Knowledge

When thinking of offshore investment funds, the Cayman Islands should immediately spring to mind as the jurisdiction of choice. The Private Funds Act (the "PFA") governs certain closed-ended investment funds. Under the PFA, such funds must be registered with, and regulated by, the Cayman Islands Monetary Authority ("CIMA").

Cayman private funds are commonly used in the private equity space, investing in more illiquid assets, requiring time to realise value, or to hold investments for a defined period of time.

This guide provides a high level regulatory overview of closed-ended investment funds that meet the definition of a private fund under the PFA.

What is a private fund?

A private fund can be a (i) company, (ii) unit trust, or (iii) a partnership that offers or issues investment interests with the purpose of pooling investor funds. Investors receive profits or gains from the fund's acquisition, holding, management or disposal of investments. The holders of such interests do not have any day-to-day control over the investments, which are managed as a whole by, or on behalf of, the operator of the fund (either directly or indirectly).

All funds will be required to be registered with CIMA, unless that fund is excluded or exempted. Funds that are explicitly excluded from the PFA as "non-fund arrangements" include pension funds, SPVs, joint ventures, proprietary vehicles, holding vehicles, individual investment management arrangements, debt issuing vehicles, structured finance vehicles, preferred equity financing vehicles, sovereign wealth funds, single family offices, and funds that are listed on a recognised exchange.

The operator of a fund is considered to be its managing body, meaning (depending on the type of fund vehicle) the board of directors of a company, the general partner of a partnership, the manager (or equivalent) of a limited liability company, or a trustee of a unit trust. Operators must apply appropriate corporate governance. CIMA has issued statements of guidance on corporate governance, corporate governance on regulated entities, and internal controls of regulated entities (together, the "Regulatory Measures"). The Regulatory Measures need to be applied in an appropriate and proportionate way to the scale and operations of each private fund.

Registration with CIMA

An application must be made to CIMA to register a private fund within 21 days of such fund accepting capital commitments, and in any event before the fund accepts capital contributions from investors in respect of investments.

To register a private fund, certain documents must be submitted to CIMA, including (non-exhaustive) constitutional documents, a summary of the fund's offering terms, and details of the fund's service providers. The relevant application fee must be paid to CIMA at this point. Registration will be complete from the date a completed application is filed, with formal confirmation following within 2-3 weeks.

The directors (or managers of LLCs) of the fund (or directors of the general partner) are not required to be registered under the Director Registration and Licensing Act. However, CIMA has a "four-eye" policy, which means that biographies and contact details of two natural persons as directors need to be included in the registration application (whether registered as companies, LLCs, general partner or a corporate director of a private fund).

Ongoing requirements

Among other laws and regulation, the PFA specifies certain ongoing regulatory requirements for registered private funds. Failure to adhere to such requirements can incur significant fines, depending on the nature and seriousness of the breach. There are also criminal offences for breaching the PFA e.g. failure to register or dishonest/intentionally misleading marketing.

