I OVERVIEW OF RECENT ACTIVITY
Asset management vehicles established in the Cayman Islands can be divided into two distinct groups:
- a regulated open-ended funds, for which there is an abundant supply of publicly available statistical information (although it lags behind the market, as is inevitably the case for information compiled by a regulator); and
- b other asset management vehicles (including closed-ended funds), for which the available data is more limited.
A cornerstone to the success of the Cayman Islands’ financial services sector is its strong legal and regulatory system, which equally benefits managers and institutional investors. The jurisdiction is attentive and responsive to developing international trends. It continues to evolve to ensure it meets the requirements of finance sector participants, and governmental and regulatory authorities. Against this background, there have been a number of noteworthy developments, which are discussed in more detail below.
The Cayman Islands continues to maintain its position as the leading jurisdiction for the registration of funds, with 11,010 funds regulated under the Mutual Funds Law (2015 Revision) as at year end-2014. While the level of exceptional growth experienced in the years preceding the global financial crisis has ended, the industry has largely held its ground since the crisis. In 2015, 987 Cayman Islands open-ended funds were registered with the Cayman Islands Monetary Authority (CIMA).2 The Cayman Islands are currently on track to see approximately the same number registered in 2016. Another indicator of the industry’s resilience is CIMA’s statistical digest for 2014, which shows growth in the net asset value of reporting funds up from US$3.213 trillion in 2013 to US$3.592 trillion in 2014.3
It is more difficult to obtain an accurate overview of the state of the Cayman Islands’ asset management industry as a whole, which would necessarily include looking at the level of managed account activity and closed-ended fund activity.
The recent past has seen a trend towards managed accounts, but this is difficult for the jurisdiction to track accurately. While single investor vehicles created as part of a managed account structure may involve registration of the relevant vehicle with the Cayman Islands registry, the vehicle will often not be required to register with CIMA because there is only one investor and therefore no pooling of investor funds (a requirement of the statutory definition of a mutual fund). Added to this is the fact that many managed accounts do not require that a separate vehicle be established, as they are operated through contractual arrangements onshore (e.g., in the EU or the US) that need not involve a tax-neutral jurisdiction such as the Cayman Islands.
There is also an exception to the need to register with CIMA for funds known as Section 4(4) funds, which are open-ended investment funds that pool investor funds but that have 15 or fewer investors, a majority of whom are given the power to appoint and remove the fund’s directors, general partner or trustee, as applicable.
Closed-ended funds (i.e., funds that do not permit investors to voluntarily withdraw all or part of their investment prior to winding-up) fall outside the regulatory regime in the Cayman Islands, so it is difficult to gauge their numbers. The most useful indicator of the level of closed-ended fund activity (which generally includes funds investing in illiquid asset classes, such as private equity, real estate or infrastructure projects) is the level of registrations of Cayman Islands exempted limited partnerships (ELPs). However, this is only a rough indicator based upon practitioners’ experience that the majority of the ELPs formed are used in closed-ended fund structures. This is borne out by CIMA’s statistical digests, which show that only a small fraction of open-ended funds are formed as ELPs; for example, ELPs accounted for only 10 per cent of the total number of reporting funds in 2014.4 Figures released by the Cayman Islands Registrar of Exempted Limited Partnerships show that at the end of 2015, there were a total of 17,896 ELPs registered in the Cayman Islands. The years since the crisis have seen a consistent increase in the number of annual ELP registrations. In 2015, the figure for new ELPs formed stood at an all-time high of 3,370 compared with 2,893 in 2014, 2,368 in 2013, 2,037 in 2012 and 1,897 in 2011.
ELPs are utilised for a variety of purposes within closed-ended structures. An ELP may well be the primary fund vehicle, but often ELPs will also serve other purposes (e.g., ELPs may be used as a feeder into an onshore fund, an alternative investment vehicle, a parallel fund or a co-investment vehicle). Changes in the rate of formation of ELPs could therefore indicate fluctuations in the rate of new fundraising, but are just as likely to point to variations in the level of transactional activity by established closed-ended funds themselves.
II GENERAL INTRODUCTION TO the REGULATORY FRAMEWORK
As noted above, investment funds in the Cayman Islands are either open-ended and subject to regulation (unless falling within the Section 4(4) exception), or closed-ended and therefore outside the regulatory regime. The primary statute regulating Cayman Islands investment funds is the Mutual Funds Law (2015 Revision) (Mutual Funds Law). Subject to the Section 4(4) fund exception, an investment fund qualifies as a mutual fund, and is, therefore, required to be regulated under the Mutual Funds Law if:
- a it is a Cayman Islands company, partnership or unit trust;
- b it issues equity interests to investors (i.e., shares, partnership interests or trust units that carry an entitlement to participate in profits or gains, and which may be redeemed or repurchased at the option of those investors prior to winding-up); and
- c its purpose or effect is the pooling of investor funds with the aim of spreading investment risks and enabling investors to receive profits or gains from investments.
