Darwin believed that evolution takes place over long periods of time and the development of the Cayman Islands mutual fund industry may be further proof of his theory. Admittedly it is taking years rather than millennia, however, rumour has it that the process of modernizing the Cayman Islands legislation governing the mutual fund industry in the British Overseas Territory is a complex and careful process.
One legislative change, the Cayman Islands law implementing the EU Savings Tax Directive has been relatively swift, however. The Reporting of Savings Income Information (European Union) Law (the "Law"), 2005, has provided guidance as to what obligations, if any, the EU legislation would mean for funds domiciled in the Cayman Islands. In a nutshell, where the paying agent, usually the administrator, is located in the Cayman Islands and the fund domiciled in Cayman is a section 5(1) fund under the Mutual Funds law, i.e., a licensed fund, which in addition is listed on the Cayman Islands stock exchange this type of Cayman Islands fund would be caught by the Law. If the scenario is as above, but the paying agent is located in the UK, Ireland or Switzerland again the fund would be caught under the provisions of the law. Should the paying agent be located outside the Cayman Islands, the UK, Ireland or Switzerland advice should be sought from lawyers in the relevant jurisdiction as to whether the Cayman fund would be treated as a UCITS equivalent fund, in which case again it would be within the scope of the Law. Nonetheless, where the paying agent is located in Cayman Islands, UK, Ireland or Switzerland and the Cayman Islands domiciled fund is a section 4(3) fund under the Mutual Funds law, i.e., one with a minimum initial subscription of around USD 50,000, such a fund would not be subject to reporting obligations under the Law.
Rapid growth in the Cayman Islands hedge fund industry is the backdrop against which the current review of the regulatory regime is taking place. The number of funds registered or licensed with the Cayman Islands Monetary Authority has been growing at a scarcely believable pace and the end of the growth period is not yet in sight.
The Cayman Islands Monetary Authority (CIMA) has requested the formation of a working group consisting of representatives from the Cayman Islands Fund Administrators Association, the Cayman Islands Society of Professional Accountants, the Cayman Islands Law Society and the Cayman Islands Bar Association in order to evaluate the recommendations of CIMA’s own Policy and Research Division which had spent considerable time examining the regulation of the mutual funds industry.
The working group’s aim is clearly to further improve the regulation of the funds industry in the Cayman Islands, with a view to striking an appropriate balance between the demands of a competitive offshore financial centre and the international standards requested of a sophisticated offshore financial centre by a number of international bodies, such as the IMF.
As early as 2001 recommendations were made by some of the accountancy firms that the Cayman Island’s Mutual Funds Law should be amended to distinguish more clearly between public and non-public funds. The aim was to make public funds compatible with IOSCO principles, whereas other funds, because of the nature of the investors in non-public funds, would, it was thought, not need to comply. IOSCO principle 17 requires that "the regulatory system should set standards for the eligibility and regulation of those who wish to market or operate a collective investment scheme". The working group is likely to endorse the view that a clear distinction between public and private funds should be made to demonstrate that the Cayman Islands are compliant with relevant international standards in this regard.
Whilst some lawyers are of the view that the current Mutual Funds Law (2003 Revision) does allow for some differentiation of public, also called "retail", funds with the section 5 licensing provision, one of the ways to deal with the public/private distinction may be the prescriptive regulations introduced to deal with Japanese retail funds. The Retail Mutual Funds (Japan) Regulations (2003) are used as a safe-harbour for compliance with Japanese Regulations. In order for a Cayman Fund to comply with the Retail Mutual Funds (Japan) Regulations it will in fact have to be licensed and in addition has to comply with a whole roster of other prescriptions contained in these regulations. This model may serve as a precedent to be followed for a number of other categories of funds, thought it is unclear at this stage whether it would again be drafted in respect of public funds offered in a particular jurisdiction or whether a broader category will be used. In any event, as the vast majority of funds domiciled in the Cayman Islands are private funds, any proposed changes in this regard are unlikely to cause major concern in the industry as long as those changes do not affect private funds as regards the freedom of service providers to be located in other jurisdictions and the speed of establishment.
As regards the effort to distinguish different categories of funds it is however likely that four, rather than two, categories of funds will be established. The likely categories are:
- Public Fund – This would be the out and out retail fund offered to the public and it would not have any minimum subscription.
- Managed Private Fund - This fund would be required to have a licensed fund administrator with a physical presence in the Cayman Islands provide the registered office. A minimum subscription of US$10,000 would also be required.
- Recognised Fund - A category that would involve funds where the equity interests are listed on a prescribed stock exchange or which are licensed or registered in a prescribed jurisdiction.
- Professional Fund – This would be the kind of fund offered only to professional investors. Rather than define "professional investor" in a complex way it is likely that a simple threshold (possibly at least US$100,000) would be adopted.
Existing mutual funds which are not public funds would be grand-fathered into the new categories and there would thus be no need to amend existing documentation of most funds. The exception would be public funds which would have to comply with IOSCO standards.
One particular confusion in relation to the Cayman Islands "Mutual Funds Law" has at times been its very name. For those who think that a hedge fund is not a mutual fund the working group proposes to name the amended Mutual Funds Law "Investment Funds Law". Those who had trouble reconciling a hedge fund as being a mutual fund, should have no trouble to accept a hedge fund is an investment fund.
A somewhat more important change could relate to the operation of funds. It is currently against Cayman Islands law for a fund that has to be registered to operate without having registered. This sounds like clear common sense, however, in practice a promoter may be anxious to begin operating the fund at the earliest possible moment and whilst the required documentation has been submitted for registration and CIMA would generally issue a registration certificate in a short period of time, dated as of the date of submission of the required documentation, the promoter was at times exposed to the risk of some minor technicality preventing the registration. It could be a mis-spelling on an MF1 Form or some other mishap. As a result a fund may have started to operate on the not unreasonable assumption that its registration certificate would be returned in due course with a date which would enable it to operate lawfully as of the intended date, only to find that the registration is delayed by a short period of time. Whilst a rare occurrence, the working group proposes to avoid such mishaps with the introduction of a grace-period, probably of 14 days.
A further proposal of the working group, whilst not intended to save market participants money is likely to have that result, namely the proposal to provide broader powers to CIMA to waive the requirements for an audit for licensed or registered funds. Instances where a fund was not launched or where a fund is wound up with only a few investors are examples of where such a waiver may prove desirable.
Areas where the current Mutual Funds Law may be ambiguous are to be clarified. Thus, for instance section 4 (4) which currently states that funds "in which the equity interests are held by not more than fifteen investors, the majority of whom are capable of appointing or removing the operator of the fund" are to be exempted from the Mutual Funds Law, is to be clarified. The term "majority" has been questioned in as far as some believe it refers to the number of investors, others believe it refers to shareholder interests. The revised investment funds law is going to clarify this ambiguity.
While the above is intended to provide a flavour of the changes which can be expected, it is by no means a complete list of all the reforms which are likely to be implemented at some point in the future. It is impossible to say when such implementation will take place exactly, however, the review process has been going on for some time now, years in fact, and it may be that it is coming to a conclusion. Having said that, the new laws and regulations will need to be drafted and approved so there is still some time to prepare for the new regulatory regime. When all is said and done the regulatory regime will need to strike the right balance between regulation and the needs of the funds industry. Cayman’s regulators have been able to achieve such a delicate equilibrium in the past and despite the Cayman Island’s phenomenal success they are clearly not resting on their laurels but are intent on improving further an offshore jurisdiction already in the highest possible demand. Their hope is that the Cayman Islands continue to be the natural selection of fund professionals.
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