Statistics published by the Cayman Islands Monetary Authority show that the Cayman jurisdiction remains the preferred jurisdiction for managers looking to establish offshore alternative investment funds.
This article is intended to provide a high-level overview of some of the considerations and steps involved in setting up an open-ended Cayman investment fund.
A typical "Hedge Fund" is a Cayman domiciled open-ended alternative investment fund. Funds of this type can be organised as a unit trust, a corporate entity or a limited partnership.
While a Cayman company is the vehicle most commonly used for new hedge funds, the type of fund and the location of the investors the fund manager hopes to attract may have a bearing on the ultimate structure of the fund. For example, managers looking to promote a fund in Asia would be advised to consider using a unit trust structure as this product is familiar to Asia-based investors.
Managers looking to attract US-based investors will often choose to use a master/feeder structure. A typical master/feeder structure will consist of: an onshore feeder fund through which US taxable investors can enter the fund; an offshore feeder fund, generally based in the Cayman Islands, through which non-US and US tax-exempt investors can enter the fund; and a master fund through which all trading activity is carried out which will usually also be a Cayman vehicle. Because the onshore feeder fund is typically organised as a limited partnership or an LLC some US counsel prefer to mirror this structure by using a Cayman limited partnership for the offshore funds.
A manager looking to establish an "umbrella" fund may wish to use a Segregated Portfolio Company ("SPC") as the fund vehicle. An SPC fund can create sub-funds in the form of individual segregated portfolios, the assets and liabilities of which are legally segregated from the assets and liabilities of the other segregated portfolios. These sub-funds are not treated as separate funds by the Cayman regulator meaning new, legally segregated, sub-funds can be created within the umbrella structure for a fraction of the cost of setting up an entirely new fund.
Regulation and Compliance
The primary investment fund legislation in the Cayman Islands is the Mutual Funds Law (as revised) (the "Mutual Funds Law"). Regulatory oversight falls to the Cayman Islands Monetary Authority ("CIMA").
The Mutual Funds Law regulates companies, unit trusts and partnerships that issue "equity interests" for the purpose of pooling investment funds. It is important to note that the definition of "equity interest" excludes shares, units or partnership interests that are not redeemable at the option of the holder thereof, meaning closed-ended funds that do not permit withdrawals, such as a typical private equity fund, are not regulated by the Mutual Funds Law. The definition of "equity interest" also explicitly excludes debt and other alternative financial instruments.
Cayman Islands investment funds that are subject to the Mutual Funds Law are referred to in this article as "regulated funds". Typical hedge funds will be regulated funds and must therefor comply with the Mutual Funds Law provisions. Regulated funds have a number of compliance options:
Fifteen or Fewer Investors
Section 4(4)(a) of the Mutual Funds Law provides that a regulated fund can operate in or from the Cayman Islands if its equity interests are held by 15 or fewer investors a majority of whom are capable of appointing or removing the fund's operator (either the trustee, general partner or directors).
Unlike other exemptions, a regulated fund operating under section 4(4)(a) does not have to register with CIMA or submit audited accounts and is therefore largely unregulated.
There is an exception to this rule stipulating that any master funds that has one or more Cayman "feeder funds" investing into it cannot rely on this exemption and must be registered with CIMA. For the purposes of this requirement, a "feeder fund" is defined in the Mutual Funds Law as a Cayman fund that is regulated under the Mutual Funds Law and conducts more than 51% of its investing through another regulated Cayman fund.
Listed on Approved Exchange
According to section 4(3)(a)(ii) a regulated fund may operate in or from the Cayman Islands if its equity interests are listed on a stock exchange that has been approved by CIMA.
The list of approved stock exchanges is available in Appendix G12 of CIMA's Regulatory Handbook available at www.cimoney.com.ky.
Minimum Initial Investment of US$100,000
The most common type of regulated Cayman fund is one that operates pursuant to section 4(3)(a)(i) of the Mutual Funds Law. Section 4(3)(a)(i) permits a regulated fund to operate in or from the Cayman Islands if it has a minimum initial investment amount of at least US$100,000 or its equivalent in any other currency.
A regulated fund can operate in or from the Cayman Islands pursuant to section 4(1)(b) of the Mutual Funds Law without complying with any of the foregoing if it has a "principal office" in the Cayman Islands provided by a licensed mutual funds administrator.
All fund administrators in the Cayman Islands are required by law to be licensed and can provide the principal office service. In addition to the normal fund administration services, an administrator that is providing a principal office will need to act as a liaison between the fund and CIMA, and certify to CIMA that it is acting as principal office.
regulated funds that comply with the Mutual Funds Law by virtue of being listed on an approved exchange, by having a minimum initial investment amount of at least US$100,000 or that have a licensed mutual funds administrator providing a principal office in the Cayman Islands are required to register with CIMA and provide copies of the current offering documents. The fee for CIMA registration is currently US$3,658.54 upon registration and annually thereafter. A regulated fund that is registered with CIMA is required to have its accounts audited annually by a CIMA-approved auditor with offices in the Cayman Islands. Copies of the audited accounts must be provided to CIMA within six months of the end of the fund's financial year.
Mutual Funds Licence
Failing any of the above, a regulated fund can apply to CIMA for a Mutual Funds Licence. The requirements for obtaining a Mutual Funds Licence are considerably more onerous than compliance with the foregoing provisions and, not surprisingly, less than 1.5% of the approximately 10,000 regulated funds in Cayman are licensed funds.
A licensed hedge fund is required to have its accounts audited annually and to provide copies of the audited accounts to CIMA within six months of the end of its financial year.
Set Up Process
Once the structure of the fund has been determined, the fund's legal counsel will draft the main offering circular and constitutional documents. In the case of a corporate structure the main constitutional documents of the fund will be the memorandum and articles of association; in respect of a unit trust this will take the form of a declaration of trust and for limited partnership structures it will be in the form of a limited partnership agreement. These documents will normally go through a number of drafts before being finalised.
Ancillary documents include the subscription agreement, redemption request form, and agreements with the various service providers including the fund manager and advisor. These will either be drafted by the fund's legal counsel or provided by the relevant service provider.
Once the fund documentation is in order the fund's legal counsel will form the fund vehicle either by incorporating the company, or registering the partnership or trust.
Once the fund is formed, the fund's Cayman legal counsel will, if required, file an application with CIMA to have the fund registered or licensed. Assuming the documents are in good order CIMA will normally approve applications within 15 working days, at which time the fund can begin taking subscriptions, issuing equity interests and implementing its investment objective.
More detailed information on this topic can be found at www.caymanhedgefundworld.com.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.