The key distinction between such a fund and a closed-ended fund is the ability of investors to voluntarily withdraw some or all of their investment prior to winding-up, whether at will or on a specified period of notice. However, the question of whether shares, partnership interests or trust units are voluntarily redeemable or can be repurchaseable prior to winding-up can be difficult to answer where long lock-up periods are part of a transaction’s terms, although Cayman Islands practitioners and CIMA generally consider that a lock-up period should be at least three years for an investment fund to be regarded as closed-ended at the outset.
In December 2011, legislation aimed at the registration of master funds in a multi-level investment fund structure was brought into effect. A master fund within such a fund structure will be deemed to be a mutual fund for the purposes of the Mutual Funds Law and, accordingly, will be required to be regulated under the Mutual Funds Law, if it:
- a is a Cayman Islands company, partnership or unit trust;
- b issues equity interests to one or more investors;
- c holds investments and conducts trading activities for the principal purpose of implementing the overall investment strategy of the regulated feeder fund; and
- d has one or more regulated feeder funds (i.e., a mutual fund regulated under the Mutual Funds Law that conducts more than 51 per cent of its investing in a master fund, whether directly or indirectly via an intermediary entity), whether directly or through an intermediary entity established to invest in the master fund.
Due to the definition of master fund under the Mutual Funds Law, a master entity in a structure having only one investor (so there is, strictly speaking, no pooling element) will constitute a mutual fund. The exact fund structure will, in each case, determine whether registration of a master entity, or any other entity, is necessary, although there are certain structural approaches that may allow such an entity to fall outside the scope of the master fund registration regime under the Mutual Funds Law.
Few investment funds are fully licensed under the Mutual Funds Law, as this is generally only necessary for retail funds, while the majority of investment funds formed in the Cayman Islands are intended for institutional or high-net-worth investors. Of the total number of 10,940 regulated investment funds at the end of 2015, only 101 were fully licensed by CIMA under the Mutual Funds Law.5
The two alternatives to obtaining a full licence under Section 4(1)(a) of the Mutual Funds Law are to be regulated as an administered fund under Section 4(1)(b) of the Mutual Funds Law, or as a registered fund under Section 4(3) of the Mutual Funds Law. As at 31 December 2015, the numbers of administered and registered funds (including master funds) were 380 and 10,459 respectively.6
Administered funds have steadily declined in popularity in recent years (from 510 in 2008 to 380 in 2015),7 perhaps because the administrators who originally saw them as a source of higher fees came to realise that the higher fees were counterbalanced by higher risks. Registration as an administered fund is achieved by designating a Cayman Islands licensed mutual fund administrator as the fund’s principal office. The administrator must satisfy itself that the promoters of the fund are of sound reputation, that the fund’s administration will be undertaken by persons with sufficient expertise who are also of sound reputation, and that the fund’s business and its offering of equity interests will be carried out in a proper manner. The administrator is obliged to report to CIMA any suspected infringements of the Mutual Funds Law (or any other law) by the fund, or any suspicion that it may be insolvent or that it may be acting in any manner prejudicial to its creditors or investors. Clearly, this imposes a role of quasi-regulator and compliance monitor on the administrators themselves, which they will find burdensome to carry out effectively.
Registered funds regulated under Section 4(3) of the Mutual Funds Law account for approximately 95 per cent of all regulated investment funds in the Cayman Islands as at 31 December 2015.8 The straightforward requirements for registration and the absence of a pre-approval process are the most obvious drivers of this popularity. The basic requirements for registration under Section 4(3) (for both traditional mutual funds and master funds) are that the minimum investment per investor is at least US$100,000 (or its equivalent), or that the equity interests are listed on a recognised stock exchange. Registration involves the online filing of an application form together with the fund’s offering document and consent letters from its Cayman Islands auditor and its administrator. A separate offering document is not required for a regulated master fund. On an ongoing basis, the fund must file an amended offering document within 21 days of any material change that occurs while it is still offering its equity interests. It must also file with CIMA annual audited accounts, a key data elements form and a fund annual return (all submitted electronically by the fund’s auditor) within six months of the end of each financial year.
There are no local service provider requirements for Cayman Islands regulated investment funds, other than the requirement to have an approved local auditor.
The corporate governance regulatory framework for funds is currently a focus for CIMA. Partly in response to industry trends and regulator requests, CIMA issued a Statement of Guidance on Corporate Governance for Regulated Mutual Funds (SOG) on 13 January 2014. The SOG is relevant to all regulated mutual funds, their individual operators and their governing bodies. It does not extend to the banking and insurance sector. The purpose of the SOG is to provide individual operators and governing bodies of funds with guidance on CIMA’s minimum expectations for the sound and prudent governance of a regulated mutual fund. It is not intended to be an exhaustive guide. While the SOG is not directly enforceable by CIMA, CIMA may look to the SOG as a guide should it need to consider whether the direction and management of a regulated mutual fund has been conducted in a ‘fit and proper manner’.
