The Government of the Cayman Islands has just published a Private Funds Bill and a proposal to amend the Mutual Funds Law (2019 Revision) as a result of pressure from the European Union and other international bodies. The idea is to align the Cayman Islands' regulatory regime for investment funds with those of other jurisdictions.

The Bill and the MFL amendment are expected to go before the Cayman Islands Legislative Assembly on 30 January and final amendments may be made then, before they become law. Everyone expects there to be a transition period for existing structures. In this article we explore the main features of these pieces of legislation in their present form.

Private Funds Bill

Who is to be affected?

The Bill applies to any Cayman-Island closed-ended fund. If such a fund falls into the category of a "private fund," the Bill proposes to force it to register with, and be regulated by, the Cayman Islands Monetary Authority (CIMA). The Bill does not suggest any changes for "mutual funds" such as open-ended hedge funds, which are going to continue being 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 investors' funds with the aim of spreading investment-related 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 in line with 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 into the ambit of the Bill. The Bill also expressly seeks to exempt "non-fund arrangements" including securitisation special purpose vehicles (SPVs), 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 ought to be outside the scope of "private funds" in view of the "pooling of investor funds" requirement.

When should registration occur?

The Bill expressly seeks to permit a private fund to sign agreements (which, according to our sources, 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 application for registration to CIMA. If any investor is not a high-net-worth (HNW) or sophisticated investor, the 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 ought to register with CIMA before accepting capital contributions from investors in respect of investments.

Should registration involve the sending of an offering document to CIMA?

The Bill does not propose a specific requirement to have an offering document as part of the private fund registration process. It wants "prescribed details" to be sent over; we shall only know what this entails when the Government issues separate regulations.

What operating requirements are to apply?

The Bill seeks to allow the regulator to know all about every private fund's core operations and processes and to ensure that they are properly accounted for on paper. It aims to achieve this though rules that pertain to auditing, valuation, custody, cash monitoring and the identification of securities. These rules are consistent with most private funds' current procedures. Let us look at each set of rules in turn.

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, at least every year. To the extent that valuations are not performed by an appropriately qualified independent third party, the valuation function established by the manager or operator (e.g. the 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 divulged to investors.

Custody. A custodian must be appointed to: (i) take into custody  the custodial fund assets in segregated accounts; (ii) verify that the private fund holds title to any other fund assets; and (iii) keep a record of those other fund assets. A private fund need not 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 that it holds. In such circumstances, a private fund must appoint a person to carry out title verification. To the extent that this 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 divulged to investors.

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Cash monitoring. A private fund must appoint a person to: (i) monitor the cash flows of the private fund; (ii) ensure that all cash has been booked in cash accounts opened in the name, or for the account, of the private fund; and (iii) ensure that all payments made by investors in respect of investment interests have been received. To the extent that such a 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 divulged to investors.

The identification of securities. A private fund that regularly trades in securities or holds them consistently must keep a record of the identifying codes of the securities that it holds and in which it trades and must make this record available to CIMA upon request.

Although the Bill does not say this, CIMA has said 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 ought to be appropriate and proportionate according to the scale and operations of a private fund. If independent third parties are not paid to carry out the above functions, CIMA may call for third-party verification. The Bill says that CIMA's supervision and monitoring of private funds, including the above operating conditions, ought to be risk-based.

The Bill suggests that "alternative investment vehicles" ought not to have to comply with these operating requirements. The Government intends to publish its definition of that term in subsequent regulations.

Does the Bill contemplate different categories of private fund?

The Bill mentions a new type of fund that it calls a "restricted-scope private fund." The Government has not yet decided how a private fund might qualify for this category. It has also not decided on the effect that this type of fund might have on the registration and continuing obligations otherwise applicable to private funds.

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 Bill proposes to allow the Cayman Islands Government to decide when it, or various sections of it, will come into force and to make regulations for transitional provisions. The Government has stressed that it knows 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.

The Mutual Funds (Amendment) Bill 2020

Who is to be affected?

The draft amendment, if passed in its present form, will affect open-ended funds that do business in or from the Cayman Islands that were previously exempt from CIMA regulation by section 4(4) Mutual Funds Law (s4(4) funds). This section currently exempts any mutual fund whose equity interests are held by not more than fifteen investors, a majority of whom are capable of appointing or removing the fund's operator, from the need to register.

What is to be required of affected funds?

According to the amendment, a s4(4) fund should be required to register with CIMA by:

(i) sending it a certified copy of its constitutive documents which specify that a majority of investors in number are capable of appointing or removing the operator of the fund;
(ii) sending it such other information as may be required in the prescribed form; and
(iii) paying the prescribed registration fee.

According to the current draft amendment, a s4(4) fund will not have a prescribed minimum initial investment amount nor any obligation to have an offering document or send one to CIMA.

It is expected that s4(4) funds will be required to have at least two people acting as, or for, the operator (board of directors, general partner etc), and that these people will have 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 suggests that the accounts should 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 amendment itself suggests a six-month transitional period for compliance once it is in force.

* James Bergstrom can be reached on +1 345 815 1855; Angus Davison can be reached on +1 345 815 1788; Joanne Huckle is on +1 345 815 1895; Bradley Kruger is on +1 345 815 1877; Nick Rogers is on +1 345 815 1844; Justin Savage is on +1 345 815 1816; and Giorgio Subiotto is on +1 345 815 1872; Kate Hodson is on +852 3656 6049; Nicholas Plowman is on +852 3656 6014.