New Registration Requirements for Unregulated Investment Funds

On 8 January 2020, the Cayman Islands Government published a draft Private Funds Bill, 2020 (the Bill) and a draft amendment to the Mutual Funds Law (2019 Revision) (MFL Amendment).  The proposed legislation is a result of certain EU and other international recommendations and has been developed to align the Cayman Islands investment fund regulatory regime with other jurisdictions.  The Bill and the MFL Amendment are expected to be put before the Cayman Islands Legislative Assembly on 30 January 2020, where final amendments may be made before they are passed into law. It is expected that there will then be a transition period for existing structures.

However, given the significance of the Bill and the MFL Amendment to many of our clients, this advisory summarises key features of the Bill and the MFL Amendment in their current draft form.

Private Funds Bill, 2020

Who is caught by the Bill?

The Bill applies to any Cayman Islands closed-ended fund.  If such a fund falls within the definition of a "private fund", the Bill provides for its registration with, and its regulation by, the Cayman Islands Monetary Authority (CIMA). "Mutual funds" such as open-ended hedge funds are not caught by the Bill and continue to be regulated by the Mutual Funds Law.

The definition of "private fund" captures any company, unit trust or partnership whose principal business is the offering and issuing to investors of its participating, non-redeemable 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 vehicle's investment activity, where (a) the holders of investment interests do not have day-to-day control over the vehicle's investment activities; and (b) the investments are managed as a whole by or on behalf of the fund operator for reward based on the vehicle's assets, profits or gains. 

Vehicles that only issue debt or prescribed alternative financial instruments are not deemed to be issuing investment interests and so do not fall within scope of the Bill.  The Bill also expressly exempts "non-fund arrangements" including securitisation special purpose vehicles, joint ventures, proprietary vehicles, holding vehicles, preferred equity financing vehicles, sovereign wealth funds and single family offices.

"Funds" which are established for only one investor will be outside the scope of a "private fund" given the "pooling of investor funds" requirement.

What are the timing requirements for registration?

The Bill expressly permits a private fund to enter into agreements (which we understand would include subscription agreements, side letters and a partnership agreement) with investors and accept capital commitments from investors for the purpose of making investments before submitting its registration application to CIMA.  If any investor is not a high net worth or sophisticated investor, a private fund must submit an application for registration to CIMA within 21 days of its acceptance of capital commitments.

In all cases, a private fund must register with CIMA before accepting capital contributions from investors in respect of investments.

Does registration involve filing an offering document?

The Bill does not include a specific requirement to have or file an offering document as part of the private fund registration process. "Prescribed details" will need to be filed; exactly what this entails will be confirmed in separate regulations.

What operating requirements apply?

The Bill seeks to ensure that there is transparency and a proper papering of a private fund's core operations and processes. The Bill achieves this though audit, valuation, custody, cash monitoring and securities identification requirements that will align with most private funds' current procedures:

Audit – audited financial statements, signed-off by a Cayman Islands auditor, must be submitted to CIMA within six months of a private fund's financial year end.

Valuation – valuations of the assets of a private fund must be carried out at a frequency that is appropriate to the assets held by the private fund and, in any case, on at least an annual basis.  To the extent valuations are not performed by an appropriately qualified independent third party, the valuation function established by the manager or operator (eg, general partner) of the private fund must be independent from the portfolio management function or the potential conflicts of interest must be properly identified, managed, monitored and disclosed to investors.

Custody – a custodian must be appointed to: custody, in segregated accounts, the custodial fund assets; verify that the private fund holds title to any other fund assets; and maintain a record of those other fund assets. A private fund shall not be required to appoint a custodian if it has notified CIMA and it is neither practical nor proportionate to do so, having regard to the nature of the private fund and the type of assets it holds.  In such circumstances, a private fund must appoint a person to carry out title verification. To the extent such verification is not performed by an independent third party, the verification function established by the manager or operator of the private fund must be independent from the portfolio management function or the potential conflicts of interest must be properly identified, managed, monitored and disclosed to investors.