Following on from the issue of the SOG came the Directors Registration and Licensing Law, 2014 (DRL Law) in June 2014. The DRL Law was brought into force to assist CIMA in verifying and maintaining key information on directors of companies regulated by CIMA as funds under the Mutual Funds Law; and companies registered with CIMA as ‘excluded persons’ under certain heads of the Securities Investment Business Law (2015 Revision), usually due to involvement as the investment manager in a fund structure (together, covered entities); this was done both for CIMA’s own purposes and to assist CIMA with overseas regulator requests. The DRL Law requires directors of covered entities to be registered with or licensed by CIMA, and allows CIMA to regulate ‘professional directors’ and ‘corporate directors’ of covered entities. The DRL Law will be relevant to any person who is, or who intends to become, a director of a company that is or will be a covered entity, whether that person is resident in the Cayman Islands or elsewhere.
III COMMON ASSET MANAGEMENT STRUCTURES
Three types of vehicle are most commonly utilised by Cayman Islands investment funds: exempted companies, ELPs and exempted unit trusts. Exempted in this context simply means that the vehicle is eligible to apply to the government for an undertaking (lasting 20 or 50 years depending on the type of vehicle) that, if any taxation is introduced in the Cayman Islands during the period to which the undertaking applies, such taxation will not apply to the vehicle in question. In return, exempted vehicles are not permitted to carry on business within the Cayman Islands.
Exempted companies limited by shares are the most commonly used vehicle for open-ended funds. In 2014, 77 per cent of reporting funds were exempted companies (including segregated portfolio companies).9
Typically, closed-ended funds established in the Cayman Islands are established as ELPs. Most jurisdictions with managers of, or investors in, such funds have become comfortable with the limited partnership structure prevalent in the United States, which is replicated to a significant degree in the Cayman Islands ELP structure. While exempted companies are extremely flexible in the extent to which voting and economic rights can be mixed among different classes of shares, companies, by their very nature, have certain limitations that do not apply to ELPs.
There are fewer statutory rules governing the approvals processes within an ELP, which makes them generally more flexible. For instance, general partners can be, and usually are, delegated a certain degree of unilateral authority to amend the limited partnership agreement of an ELP, while such powers cannot be delegated to the directors of an exempted company in relation to its memorandum and articles of association (which can only be amended by special resolution of its shareholders). However, the key reasons for the use of ELPs for closed-ended funds relate to distributions. First, general partners are only limited by the terms of the limited partnership agreement when considering which sources of funds to utilise, while the directors of a company are restricted by statutory and common law maintenance of capital rules. Even more significant, however, is:
- a the ability of partners to directly enforce the limited partnership agreement against one another; and
- b the fact that the terms of investment can easily be expressed to survive a partner’s withdrawal (whereas a shareholder in a company ceases to be subject to its articles of association when he or she no longer holds any shares).
Closed-ended funds generally make distributions on a waterfall basis, most commonly by paying distributions first to investors until all capital contributions have been returned and a certain level of return obtained, then to the manager or general partner until it has received a specified percentage of the aggregate amount of all distributions, and then to investors and the manager or general partner in specified percentages. Such distributions are often subject to claw back at the end of the fund’s life if, once all distributions have been made, the manager or general partner has received a higher proportion of the aggregate distributions than intended, or in some cases to fund indemnity payments. Utilising a company in this situation would generally require these obligations to be set out in a separate shareholders’ agreement that is also signed by the company to ensure that the obligations survive a shareholder’s withdrawal, and can be directly enforced by each investor and the company as against each other.
Investment funds structured as unit trusts are primarily formed in the Cayman Islands for distribution in Japan, where the demand is generated by familiarity with the unit trust structure and historical local tax benefits relating to trust units as opposed to company shares or limited partnership interests. The Cayman Islands also has specific regulations10 that such investment funds can elect to comply with when applying for a licence under the Mutual Funds Law, which under current guidelines set by the Japan Securities Dealers Association permit them to be marketed to the public in Japan. Although companies and limited partnerships are also eligible to use this regime, the popularity of unit trusts with Japanese investors means that funds regulated under this regime are usually unit trusts.
IV MAIN SOURCES OF INVESTMENT
The disparity of available information between regulated and unregulated investment funds in the Cayman Islands is evident when analysing the source and value of investments in such funds. CIMA’s published statistics11 provide a useful indication of the scale of the regulated industry, with the net asset value of reporting funds in 2014 being almost US$3.6 trillion, and reported inflows and outflows during 2014 from such funds of US$1.113 trillion and US$808 billion respectively. It is worth bearing in mind that the actual figures for open-ended funds alone will exceed these amounts because CIMA’s figures are based only on the 89 per cent of regulated funds as at December 2014 that had actually filed their fund annual returns for 2013 by December 2013, and they do not capture funds exempted from regulation under Section 4(4) or funds held in managed accounts.
