Alternative Investment Management Association Representing the global hedge fund industry
Quin & Hampson
There has been a great deal of debate in the United States and England recently as to whether hedge funds should be subject to increased regulation. From a Cayman Islands perspective, the success of the domicile in attracting hedge funds and the limited number of failures bears testimony to the effectiveness of the current regulatory system.
Emphasis is placed on the statutory requirement for full and proper disclosure in the offering document of all information necessary to enable a prospective investor to make an informed investment decision, and involvement of service providers. This, in turn, means no regulatory consents are required with respect to investment policy, the contents or circulation of offering memoranda or prime broker arrangements.
The Cayman Islands legislation which governs hedge funds, the Mutual Funds Law, was drafted on the clear principle of ‘caveat emptor’, that is, acceptance of risk by the investor.
Hedge funds are regulated by the Cayman Islands Monetary Authority (CIMA). No hedge fund may carry on or attempt to carry on business in or from the Cayman Islands unless it complies with one of three registration alternatives, or is within the class of hedge funds that is exempt from this requirement. The most common alternative used by hedge funds is registration under section 4(3) of the Mutual Funds Law, which is applicable where the minimum investment per investor is not less than US$50,000, or where the equity interests are listed on a recognised stock exchange, including the Cayman Islands Stock Exchange.
To register a hedge fund with CIMA, the directors, general partner or trustee of the fund must ensure that the fund has filed with CIMA a fund filing form, the current offering document, and consent letters from an administrator and an approved auditor agreeing to act for the fund. Once the fund has been registered, its continuing obligations are to have its accounts audited annually by a local auditor approved by CIMA, and to send a copy of those accounts to CIMA within six months of the end of the relevant financial year. It must also file with CIMA a revised offering document or revised prescribed details if there is any change materially affecting any information in those documents and pay an annual registration fee.
CIMA has various supervisory powers with respect to regulated hedge funds and may at any time instruct a hedge fund to have its accounts audited and submitted to CIMA. In addition, CIMA may request the directors, general partner or trustees of a fund to provide CIMA with such information or explanation in respect of the fund as CIMA may reasonably require to enable it to carry out its duties.
All regulated hedge funds established in the Cayman Islands are required, as “financial service providers”, to comply with the Cayman Islands money laundering legislation by putting in place appropriate procedures for the prevention of money laundering. CIMA permits delegation of a hedge fund’s money laundering obligations to persons or institutions that are regulated in a country with equivalent anti-money laundering legislation. Delegation is usually made to the hedge fund’s administrator or to the investment manager.
Any proposal to increase the level of regulation of hedge funds demands very careful review and detailed analysis. Fortunately, the need to maintain a balance between commercial flexibility and an appropriate level of regulation of hedge funds is widely recognised by regulators and stakeholders in the Cayman Islands hedge fund industry. This is well demonstrated in the report of a working group established by the Cayman Islands Monetary Authority (CIMA), comprising government officials and private sector representatives, which reviewed the Mutual Funds Law and made recommendations for certain amendments . Some of the key recommendations of the working group are summarised below.
In response to concerns expressed by the International Organisation of Securities Commissions (IOSCO) and the International Monetary Fund (IMF), it is recommended that the distinction between public and non-public funds is clarified. The term 'mutual fund', which is more typically associated with the retail market in other jurisdictions, will be replaced with the term 'investment fund' to bring the Mutual Funds Law (to be renamed the Investment Funds Law) more in line with international terminology. The following four categories of investment fund are proposed:
Public Fund – This fund would be offered to the public and have no minimum subscription.
Managed Private Fund – This fund would be required to have a licensed fund administrator with a physical presence in the Cayman to provide a principal office. The fund would have a minimum subscription of $10,000 and the administrator would be required to have access to certain records which would be available for inspection by CIMA. This category would replace the current “administered fund” category under the Mutual Funds Law.
Recognised Fund – This category would involve funds whose equity interests are listed on a stock exchange prescribed by CIMA or which is licensed or registered in a jurisdiction prescribed by CIMA.
Professional Fund – This fund would be sold only to professional investors and would replace the current “registered fund” category under section 4(3) of the Mutual Funds Law. It is proposed that the minimum investment threshold for professional funds is increased to $100,000, bringing the Cayman Islands into line with the rules in many other jurisdictions (for example, the minimum for funds listing on the Irish Stock Exchange) and satisfying a recommendation of the IMF.
The change of name of the fund categories will not affect the current regulatory regime, but will ensure consistency with investment fund classification in other jurisdictions. The increase in the minimum investment threshold for professional funds is also unlikely to have much impact in practice, as 80% of funds registered with CIMA have a minimum subscription of $1m or more, and only 5% have an investment minimum of less than $100,000. Existing funds will be 'grandfathered', and will not be affected by the change.
Other noteworthy proposed changes to the Mutual Funds Law include: allowing CIMA to waive the submission of audited financial statements in certain circumstances, such as where a fund was not launched or was in the process of being wound up; no longer requiring funds domiciled in IOSCO member jurisdictions which are administered in Cayman to be registered as foreign companies in Cayman and regulated by CIMA; the introduction of a 14-day grace period within which professional funds could operate legally without registration while an application was being processed by CIMA; and amending the fee structure applicable to segregated portfolio companies, so that where resources are employed by CIMA to register and monitor new segregated portfolios these costs are borne and paid for by each fund.
It is anticipated that the proposed amendments to the Mutual Funds Law will be enacted during the course of 2006. These amendments should assist in making the Cayman Islands legislation more easily digestible to the international audience, and in clarifying a few areas of the Mutual Funds Law which have previously engendered some debate. No fundamental changes are proposed that might diminish the attractiveness of the Cayman Islands as the domicile of choice for offshore hedge funds.