• Valuation - all private funds are required to conduct an asset valuation on (at least) an annual basis in accordance with CIMA's valuation policy. Valuations must be carried out in a frequency appropriate to the assets held. The fund's written valuation policy must be disclosed to investors. Valuation must be performed by an appropriate qualified third party, independent from the manager or operator of the fund.
• Audit - audited financial statements must be prepared by a local Cayman auditor approved by CIMA, and must be submitted to CIMA within 6 months of the fund's year end. CIMA may allow an extension up to a maximum of three months. A fund must also file consolidated or combined accounts in certain circumstances (e.g. a consolidation with a non-Cayman fund).
• Safekeeping of assets - a custodian is required to be appointed to (i) hold assets which are capable of physical delivery or capable of registration in a segregated custodial account (except where not practical nor proportionate), and (ii) to verify title to, and maintain records of, assets held by the fund based on information provided by the fund or external information. Where no custodian is appointed, the fund must notify CIMA. The fund must appoint a person to carry out title verification in line with the above. This function may be performed by an administrator or an independent third party or the manager (or a person with control relationship of the manager), subject to the conflict rules.
• Cash monitoring - a person must be appointed to monitor the cash flow of the fund. Proper cash monitoring policies and procedures must be in place for its investment strategies and types of investments held. The fund can choose to conduct the cash monitoring process internally, provided the function is separate from the portfolio management function.
• Annual fees - all funds must pay the applicable annual fee to CIMA by 15 January each year. If the annual fee is not paid by 15 January, a penalty of half of the annual fee will be payable each month the fee remains unpaid.
• Separation of assets - all funds must establish, implement and maintain (or oversee the same) strategies, policies, controls and procedures to ensure compliance with the segregation rules, provided for by CIMA (the "Segregation Rules"). These must be consistent with the funds marketing and offering document (and be appropriate for the fund's size, complexity and nature of activities and investors). The Segregation Rules state that all financial assets and liabilities of the fund and any part thereof (e.g. including investor funds and investments) (the "Portfolio") must be accounted for separately from any assets of the manager, operator or custodian of the private fund. The Segregation Rules also provide the overring requirement of the manager etc. not to use the Portfolio to fund any part of its operations.
• AML compliance - the fund must comply with the Anti-Money Laundering Regulations, the Proceeds of Crime Act, the Proliferation Financing (Prohibition) Act, and the Terrorism Act (together, the "AML Regime"). Private funds are generally considered to fall within the scope of the AML Regime, as will be considered to be engaged in "relevant financial business", as defined under the Proceeds of Crime Act. The fund must appoint natural persons to the roles of anti-money laundering compliance officer, AML reporting officer, and Deputy AML reporting officer These roles can be outsourced, if necessary.
• FATCA and CRS - almost all private funds will be a "Reporting Cayman Islands Financial Institution" for the purposes of the US Foreign Account Tax Compliance Act ("FATCA") and the Common Reporting Standard issued by the OECD ("CRS"). The fund must conduct due diligence on all its investors to identify the tax residency of each investor, and assess whether the interest held by that investor constitutes a "reportable account" under FACTA or CRS. Funds address this by (i) seeking appropriate self-certifications and beneficial ownership information from investors at the time of investment, and (ii) engaging the fund administrator or other specialist to assist with reporting obligations. The fund is required to notify the Cayman Islands Tax Information Authority (the "TA") of certain prescribed details and to identify a "Principal Point of Contact' and a "Change Notice Person", such notification is to be made during the first financial year after registration. Reporting on each of the fund's "Reportable Accounts" should be made to the TA each calendar year. The fund must maintain written compliance policies and procedures in connection with the fund's compliance with FACTA and CRS. In the case of CRS, a CRS compliance form containing certain prescribed information should be filed each year.
• Data protection - the Cayman Islands Data Protection Act (the "DPA") provides a framework of rights, duties and principles to regulate individuals' personal data. This is broadly based on the same internationally recognised privacy principles. Any entity established in the Cayman Islands has certain obligations under the DPA for the handling of individuals' data (e.g. contracts with service providers that process personal data on behalf of the fund).
• Economic substance - private funds will be regarded as "investment funds" under the International Tax Co-operation (Economic Substance) Act (the "ESA") and are therefore excluded as a "relevant entity" under the ESA. Funds will need to make an annual notification filing to confirm such exempt status.
• Beneficial ownership - under the Beneficial Ownership and Transparency Act, the exemption for regulated funds in the Cayman Islands was removed. Private funds are now required to either establish a beneficial ownership register or determine if they can follow an alternative route to compliance. This alternative route to compliance will require funds to give their corporate service provider (e.g. registered office) the contact details for the beneficial ownership register.

In summary

An effective and commercially-minded regulator, combined with appropriate but flexible regulation, means that the Cayman Islands will continue to be the top choice of jurisdiction for private funds. The Cayman Islands' reputation as a tax neutral regime, coupled with expertise in professional service providers, means that fund managers can be assured that their funds will be in safe hands throughout their lifecycle.

Bedell Cristin specialises in formation, ongoing regulatory requirements, financing and restructuring of investment funds in the Cayman Islands. Please contact us if you have any queries.