We can speculate that the size of the closed-ended fund industry in the Cayman Islands is of a similar order. However, as previously noted, the exact number of closed-ended fund vehicles is difficult to establish, and the details of equity holders in those vehicles and the size of their investments is not publicly available information. Therefore, it should be noted that this is at best an educated guess.
V KEY TRENDS12
The Cayman Islands has consistently adapted its regulatory and legal system to meet the demands of the finance sector and align it with international best practice. As a jurisdiction, it has proven to be highly responsive to the needs of the recovering global financial industry through industry consultation projects, statutory amendments and new legislation, and through the growth and development of a commercially sophisticated judicial system.
Increasingly, the majority of in-flows to hedge funds are from institutional investors. Institutional money has typically favoured larger managers, and this trend, together with recent positive industry performance, is reflected in the increasing total assets under management (AUM) figure for the industry (which is currently estimated to be over US$3 trillion).
Approximately 53 per cent of new funds were launched by managers with over US$1 billion AUM at the time of launch (whether from pre-existing funds in the market or due to a US$1 billion plus launch). On the other hand, approximately 31 per cent of new funds were launched by managers with under US$100 million AUM at the time of launch, showing that there are a number of new start-ups out there despite the increased regulatory burden and other challenges faced by emerging managers in the current environment.
Recently, we have also noted a steady increase in specific ERISA funds, and in funds allowing ERISA investors on the traditional basis. We have also worked on a number of ERISA restructurings. However, the number of new funds permitting the admission of ERISA investors has dropped to 68 per cent in the first half of 2015.
Equity long-short funds have consistently constituted the highest proportion of funds launched since 2010. Other strategies such as managed futures and fixed income have fluctuated in popularity. There has been a recent increase in the number of new fund of funds launching following a marked decline in fund of funds launching over the previous two years.
Since 2010 we have, unsurprisingly, seen a steady increase in the number of regulated managers. This is undoubtedly driven by the Dodd-Frank Wall Street Reform and Consumer Protection Act, which was signed into US federal law on 21 July 2010, requiring the implementation of more than 400 new rules and including changes to legislation that removed certain exemptions to registration with US regulatory bodies. In recent years, around 30 per cent of managers launching new funds were not federally regulated. This is reflective of some start-up managers not yet being regulated due to assets under management being below certain thresholds.
Both investors and regulators have pushed for greater transparency and accountability, which has led to changes in board composition. While independent directors on boards have steadily increased, we have also seen a trend for a segment of the launch market towards split boards consisting of independent directors appointed from more than one service provider as well as a manager-affiliated director. This trend has been more marked in the US than other regions. Independent directors are now regarded as significant to the overall structuring of a fund, as a robust board can be critical to the fund’s success and significant decisions in crisis situations (such as gating and suspending redemptions) can rest with the board. As of 31 July 2015, 76 per cent of Cayman funds used two or more independent directors, an all-time high and an increase from 70 per cent as of 31 December 2014. Beyond an uptick in the use of independent directors, there has been a significant shift in the manner in which directors engage with the fund, its service providers and investors. The institutionalisation of the industry and the impact of new regulatory initiatives aimed at protecting investors has led to a much greater degree of scrutiny on corporate governance, resulting in more proactive and engaged directors than ever before.
Post 2008, preserving liquidity has been of major concern to investors. There has been a significant decrease in funds launching with a fund-level gate, and this has been accompanied by an increase in investor level gates after a steep drop in 2011. ‘No gate’ funds have increased dramatically. We have recently seen liquidity become the most common side letter term (along with transparency) in place of fees. However, liquidity needs to be tailored to the asset class, and many investors understand that it is not always better to have greater liquidity. As a result, we still see a number of funds retaining the ability to create side pockets, effect suspensions, etc.
i Statutory revisions and new legislation
A key strength of the Cayman Islands funds regime continues to be the ability to marry robust yet flexible laws, which are updated to keep pace with industry needs, with a commercial approach to business. The past few years have been a particularly busy period for Cayman Islands legislation in this regard. Legislation and regulations have been amended when necessary to meet OECD, AIFMD, the US Foreign Account Tax Compliance Act (FATCA) and other external requirements, but change for its own sake has been avoided, and this approach can be expected to continue. The Cayman Islands fund industry is focused on, and responsive to, the legal and regulatory changes taking place worldwide, particularly in the US, Europe and Asia.
