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On 31 January 2020 the government approved the Private Funds Bill 2020 and an amendment to the Mutual Funds Law (2020 Revision) (MFL Amendment). The legislation is the result of certain EU and other international recommendations and has been developed to align the Cayman Islands investment fund regulatory regime with those of other jurisdictions. Both the draft Private Funds Bill and the draft MFL Amendment were originally published on 8 January 2020 and were put before the Cayman Islands Legislative Assembly on 30 January 2020, where final amendments were made (as summarised herein). Draft regulations setting out certain outstanding definitions, as well as the anticipated phased transitional period for compliance, are expected imminently.
Given the significance of the Private Funds Bill and the MFL Amendment, this article summarises their key features.
Who is caught by the bill?
The bill applies to all Cayman Islands closed-ended funds. If such a fund falls within the definition of a 'private fund', the bill provides for its registration with, and its regulation by, the Cayman Islands Monetary Authority (CIMA). Mutual funds such as open-ended hedge funds are not caught by the bill and continue to be regulated by the MFL.
The definition of a 'private fund' captures all companies, unit trusts and partnerships whose principal business is the offering and issuing to investors of participating, non-redeemable investment interests, the purpose or effect of which is the pooling of investor funds with the aim of spreading investment risks and enabling investors to receive profits or gains from such vehicle's investment activity, where:
- the holders of investment interests have no day-to-day control over the vehicle's investment activities; and
- the investments are managed as a whole by or on behalf of the fund operator for reward based on the vehicle's assets, profits or gains.
Vehicles that issue only debt or prescribed alternative financial instruments are not deemed to be issuing investment interests and so do not fall within scope of the bill. The bill also expressly exempts non-fund arrangements, including:
- securitisation special purpose vehicles;
- joint ventures;
- proprietary vehicles;
- holding vehicles;
- preferred equity financing vehicles;
- sovereign wealth funds; and
- single family offices.
Funds which are established for only one investor will be outside the scope of a private fund given the pooling of investor funds requirement.
What are the timing requirements for registration?
The bill expressly permits private funds to enter into agreements (which are understood to include subscription agreements, side letters and partnership agreements) with investors and accept capital commitments from investors for the purpose of making investments before submitting their registration application to CIMA. If any investor is not a high-net-worth or sophisticated investor, a private fund must apply to register with CIMA within 21 days of its acceptance of capital commitments.
In all cases, private funds must register with CIMA before accepting capital contributions from investors regarding investments.
Does registration involve filing an offering document?
The bill does not include a specific requirement to have or file an offering document as part of the private fund registration process. 'Prescribed details' will need to be filed (exactly what this entails will be confirmed in separate regulations).
What operating requirements apply?
The bill seeks to ensure that there is transparency and a proper papering of private funds' core operations and processes. The bill will achieve this by aligning the below requirements with the procedures currently used by most private funds.
Audited financial statements (signed off by a Cayman Islands auditor) must be submitted to CIMA within six months of a private fund's financial year end. The bill expressly permits private funds to prepare and file financial accounts that are combined or consolidated with an alternative investment vehicle.
Valuations of the assets of a private fund must be carried out at a frequency that is appropriate to the assets held by the private fund. Generally, valuations will be required on at least an annual basis; however, the bill expressly empowers CIMA to waive the valuation requirements, either absolutely or subject to such conditions as deems appropriate. If valuations are not performed by an appropriately qualified independent third party, the valuation function established by the manager or operator (eg, general partner) of the private fund must be independent of the portfolio management function or the potential conflicts of interest must be properly identified and disclosed to investors.
A custodian must be appointed to:
- hold in custody, in segregated accounts, the custodial fund assets;
- verify that the private fund holds title to any other fund assets; and
- maintain a record of those other fund assets.
A private fund will not be required to appoint a custodian if it has notified CIMA and it is neither practical nor proportionate to do so, having regard to the nature of the private fund and the type of assets that it holds. In these circumstances, a private fund must appoint a person to carry out title verification. If such verification is not performed by an independent third party, the verification function established by the manager or operator of the private fund must be independent of the portfolio management function or the potential conflicts of interest must be properly identified and disclosed to investors.
A private fund must appoint a person to:
- monitor the cash flows of the private fund;
- ensure that all cash has been booked in cash accounts opened in the name, or for the account, of the private fund; and
- ensure that all payments made by investors in respect of investment interests have been received.
When the cash monitoring function is not performed by an administrator, custodian or another independent third party, the cash management function established by the manager or operator of the private fund must be independent of the portfolio management function or the potential conflicts of interest must be properly identified and disclosed to investors.
A private fund that regularly trades securities or holds them on a consistent basis must maintain a record of the identification codes of the securities that it trades and holds and make this available to CIMA upon request.
Although not contemplated in the bill, CIMA has separately confirmed that it will require all private funds to have at least two natural persons acting as or for the operator (eg, a board of directors or general partner) of the private fund.
All operating conditions and procedures must be appropriate and proportionate given the scale and operations of a private fund. Where independent third parties are not engaged to carry out the above functions, CIMA may require that third-party verification be undertaken. The bill provides that CIMA's supervision and monitoring of private funds (including the above operating conditions) is risk based.
The bill provides that alternative investment vehicles will not have to comply with these operating requirements, with the definition of 'alternative investment vehicles' to be published in subsequent regulations.
Does the bill contemplate different categories of private funds?
The bill contemplates a category of private fund, to be termed a 'restricted scope private fund'. It is yet to be determined what the eligibility for this category of private fund will be and the extent of its impact on the registration and ongoing obligations otherwise applicable to private funds under the bill.
The risk-based supervision requirement may allow for CIMA to adapt the registration and supervision requirements for funds with particular profiles.
Timing and fees The government has the discretion to determine when the bill or various sections will come into force and issue regulations for transitional provisions. The government has stressed that it is mindful that a smooth and successful transition for existing private funds will require preparation and time. Details of fees and prescribed forms will be covered by separate regulations.
Who is affected?
The MFL Amendment will affect open-ended funds carrying on business in or from the Cayman Islands that were previously exempt from CIMA regulation under Section 4(4) of the MFL. Section 4(4) of the MFL currently provides a registration exemption to mutual funds whose equity interests are held by no more than 15 investors, a majority of whom are capable of appointing or removing the operator of the fund.
What is required of affected funds?
Pursuant to the MFL Amendment, Section 4(4) funds will be required to register with CIMA by:
- filing a certified copy of the constitutive documents which specify that a majority of investors in number are capable of appointing or removing the operator of the fund;
- filing such other information as may be required in the prescribed form; and
- paying the prescribed registration fee.
A Section 4(4) fund registered under the MFL Amendment will not be required to have a prescribed minimum initial investment amount nor is there any requirement to have or file an offering document.
Pursuant to Section 4(4) of the MFL Amendment, funds will be required to have at least two natural persons acting as or for the operator (eg, a board of directors or general partner) and that these persons will be required to register under the Directors Registration and Licensing Law (Revised).
Will there be any audit requirements for Section 4(4) funds?
Section 4(4) funds will be required to have their accounts audited annually by a CIMA-approved auditor. The MFL Amendment requires that the accounts be prepared and audited in accordance with:
- International Financial Reporting Standards;
- US, Japanese or Swiss generally accepted accounting principles; or
- the generally accepted accounting principles of a non-high-risk jurisdiction.
What is the anticipated timing for the MFL Amendment
The MFL Amendment provides a six-month transitional period for compliance once in force; it is currently anticipated that the MFL Amendment will come into force at the same time as the bill.