The Cayman Islands is one of the most utilised international finance centres (IFC) in the Asian finance industry. The largest and most populous continent, Asia covers a diverse cultural landscape, with highly differing economies, laws and regulations and it is against this backdrop that the use of Cayman structures has been established as a legitimate and important channel for capital inflows and outflows between Asia countries and around the globe. In particular, they have been highly utilised across Asia in capital markets, structured finance, M&A, and in the funds industry, most notably in Hong Kong, Singapore, China and Japan.
Cayman Islands entities, when incorporated into a structure, can assist businesses compete for and service an international client base allowing international stakeholders to co-operate without any one stakeholder taking the "home field" advantage. There are also a number of advantages in the Cayman Islands' legislative framework that have helped secure its prominence. In particular, the Cayman Islands has historically been an attractive jurisdiction for Asia-focused funds, it has been one of the most popular domiciles for the listing vehicle for companies listing on the Hong Kong Stock Exchange (HKSE) and, in Japan, the Cayman Islands unit trust has historically been the vehicle of choice for non-domestic hedge funds. The use of Cayman Islands entities in these industries now has a long track record in the region and this familiarity amongst counterparties has contributed to its popularity.
Cayman Islands companies were first permitted to list on the HKSE in the mid-1990s. At that time, the list of approved jurisdictions (other than Hong Kong) was limited, including only the PRC, Bermuda, the Cayman Islands and the Cook Islands. The list has now been expanded to include the BVI, the Isle of Man, Jersey and Guernsey, but the Cayman Islands remains the clear favourite. At the end of 2017 Cayman Islands companies accounted for 47% of all listed companies on the HKSE's Main Board and 36% of total market capitalisation. The number of Cayman Islands companies listed has grown each year for over a decade. For the HKSE's GEM (which services small and mid-sized issuers), Cayman Islands companies account for 76% of all listed companies and 73% of market capitalisation. The number of companies has grown for seven years, following a period of declines around the financial crisis.
Given this dominance on one of the ten largest exchanges in the world, Asia founders typically look to establish a Cayman Islands holding company with a view to listing the company in the future. This has been prevalent amongst Chinese, Taiwanese and Hong Kong entrepreneurs.
In the finance space, we have seen an increase in enquiries from Chinese asset managers evaluating the possibility of securitising their loan portfolios using Cayman Islands incorporated "orphan" special purpose vehicle (SPV) structures. Global distressed debt fund specialists are actively purchasing non-performing loan (NPL) portfolios in China, with the scale of NPLs on commercial balance sheets in China being well publicised and commentators predicting that the securitisation of these acquired NPL portfolios is likely to grow.
The transaction involves the SPV acquiring underlying assets from the asset manager or fund (the Originator), using the proceeds of the issue of notes (or other securities) made by the SPV to investors. The SPV then uses the revenue-stream generated by the underlying assets to fund the coupon and principal repayments due to its investors on the notes.
In such a transaction, the SPV will most usually be established as a Cayman Islands exempted company limited by shares. The beneficial interest in the shares in the SPV is held via a Cayman Islands charitable trust or a STAR (i.e. a purpose) trust. As a result, the SPV will not be part of the Originator's corporate group and so the SPV and its assets will be "off-balance sheet".
Looking at the Chinese funds market, there are now dozens of Chinese funds that manage $1 billion or more; many of which have set up operations in Hong Kong serving as a primary offshore launch pad for mainland managers seeking to access the international markets. Whilst there is arguably plenty of capital to be raised in China, many of these managers are interested in international recognition and are expanding their portfolio to include offshore funds, predominantly structured using Cayman Islands vehicles, as they seek investment from US investors and other investors across Asia and parts of Europe.
Meanwhile China's neighbour Japan has also witnessed a drive for the "internationalisation" of its funds markets, which has directly benefited the Cayman Islands funds industry. An announcement in early 2017 by the world's largest pension fund, Japan's Government Pension Investment Fund, of its intention to allocate to alternative investments mainly outside of Japan, has been a catalyst for more pension funds and Japanese institutional investors to follow suit and allocate to alternative investments. This was further stimulated by a period of negative interest rates. As a result, a market that traditionally invested conservatively in Japanese government bonds or other conservative investments is increasingly placing some of that domestic wealth offshore and (whether investing offshore or onshore) partnering with offshore managers to seek more diversified investments.