The Cayman Islands, through applicable regulatory agencies, continues to actively engage with counterpart international regulators (such as the Securities and Exchange Commission and the Financial Conduct Authority), and remains at the forefront of evolving transparency and cooperation initiatives.
The Cayman Islands has signed two intergovernmental agreements to improve international tax compliance and the exchange of information – one with the United States and one with the United Kingdom (the US IGA and the UK IGA, respectively). The Cayman Islands has also signed, along with over 60 other countries, a multilateral competent authority agreement to implement the OECD Standard for Automatic Exchange of Financial Account Information – Common Reporting Standard (the CRS and, together with the US IGA and the UK IGA, AEOI). Cayman Islands regulations were issued on 4 July 2014 to give effect to the US IGA and the UK IGA, and on 16 October 2015 to give effect to the CRS (collectively, the AEOI Regulations). Pursuant to the AEOI Regulations, the Cayman Islands Tax Information Authority has published guidance notes on the application of the US and UK IGAs and the CRS. These developments are supported by a network of bilateral tax information exchange agreements (currently in excess of 30, with further agreements being negotiated) and adherence to multilateral conventions such as the OECD and Council of Europe Convention on Mutual Assistance in Tax Matters.
These initiatives further strengthen Cayman’s regulatory reputation on cooperation matters and align its regulatory framework with a trend towards automatic exchange of information on tax. Cayman’s evolving framework has been recognised in independent reviews. The OECD’s Global Forum on Transparency and Exchange of Information for Tax Purposes Phase 2 Peer Review Report, released in 2013, concluded that Cayman has both the appropriate organisational processes and adequate resources in place to ensure that exchange of information takes place in an efficient manner and that timely responses are received, while also noting that a number of regulators praised the quality of cooperation and speed in response times. The Cayman Islands were further recognised by the Financial Stability Board as a jurisdiction that has sufficiently strong adherence to internationally agreed information exchange and cooperation standards in the areas of banking, insurance and securities regulation.
In addition to the previously mentioned amendments to the Mutual Funds Law, the SOG and the DRL Law, there have been a number of other legislative updates.
The government has announced the establishment of two new ‘opt-in’ regulatory regimes that are consistent with the European Union’s Alternative Investment Fund Managers Directive (Directive). In August 2015, the necessary amendments to the Mutual Funds Law and Securities Investment Business Law required to implement the new regulatory regimes were passed, and the relevant supporting regulations, which will set out the detail of the new regulatory regimes, are expected in the near future. The European Securities and Markets Authority (ESMA) is currently considering a number of jurisdictions, including the Cayman Islands, with a view to making recommendations as to their eligibility for a ‘third-country passport’ under the Directive. Once enacted, it is expected that the new regulatory regimes will mean the Cayman Islands is well placed for a favourable recommendation from ESMA in due course.
The Contracts (Rights of Third Parties) Law, 2014 (CRTPL) was enacted on 21 May 2014. In summary, CRPTL will permit parties to structure agreements governed by Cayman Islands law that confer rights of enforcement on third parties where it is considered appropriate to do so. Prior to CRTPL, contracts governed by Cayman Islands law could only be directly enforced by the parties to the contract. It is welcomed as an enhancement of the principles of freedom of contract in the Cayman Islands. CRTPL is likely to be beneficial in a number of different scenarios, including, for example, in relation to Cayman Islands ELPs where the partners wish to agree to enable a wider class of persons to benefit from the indemnity and exculpation provisions in the exempted limited partnership agreement (LPA) than only the partners, but without making all of the members of the class parties to the LPA.
The Exempted Limited Partnership Law (2013 Revision) was replaced by the Exempted Limited Partnership Law, 2014 (ELP Law) on 2 July 2014. The new law is a comprehensive revision of the previous law, but does not make fundamental alterations to the nature, formation or operation of ELPs. The principal objectives of the ELP Law are:
- a to promote freedom of contract between partners;
- b to the extent consistent with Cayman Islands law, to help synchronise the drafting of the Cayman Islands LPA with its onshore counterpart where a structure comprises both onshore and offshore partnerships; and
- c to deal with certain issues that the market has signalled it would like to have addressed in order to make ELPs even more straightforward and cost-effective to set up and manage.
The basic constitution of an ELP remains the same. However, in a number of significant respects, the law governing ELPs has been improved or clarified and, in addition, welcomed new concepts have been introduced.
The enactment of the Limited Liability Companies Law, 2016 in July 2016 and the establishment of a new type of vehicle – a Cayman Islands Limited Liability Company (LLC) – served to strengthen the Cayman Island’s reputation as an innovative jurisdiction committed to developing its legislation to meet the needs of the global financial services industry. The LLC offers a new form of corporate vehicle similar in concept to the Delaware Limited Liability Company in that it combines features of the exempted limited partnership and a company limited by shares, with the result that the LLC will be a body corporate with separate legal personality with liability of members limited to the amount the member has undertaken to contribute as expressly provided in the LLC agreement or other agreement between the member and the LLC.
