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Fund managers have plenty of issues to keep abreast of, but few provide such a consistent challenge as keeping up with the rapid rate of regulatory change. Service providers, and in particular independent directors, can help, says James Macfee at International Management Services.
Investment funds face a constant barrage of pressure. Whether it’s the effects of global events such as COVID-19, concerns around generating returns, investors calling for a reduction in fees or the competition to attract and retain talent, managers always have plenty of issues on their minds.
Among the many pressures fund managers face, one in particular stands out: the ever more burdensome and complex regulatory requirements facing our industry consistently demand more focus and resources.
This article is intended to provide a brief and succinct summary of the most recent Cayman regulatory changes affecting Cayman Islands-domiciled investment funds. Ignoring the numerous recent amendments to anti-money laundering (AML) requirements in the jurisdiction, we also have one new law and an amendment to existing law.
Both have passed since the start of 2020, and draw previously exempt funds under the watchful eye of the Cayman Islands Monetary Authority (CIMA).
Private Funds Law
The Private Funds Law 2020 applies to funds (established as companies, unit trusts or partnerships) whose principal business is the offering and issuing of 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 investments where (a) the investors do not have day-to-day control over the investments; and (b) the investments are managed by or on behalf of the operator of the private fund, directly or indirectly, for reward based on the assets, profits or gains of the fund.
There are several notable exemptions for vehicles such as single family offices, sovereign wealth funds, securitisation special purpose vehicles, funds listed on approved stock exchanges, and pension funds, to name a few.
We are recommending that investment managers seek advice from Cayman counsel as to whether any of their Cayman vehicles fall within the definition of a ‘private fund’. This will give rise to a number of obligations and requirements which are summarised below.
Registration
A six-month transitional period has been given to provide an onboarding window for existing funds, and funds soon to be launching. As of August 7, 2020, all ‘private funds’ must be registered with CIMA and in compliance with the various requirements set out in the Private Funds Law.
After August 7, 2020, funds will be required to register with CIMA within 21 days of any confirmed capital commitments. They must be registered prior to accepting any capital contributions for the purposes of investments.
Appoint a custodian or administrator
Unless it can be established to CIMA’s satisfaction that it is neither practical or appropriate, funds are required to appoint a custodian or administrator to perform the functions ascribed to them in the Private Funds Law. Where it is not practical or appropriate, the manager or operator may perform these duties, which include:
- Valuation: a private fund must have an established procedure for the valuation of its assets in accordance with the Private Funds Law. Valuation procedures are to be carried out as frequently as necessary for the assets, and at least annually.
- Safekeeping of fund assets: a private fund must have an appointee hold the custodial fund assets and be able to verify that the private fund holds title to those assets.
- Cash monitoring: a private fund must monitor the cash flows and ensure that all cash flows are appropriately booked.
- Identification of securities: a private fund that regularly trades or holds securities must maintain a record of the identification codes (eg, ISIN) of such securities.
Audit
A private fund must have its accounts audited annually by a CIMA-approved auditor, with its accounts prepared in accordance with major reporting standards. Audited accounts must be submitted to CIMA within six months of the fund’s financial year end.
Annual return
A private fund must submit an annual return in a form to be prescribed.
For most private funds, the Private Funds Law is likely to result in minimal additional administrative burden beyond the requirement for
the annual audit. Certainly, the filing requirements are familiar to
Cayman Islands financial services professionals and we do not expect funds to have difficulty in adjusting to these new requirements.
Many funds in this category will already have a custodian and administrator in place.
Changes to the Mutual Funds Law
The Cayman Islands government has amended the Mutual Funds Law to capture funds which were previously exempted from registration under Section 4(4) of the Mutual Funds Law.
Mutual funds with 15 or fewer investors, the majority of whom could appoint or remove the operators of the fund (Section 4[4] of the Mutual Funds Law), were previously exempt from registering with CIMA. For most funds caught by this amendment, the requirements are relatively straightforward.
The rules do mean that such funds will have to register with CIMA. They will also be required to submit an annual return to CIMA and pay a prescribed fee annually; have at least two directors who are natural persons (registered under the Directors Registration and Licensing Law in Cayman); have their accounts audited by an approved Cayman Islands-based auditor; and file the audited accounts with CIMA within six months of the fund’s financial year end.
This amendment came into force on February 7, 2020. There is a six-month transition period for existing Section 4(4) funds which will need to comply with the registration requirements by August 7, 2020 and be in compliance with the amended law by that date. New Section 4(4) funds that start carrying on business after February 7, 2020, must comply immediately.
Benefits of these regulatory updates
These legislative changes respond to an evolution in global regulation of the financial industry, primarily driven by the Organisation for Economic Co-operation and Development, the European Union and the Caribbean Financial Action Task Force. The Cayman Islands has consistently responded to global changes like these with a thoughtful and considered approach.
This enables prompt adherence to evolving regulatory and AML standards and best practices, ensuring its position as a leading international financial centre and jurisdiction of choice for the majority of alternative investment funds.
CIMA-regulated investment funds benefit from a globally recognised regulatory environment that is based on international standards and best practices. Regulations are delivered through a risk-based approach that is balanced and proportionate. Registration with CIMA may help to broaden a fund’s investor base and assist with the due diligence requirements of investors.
EU blacklist
It would be difficult to write an article relating to the Cayman funds industry without mentioning the addition of the Cayman Islands to the EU’s list of non-cooperative jurisdictions for tax purposes on February 18, 2020.
We expect the Islands’ inclusion on the list to be temporary. The Cayman Islands government has already commenced the process for removal at the next opportunity, which is expected to be in October 2020. At the time of writing, none of the EU member states has applied administrative measures regarding transacting with structures in any of the jurisdictions on the EU blacklist.
What should you do?
Today’s constant regulatory change creates such a resource demand that the majority of investment funds will require assistance in these matters. The fund’s service providers are crucially important in helping managers keep up with the rate of change.
Cayman-based independent fund directors have a particularly important role. Alongside the usual criteria of capacity, independence, experience, qualifications and diversity, it is essential to ensure that the funds’ directors have a thorough understanding of the regulatory regime in which the fund operates.
Reaching out to your Cayman-based legal counsel and independent directors is a good place to start to ensure that your fund
always remains compliant with local regulation and is following
best practices.
International Management Services (IMS) is among the leading providers of directorship services for the alternative investment industry in the Cayman Islands. IMS’ team of qualified and experienced professional directors boast diverse backgrounds spanning legal, accounting, compliance, regulation and fiduciary services. IMS and its directors are not affiliated with other fund service providers or law firms, allowing it to provide independent corporate governance expertise to the highest industry standards.
James Macfee is an independent director based in the Cayman Islands with International Management Services. He can be contacted at: jmacfee@ims.ky
James Macfee, International Management Services