The Cayman Islands unit trust has always been, and remains, the most popular structure for these types of investors, given the similarity to the Japanese domestic investment trust and the associated historical tax benefits (despite these now having ceased to apply). Ogier has, in recent years, been involved in collaborations between some of the largest Japanese domestic investment managers on the one hand and some of the most highly regarded US and European investment managers on the other hand, managing Japanese capital in both the private equity and hedge fund space.
In the last few years we have seen global regulatory reforms, new structuring options and shifts in market trends that have changed the landscape for the alternative investment fund industry, creating a "domicile dilemma" for managers and, as a result, the Cayman Islands has seen competition from other offshore and mid-shore jurisdictions. Where the fund will mainly raise capital in Europe, Luxembourg or Ireland will likely be a preferred choice to take advantage of the European passport but otherwise the Cayman Islands continues to dominate the Asian arena in the non-retail space. The true benefit of the Cayman Islands regulatory regime lies in its design to accommodate funds marketed to sophisticated and institutional investors.
Benefits of the Cayman Islands
There are a number of key attributes of Cayman Islands vehicles which contribute to the continued popularity of the Cayman Islands across all of these sector including:
- the speed at which a Cayman Islands entity can be incorporated (can be completed as quickly as within 24 hours so that transactions can be brought to market fast);
- the flexibility of requirements relating to directors (the minimum number of directors for a non-regulated entity is one and there is no requirement for any director to be resident in the Cayman Islands);
- there is no requirement for financial records of a non-regulated Cayman Islands entity to be audited;
- the cost of forming a Cayman Islands entity is relatively low compared to other jurisdictions;
- multiple structures available including:
- the fiscal neutrality of the Cayman Islands is an important element for the cross-border nature of transactions, where investors may be spread across a number of jurisdictions. Tax-neutrality in the Cayman Islands does not affect the obligations of those stakeholders to pay tax in their home jurisdictions. Indeed, the Cayman Islands has repeatedly condemned tax evasion and was an early adopter of both FATCA and CRS, thereby taking part in a global movement towards increased transparency in the financial services industry;
- stringent AML requirements pursuant to its AML regime. The thrust of the recent changes to the Cayman Islands AML Regulations was to close gaps that remained between Cayman's anti-money laundering regime and the Financial Action Task Force 2012 recommendations;
- robust common law legal system based on English law and with ultimate recourse to the Privy Counsel of the United Kingdom; and
- developed network of sophisticated professional advisors in the Asian region advising on Cayman Islands law.
Other benefits applicable to specific sectors include:
- the speed with which a Cayman Islands fund can launch in accordance with the Mutual Funds Law, the fact that a Cayman Islands fund does not have any restrictions on the location of its investment manager or other service providers (save in the case of the auditor for a CIMA registered fund).Unlike in some Asian "mid-shore" jurisdictions, the Mutual Funds Law places no restriction on investment scope and no requirement for local directors;
- the flexible nature of Cayman Islands corporate law means the listing and ongoing requirements of the HKSE's listing rules can easily be met within the legislative framework of the Cayman Islands and the company can focus on the requirements of the HKSE rules.The HKSE rulebook also has specific sections in its listing rules setting out constitutional requirements for a Cayman Islands incorporated listing vehicle, which simplifies matters further;
- Cayman Islands legislators have developed the legal framework in the Cayman Islands to codify key concepts found in secured noted transactions, such as the need for the SPV to be "bankruptcy remote". For example section 95(2) of the Companies Law (Revised) of the Cayman Islands contains an express statutory recognition of the contractual agreement between the parties to the transaction not to petition for the winding up of the SPV whilst the notes remain outstanding;
- no government or regulatory approvals are required in the Cayman Islands for the incorporation of a Cayman Islands company to be used as a listing vehicle (on an exchange other than the Cayman Islands Stock Exchange) or of an SPV, a closed ended fund or an exempt open ended fund, in each case, as long as it is not doing business in the Cayman Islands or offering the notes/shares (as applicable) to residents in the Cayman Islands; and
- the main rating agencies all recognise Cayman Islands as a well-established jurisdiction often used by participants in financial markets.
The Cayman Island's strong track record in the region together with the multitude of advantages set out above should mean that market participants in Asia will continue to look to the Cayman Islands as a jurisdiction of choice for structures across a wide range of sectors. The commitment in the Cayman Islands to keeping pace with global regulatory standards, ensures the jurisdiction is well placed to adhere to today's legal and global regulatory demands and participate in the continued growth we see in the Asian economy.
This piece first appeared in Cayman Finance Magazine.