In the litigation context, statutory amendments13 have been introduced to allow the Grand Court to grant interim relief (including by way of freezing order) in support of foreign proceedings without the need for substantive proceedings in the Cayman Islands (i.e., ‘free-standing’ interim relief). Prior to this legislation, in the absence of substantive proceedings, relief of this nature could only be granted against a defendant located in the Cayman Islands.
ii Recent case law
Commercially significant litigation is handled by the Financial Services Division of the Cayman Islands Grand Court (FSD), and each proceeding is assigned to one of the FSD’s highly experienced commercial judges. Appeals from the Grand Court, including the FSD, are to the Cayman Islands Court of Appeal (CICA), with a further potential right of appeal to the Privy Council in London. On the whole, the decisions of the courts in these cases have endorsed the mechanisms utilised by Cayman Islands funds and represent an orthodox common law approach to complex legal issues. Summarised below are examples of topical legal issues.
The circumstances in which a fund may be subject to a formal liquidation under the supervision of an independent and licensed insolvency practitioner14 remains a topic that continues to occupy the FSD. One group of cases (collectively the Belmont cases15) focused on the common practice among managers following the 2008 financial crisis of conducting a ‘soft wind-down’ of a fund by ceasing to actively trade, reducing the fund’s assets to cash over a period of time and then redeeming out investors as liquidity became available. The Belmont cases each involved a petition by investors for the just and equitable winding-up of a corporate fund (i.e., a formal liquidation) on the basis that the fund was no longer operating within the reasonable expectations of its investors and therefore had lost its substratum. These judgments show that a fund that is in soft wind-down will generally be considered as having lost its substratum16 in circumstances where there had been no express disclosure in the fund’s offering or constitutional documents that a soft wind-down might be conducted (i.e., not within the reasonable expectation of investors) making it just and equitable to place the fund into formal liquidation. However, the 2016 FSD decision in Washington Special Opportunity Fund, Inc17stressed that the winding-up of a Cayman Islands open-ended mutual fund is a drastic measure, which will not be readily granted, and so the circumstances in which the FSD will place funds into formal liquidation on the just and equitable ground remains an area to be monitored.18
In Pearson v. Primeo Fund (in official liquidation), the CICA confirmed that where redeemable shares have been redeemed in accordance with the articles of association, but the redemption proceeds are unpaid on the date that liquidation proceedings are commenced, the redeemed investors are creditors of the company, ranking behind unsecured creditors but ahead of non-redeeming investors in the liquidation waterfall. The opening of liquidation proceedings cannot unwind the redemption and a redeemed investor remains a redeemed investor.19 Where a creditor or shareholder of a fund has contractually agreed that disputes between them should be determined exclusively by another tribunal (e.g., through an arbitration agreement or exclusive jurisdiction clause), another layer of complexity can arise in the winding-up context. In In re Cybernaut,20 the court considered when it would be appropriate to stay or strike out a winding-up petition brought in alleged breach of an arbitration agreement by which disputes arising out of or relating to a limited partnership agreement were to be resolved by arbitration in New York. The winding-up petition was based on grounds that it was just and equitable to wind up the fund. The court held that a petition for the winding-up of a Cayman Islands fund was a non-arbitrable matter.21 Accordingly, where there are credible allegations of breaches of contractual and statutory duties that are said to give rise to a justifiable loss of trust and confidence in the general partner (or directors of a company) by the petitioning investor, limited partners (or members of a company), as the law currently stands in the Cayman Islands, may not be forced to successfully arbitrate such matters before being able to file a winding-up petition. Similarly, when considering circumstances22 in which a winding-up petition was resisted on the basis of a disputed debt that was arguably covered by an exclusive jurisdiction clause, the court confirmed that it must first consider whether there really is a dispute between the parties and, if there is, whether it should then defer to the exclusive jurisdiction clause.23 The issue as to how arbitration agreements and winding-up proceedings relate to each other has also been considered by the court in circumstances where winding-up proceedings have already been commenced. In the matter of the Sphinx group of companies (in official liquidation),24 the CICA held that the ability of official liquidators to estimate the quantum of potential future liquidation expenses, in order to set reserves to facilitate distributions, can be limited by the existence of a binding arbitration agreement. Therefore, where the reduction in the level of reserves set would require the court to address the merits of a disputed claim that was subject to an arbitration agreement, an official liquidator’s statutory power to set or reduce reserves did not override the arbitration agreement – the disputed claim would need to be arbitrated before the level of reserves could be set. The CICA was asked to overrule the decision in Cybernaut but declined to do so. The question of how two matters of public policy (respecting the parties’ decision to submit disputes to arbitration and the collective insolvency process) interrelate is one that is likely to remain an open issue until firm principles emerge from Cayman Islands case law.
