John Wolf and Ian Dillon take a look at the implications of the amended Cayman Islands mutual funds law for hedge fund promoters and administrators six months after its introduction.
The Mutual Funds (Amendment) Law, 2006 (the “MF Amendment Law”), which came into effect on 14 November 2006, made a number of significant changes to the regulation of mutual funds in the Cayman Islands, dealing with matters from minimum subscriptions to whistle-blowing. In the six months since the new rules came into effect, the changes have been the subject of considerable discussion amongst members of the Cayman Islands mutual funds industry, with some changes receiving considerably more attention than others.
Increase to the minimum subscription
The anticipated increase in the minimum subscription for Sophisticated/ Professional Investor funds (so called section 4(3) or MF1 funds) from US$50,000 to US$100,000 in aggregate has been well received, given that the original US$50,000 minimum dated from 1993. The increase applied immediately the law came into effect, but the transitional provisions of the MF Amendment Law exclude all existing funds carrying on business in or from the Cayman Islands prior to the enactment of the MF Amendment Law from the increase in the minimum subscription. In addition, the Cayman Islands Monetary Authority (CIMA) has clarified that these transitional provisions extend to existing funds that create new classes or new segregated portfolios after the introduction of the MF Amendment Law. Hence, for pre-existing funds, the US$50,000 will continue to apply even to new classes or portfolios created after 14 November 2006.
Minimum holdings versus initial investments
Of course, the new minimum—being somewhat higher than the previous minimum—does mean that, whereas before, funds could comfortably meet the previous minimum requirement, often applying minimums higher than those required by the law, more funds are now applying the statutory minimum. This has led to a greater need for clarification on the question of minimum holdings versus initial investments. CIMA is continuing its pragmatic approach by applying the strict letter of the law, thereby imposing the minimum on the initial investment only. This allows fluctuations in net asset value and redemptions of investors’ holdings to reduce the value of an investor’s shareholding to below US$100,000 without falling foul of the Mutual Funds Law.
Perhaps the most controversial change, at least at the time, requires that Cayman Islands licensed administrators must satisfy themselves for all funds (not just “retail” section 4(1)(b) funds with no statutory minimum subscription amount) that the promoters are of sound reputation (per section 16(1)(a)), and that the business of the fund and offers of equity interests are carried out in a proper way (per section 16(1)(c)). This effectively puts retail type funds with no minimum subscription and nonretail type funds (including section 4(3) or MF1 funds with a statutory minimum subscription of US$100,000) on the same footing as regards Cayman Islands administrators’ obligations.
At the time the changes came into place, there was much discussion about the practicality and efficacy of this requirement, in particular, the ability of administrators to ensure that the business of the fund and offers of equity interests are carried out in a proper way. In addition, it was noted that non-Cayman administrators are not subject to this requirement, potentially imposing a competitive disadvantage on Cayman administrators.
Shortly after the enactment of the MF Amendment Law, industry discussion suggested that a further modification to section 16 of the Mutual Funds Law was under consideration by CIMA and was likely to result in a restriction of the scope of this requirement so that it would apply, as formerly, to “retail” section 4(1)(b) funds only. However, as we approach the end of the second quarter of 2007, amending legislation has not yet been passed or tabled. In the meantime, therefore, prior to any amendment being introduced, the new obligations on Cayman administrators continue to apply.
It remains to be seen whether this change—which effectively puts Section 4(3) funds with a statutory minimum subscription amount of US$100,000 and Section 4(1)(b) funds with no statutory minimum subscription amount (but which require a Cayman Islands administrator as principal office) on the same footing—will result in a greater number of promoters opting for Section 4(1)(b) funds registrations, allowing them to have a minimum investment amount of less US$100,000.
Perhaps the most significant change brought about by the MF Amendment Law was the establishment by CIMA of the e-reporting regime for Cayman Islands Mutual Funds. The MF Amendment Law provides that CIMA may specify the manner in which annual audited accounts are filed with it and, in this regard, the new law was the precursor to the electronic reporting regime that took effect from 27 December 2006 through the Mutual Funds (Annual Returns) Regulations 2006. Pursuant to these new regulations, information that was previously filed in hard copy form (generally in the audited accounts) will now be filed electronically via a secure system in the form of annual returns submitted electronically through a fund’s auditor.
Given that CIMA reported that the number of funds overseen by the Authority at the start of March 2007 was in excess of 8,300, the efficiencies to be gained from the e-reporting system are obvious. At the time of implementation, this was not viewed as placing any additional regulatory burden on regulated funds, and it would appear that the implementation of the regime has been smooth. A recent CIMA press release dated 29 March 2007 notes that the testing phase has been completed and that the new internet portal through which local auditors will submit the returns is now operational. The industry looks forward to the new level of statistical reporting promised by the implementation of this regime. Any reports published will not identify specific funds and will provide aggregate industry data only.
The other changes brought about by the MF Amendment Law include additional whistle-blowing obligations for Cayman Islands auditors, the power for CIMA to waive the requirement for an annual audit for registered mutual funds, and further provisions dealing with mutual funds offering interests in the Cayman Islands. These are briefly summarised below.
If an auditor becomes aware that a registered mutual fund is in breach of the Mutual Funds Law or the Money Laundering Regulations or is carrying on business in a fraudulent or criminal manner, the auditor must immediately notify CIMA. Nevertheless, it appears that this does not impose an obligation on auditors to actively seek out wrong doing or to do more than the usual audit checks.
Investment funds that are not established or incorporated in the Cayman Islands, but that are either managed or administered in the Cayman Islands, and that make an invitation to the public in the Cayman Islands to subscribe for equity interests must be registered under the Mutual Funds Law—except in the case of funds whose shares are listed on an approved stock exchange, or that are regulated in an approved category by an approved overseas regulatory authority and that are marketed through a person licensed under the Securities Investment Business Law. The shares of such funds can be sold freely in the Cayman Islands through a person licensed under the Securities Investment Business Law.
As promised, CIMA appears to be using its power to waive audits sparingly, for example, for part financial periods ending with the fund being placed into voluntary liquidation, and only after due investigation into the circumstances.
Six months after their enactment, these changes brought by the MF Amendment Law have, by and large, been positively received by the Cayman Islands investment funds industry, which continues to grow at a pace. The e-reporting regime is quite unique and promises to bring benefits both in terms of regulatory oversight and statistical information
John Wolf (firstname.lastname@example.org), Ian Dillon (email@example.com) or Robert Searle firstname.lastname@example.org) can be contacted at Campbells, Cayman Islands attorneys-at-law