Cash monitoring – a private fund must appoint a person to: monitor the cash flows of the private fund; ensure that all cash has been booked in cash accounts opened in the name, or for the account, of the private fund; and ensure that all payments made by investors in respect of investment interests have been received. To the extent such cash monitoring function is not performed by an administrator, custodian or another independent third party, the cash management function established by the manager or operator of the private fund must be independent from the portfolio management function or the potential conflicts of interest must be properly identified, managed, monitored and disclosed to investors.

Securities identification – a private fund that regularly trades securities or holds them on a consistent basis must maintain a record of the identification codes of the securities it trades and holds and shall make this record available to CIMA upon request.

Although not contemplated in the Bill, CIMA has separately confirmed that it will require all private funds to have at least two natural persons acting as, or for, the operator (board of directors, general partner etc) of the private fund.

All operating conditions and procedures need to be appropriate and proportionate given the scale and operations of a private fund.  Where independent third parties are not engaged to carry out the above functions, CIMA may require that third party verification be undertaken.  The Bill provides that CIMA's supervision and monitoring of private funds, including the above operating conditions, is risk-based. 

The Bill provides that alternative investment vehicles will not have to comply with these operating requirements.  The definition of alternative investment vehicles will be published in subsequent regulations.

Does the Bill contemplate different categories of private funds?

The Bill contemplates a category of private fund, to be termed a "restricted scope private fund". Details as to eligibility for this category of private fund and the impact on the registration and ongoing obligations otherwise applicable to private funds under the Bill, are still to be determined.

The risk-based supervision requirement may allow for CIMA to adapt the registration and supervision requirements for funds with particular profiles.

What do we know about timing and fees

The Cayman Islands Government has the discretion as to when the Bill or various sections will come into force; and to make regulations for transitional provisions. The Government has stressed that it is mindful that a smooth and successful transition for existing private funds will require preparation and time. 

Details of fees and prescribed forms will also be covered by separate regulations.

Mutual Funds (Amendment) Bill, 2020

Who is affected?

The MFL Amendment will affect open-ended funds carrying on business in or from the Cayman Islands that were previously exempt from CIMA regulation under section 4(4) of the Mutual Funds Law (s4(4) Funds). Section 4(4) of the Mutual Funds Law currently provides a registration exemption to mutual funds whose equity interests are held by not more than fifteen investors, a majority of whom are capable of appointing or removing the operator of the fund.

What is required of affected funds?

Pursuant to the MFL Amendment, a s4(4) Fund will be required to register with CIMA by:

(i) filing a certified copy of their constitutive documents which specify that a majority of investors in number are capable of appointing or removing the operator of the fund;

(ii) filing such other information as may be required in the prescribed form; and

(iii) payment of the prescribed registration fee.

Based on the current draft MFL Amendment, a s4(4) Fund does not have a prescribed minimum initial investment amount nor any requirement to have or file an offering document.

It is expected that s4(4) Funds will be required to have at least two natural persons acting as, or for, the operator (board of directors, general partner etc), and that these persons will be required to register under the Directors Registration and Licensing Law (Revised).

Will there be any audit requirements for s4(4) Funds?

A s4(4) Fund will be required to have its accounts audited annually by an auditor approved by CIMA.  The MFL Amendment requires that the accounts be prepared and audited in accordance with International Financial Reporting Standards or US, Japanese or Swiss GAAP or GAAP of a non-high risk jurisdiction.

What is the anticipated timing for the MFL Amendment?

The Government has not commented on the likely commencement date for the MFL Amendment but the MFL Amendment provides a six month transitional period for compliance once in force.

For further information or to discuss specific structures, please contact your regular Ogier contact or a member of the investment funds regulatory team listed.

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Disclaimer

This client briefing has been prepared for clients and professional associates of Ogier. The information and expressions of opinion which it contains are not intended to be a comprehensive study or to provide legal advice and should not be treated as a substitute for specific advice concerning individual situations.

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