Where limited partners had applied to the court for a winding-up order in respect of the limited partnership, the FSD held in In the matter of Rhone Holdings that:
- a limited partnership agreements preventing partners seeking to wind up the partnership (non-petition clauses) are effective; and
- b in light of the non-petition clause, the court was, pursuant to Section 95(2) of the Companies Law (2013 Revision), required to dismiss the winding-up petition.25
The CICA refused an application to extend time for obtaining leave to appeal and in doing so stated that the effect of Section 95(2) of the Companies Law (2013 Revision) was that an agreement not to present a winding-up petition was not contrary to Cayman Islands public policy.26
Another topical issue in the funds context is the function and effect of side letter agreements. A side letter is a familiar feature of Cayman Islands funds and is typically used to provide large certain investors with more favourable commercial terms than the fund might otherwise provide in its standard constitutional documents. There is now a series of decisions27 that establish that, to ensure the validity and effectiveness of a side letter agreement, it should be executed by the correct parties (i.e., executed between the fund and the investor of record and not, for example, the underlying beneficial owner or an unauthorised agent of the fund such as an investment manager), and its terms must be consistent with the fund’s constitutional documents. Although careful not to undermine the important principle that companies are not obliged to look behind their registers of members, as well as privity of contract, the court has found that principles of agency and estoppel may operate to avoid commercially unreasonable results.28
Many Cayman Islands funds conduct their business and hold their assets outside of the jurisdiction. Therefore, especially in the context of a winding-up or restructuring, the Cayman Islands courts have had to deal with complex cross-border and conflicts-of-laws issues. In recent years, the courts have demonstrated their willingness to facilitate cooperation in cross-border and foreign proceedings to ensure the efficient administration of justice. For example, in the liquidation of Trident Microsystems (Far East) Limited,29 the courts utilised the flexibility of the Cayman Islands provisional liquidation process to support a Chapter 11 restructuring procedure in the US. The Cayman Islands has no restructuring process equivalent to Chapter 11 in the US or administration in the UK, so in circumstances where a Cayman Islands fund intends to seek a restructuring, the provisional liquidation procedure is being more commonly used in support of such foreign restructuring proceedings.30 The same Cayman Islands provisional liquidation and related US Chapter 11 proceedings were utilised to restructure the Arcapita group and its underlying funds.
Finally, in the much-anticipated CICA decision in the ongoing Weavering31 saga, the CICA agreed with the Grand Court that the directors of the Weavering fund had been negligent. However, it also held that the evidence that was before the Grand Court did not support a finding of wilful neglect or default on the part of the fund’s directors (i.e., that the directors had known that they were breaching their duties, which the CICA confirmed was a critical element of the test for a finding of wilful neglect or default). The directors were therefore able to rely upon the indemnity and exculpation provided to them in the fund’s articles of association.
VI SECTORAL REGULATION
There are no specific rules that apply to insurance asset management in the Cayman Islands. Local insurance companies licensed by CIMA under the Insurance Law, 2010 may have restrictions imposed on them by CIMA regarding the classes of assets in which they are permitted to invest.
There are no specific rules that apply to pension asset management in the Cayman Islands. Local pension plans must be registered with the Supervisor of Pensions under the National Pensions Law (2012 Revision), and the administrators of such plans are subject to statutory duties of care, diligence and skill (comprising both objective and subjective tests) in their management of the plan assets.
iii Real property
There are no specific rules that apply to property fund management in the Cayman Islands.
iv Hedge funds
Hedge funds will generally be open-ended vehicles, and therefore need to comply with the provisions of Mutual Funds Law, as described in Section II, supra.
v Private equity
There are no specific rules that apply to private equity funds in the Cayman Islands. However, as noted above, the recent changes to the ELP Law bring the law more into line with the current commercial demands of private equity funds.
VII TAX LAW
The Cayman Islands imposes no taxation on the income or capital gains of investment funds or their investors, and no transfer taxes on the transfer of interests in investment funds. Exempted companies, limited partnerships and unit trusts can obtain undertakings from the government that if any such taxation is introduced during a 20-year period (companies) or 50-year period (limited partnerships and unit trusts),32 as applicable, from the date of the undertaking (or date of creation of the unit trust), such taxation will not apply to the entity to which the undertaking is given.
As the Cayman Islands continues to respond and adapt to regulatory changes and improve the laws relating to the fund vehicles preferred by sponsors and investors alike, we expect the next few years will witness ongoing growth in the jurisdiction’s share of the hedge, private equity and venture capital fund formation market.
Further, the demand for an inexpensive, tax-neutral and secure method of pooling capital from multiple jurisdictions, and of transmitting that capital to where it can best be employed, is unlikely to disappear in the near future, as demographics continue to drive increased demand for alternative investment classes. The secure legal and regulatory framework and level of specialist expertise, combined with a proactive and pro-industry regulator, should enable the Cayman Islands to continue taking advantage of this demand, and to maintain its position as a premier jurisdiction for offshore investment funds.
