Guide is for general information only and not intended to be relied upon for legal advice in any specific or individual situation.
Appendix Regulatory Flowchart for Cayman Islands Investment Funds
No investor redemption rights?
Closed-ended fund (typically used for private equity/ venture
capital type investments)
Will the fund have 15 or fewer investors and can a majority in number of them appoint or remove the operator of the fund?
Minimum Initial investment is US$100,000
Principal office in Cayman provided by a licensed fund administrator and no minimum initial investment amount?
None of the above?
Exempted Mutual Fund (typically used for family offices or seeding vehicles)
Registered Fund (typically used for high-net worth/ institutional type investors not licensed, some filing requirements. Most popular regulated fund in the Cayman Islands)
Administered Fund (local administrator must report to and be regulated by CIMA)
Licensed Mutual Fund (typically used for retail investors and very rare in the Cayman Islands)