1 Nicholas Butcher and Matthew Crawford are partners and Anna Goubault is an associate at Maples and Calder.
2 Figures taken from the Mutual Funds Licensed or Registered and Mutual Fund Administrators (Annual and Quarterly) in the Investment Fund Statistics and Regulated Entities section of the CIMA website: www.cimoney.com.ky.
3 CIMA: Investments Statistical Digest 2014.
4 Ibid, p. 11.
5 Figures taken from the Mutual Funds Licensed or Registered and Mutual Fund Administrators (Annual and Quarterly) in the Investment Fund Statistics and Regulated Entities section of the CIMA website: www.cimoney.com.ky.
7 Op cit 5.
8 Op cit 5.
9 CIMA: Investments Statistical Digest 2014.
10 The Retail Mutual Funds (Japan) Regulations (2007 Revision), as amended pursuant to the Retail Mutual Funds (Japan) (Amendment) Regulations, 2012.
11 Op cit 9.
12 The following trends and statistics are based upon our own client and transaction experience.
13 The Grand Court (Amendment) Law, 2014 and related Grand Court Rules.
14 Funds in the Cayman Islands are generally structured as either companies or limited partnerships.
15 Belmont Asset Based Lending Limited  1 CILR 83; ICP Strategic Credit Income Fund Ltd (Grand Court, unreported 10 August 2010); Wyser-Pratte Eurovalue Fund Limited  CILR 194; Re Heriot African Trade Finance Fund Limited  1 CILR 1.
16 In ABC Company (SPC) v. J & Co Ltd  (1) CILR 300, the Belmont cases were considered in the context of a segregated portfolio company in which only about one-third of the portfolios were subject to a ‘soft wind-down’ by the fund’s manager and where the remaining portfolios were operating normally. The CICA held that in such circumstances the fund had not ceased to carry on business within the reasonable expectation of its investors, as an experienced investor must reasonably expect that the illiquidity of a single portfolio would lead to an inability to pay redemptions without affecting the other portfolios, and therefore it could not be said that the entire fund had lost its substratum.
17 Grand Court, unreported, 1 March 2016.
18 It should be noted that in Washington Capital the solvent fund had amended its articles of association so as to permit a ‘soft wind-down’, and so the factual circumstances were not equivalent to those in the Belmont line of cases.
19 Grand Court, unreported, 19 July 2016. It is understood that an appeal to the Privy Council is likely.
20 In re Cybernaut Growth Fund, LP  (2) CILR 414.
21 A different conclusion was reached by the High Court of the BVI in similar circumstances in Artemis Trustees Limited & Ors v. KBC Partners LP & Ors (BVIHC (COM) 2012/0137).
22 In re SRT Capital SPC Ltd (Grand Court, unreported, 22 November 2013).
23 The decision in In re SRT has sought to further clarify the dicta in Re Times Property Holdings  (1) CILR 233, bringing it more in line with the position in Re Duet Real Estate Partners 1 LP (Grand Court, unreported, 7 June 2011) whereby the court showed a willingness to look at the merits of the underlying alleged dispute.
24 Cayman Islands Court of Appeal, unreported, 2 February 2016.
25 Grand Court, unreported, 18 August 2015.
26 Cayman Islands Court of Appeal, unreported, 3 February 2016.
27 Re Medley Opportunity Fund Ltd  (1) CILR 360, Lansdowne v. Matador Investments Limited (in official liquidation)  (2) CILR 81, Swiss-Asia Genghis Hedge Fund v. Maoming Fund (Grand Court, unrep., 24 July 2013) and KBC Investments Limited v. Varga (as Official Liquidator of Lancelot Investors Fund Ltd)  (1) CILR 328.
28 It is important to note that the CRTPL is likely to affect side-letter cases going forward. This legislation allows parties to contracts to agree to extend the right to rely upon and sue under the contract to non-parties, and should offer greater comfort to non-parties seeking the enforcement of the terms of properly constructed side letters.
29 Trident Microsystems (Far East) Limited  (1) CILR 424.
30 In addition to Trident, see, for example, Re Fruit of the Loom  CILR N-7.
31 Weavering Macro Fixed Income Fund Limited (in Liquidation) v. Stefan Peterson and Hans Ekstrom  (1) CILR 45. This decision is the subject of an appeal to the Privy Council that has been heard and judgment is awaited.
32 Companies are entitled to a 20-year undertaking under Section 6 of the Tax Concessions Law (2011 Revision), limited partnerships are entitled to a 50-year undertaking under Section 38 of the ELP Law, 2014 and trusts are entitled to an undertaking under Section 81 of the Trusts Law (2011 Revision).