THE WORLD’S LEADING financial institutions and investment fund managers have long recognised Cayman’s strengths which include swift turnaround time for fund establishment, depth of relevant professional expertise and services, and the absence of a prescriptive regime mandating the location of service providers. That recognition has rewarded Cayman with a steady increase in institutional investment funds business.
As a result, September 2006 saw Cayman break through the 8,000 registered funds barrier for the fi rst time with the Cayman Islands Monetary Authority (CIMA) confirming a total of 8,088 active registered hedge funds.
While some have claimed that fund terminations cast some doubt on the industry’s growth numbers, the rate of terminations remains less than one third of new fund registrations. The Cayman investment funds industry and CIMA do not view the numbers of fund closures with any concern, believing it demonstrates the efficiencies of the investment industry, where sophisticated investors do not allow poor performance or inappropriate strategies to go unpunished and where start-ups without appropriate risk controls in place do not get sufficient allocated capital.
One of the primary reasons for the continuing climb in hedge fund numbers, despite notable crashes like Amaranth, is that hedge fund managers are finding more innovative ways to employ hedge funds. They continue to find favour with pension funds around the world – from the US and Canada to the UK, Japan, and Europe. This means more funds work, not only for Cayman, but also for other jurisdictions around the world including the BVI and Jersey.
In addition, emerging markets like the Middle East and Asia are maturing and are looking for more sophisticated structures such as private equity and hedge funds. The Cayman Islands are a particularly attractive jurisdiction for Asia-focused hedge funds because the regulatory and legal framework mandates transparency and disclosure – a critical need for institutional investors and high net worth individuals – over and above even what the US currently requires.
Cayman’s regulators continue to take strides to encourage more business. One major step has been efforts by both CIMA and the Cayman Islands government, strongly backed by the private sector, to improve Cayman’s benchmark Mutual Funds Law.
Amendments to the Mutual Funds Law have now been passed by the Cayman Islands government and are expected to become operative in November 2006. These changes, which were developed through consultation with hedge fund and financial professionals in Cayman, will bring a number of key benefits to investors.
The change expected to have the most commercial impact permits Cayman based hedge fund administrators to administer foreign hedge funds without the need for those funds to be registered in Cayman with CIMA. Cayman fund administrators often administer offshore funds in Master-Feeder structures, but miss out on the opportunity to administer US domestic feeders, typically Delaware registered, as current legislation requires the Delaware fund to register with CIMA and duplicate registration costs. A more precise definition of “carrying on business in or from the Islands” in the new law will remove this impediment, permitting foreign-domiciled funds to be administered in the Cayman Islands without the need for registration with CIMA. This will effectively allow Cayman based administrators to compete for and take on more business in Cayman.
Even with this change there will continue to be some regulatory oversight of foreign-domiciled funds. Only funds domiciled in countries with registration/ oversight standards approved by CIMA will be eligible to operate without CIMA registration. To avoid duplication, CIMA will almost certainly make use of the Schedule 3 list that is currently used in determining appropriate jurisdictions for anti-money laundering purposes. Obviously the USA, the UK and all other OECD countries are on this list.
On the audit side, the changes to the Mutual Fund Law will give CIMA discretion, on application and in restricted circumstances, to waive the requirement for an annual audit for hedge funds. Auditors find themselves with extended reporting responsibilities and CIMA picks up power to disqualify an audit firm temporarily or permanently from being an auditor to a regulated fund.
Whistle-blowing responsibilities for auditors will be extended to cover an auditor who resigns or is terminated before carrying out an audit. Auditors will also now be required to notify CIMA if, in the course of carrying out an audit, the auditor becomes aware of solvency issues, or that a fund is carrying on business or effecting a voluntary winding up, in a manner prejudicial to investors or creditors, is not keeping adequate, auditable accounting records or is carrying on business in a fraudulent or criminal manner.
Under the revised law the distinction between private funds and public funds has been stepped up and is further strengthened by an increase in the minimum investment threshold to US$100,000, effectively dealing with concerns expressed by the International Organisation of Securities Commissions (IOSCO) and the International Monetary Fund (IMF). The change will have little effect in practice as CIMA indicates that more than 90 per cent of the hedge funds registered in Cayman have minimum investment requirements of more than US$1m. All existing Cayman hedge funds are ‘grandfathered’ in and the changes will not affect any hedge fund registered in Cayman before the amendments to the Mutual Funds Law become operative and will not effect any additional issue of shares made by an existing registered hedge fund.
In another significant step to improve efficiencies and reduce the burden of supervising greater numbers of hedge funds, under the new law CIMA will implement an electronic reporting system (e-report) for all hedge funds with audits submitted after 31 December 2007 in which key data, reporting requirements and audited accounts will be migrated to an electronic platform.
The new audit and e-reporting system will provide reliable aggregate statistics relating to the Cayman funds industry, increase security for the filing of audited accounts, permit CIMA to conduct its existing supervisory and cooperative responsibilities more efficiently and provide ‘scalability’ enabling CIMA to accommodate increasing numbers of regulated entities without a proportionate increase in staff and costs.
Audits submitted after 31 December 2006 must be submitted directly to CIMA from one of Cayman’s approved auditors through secure electronic transmission. This process will increase security considerably for CIMA by ensuring that all audits are submitted to CIMA through a known and approved audit source.
In addition to the electronic audit, every fund must also submit an electronic report (e-report), completed by a director, general partner, or trustee. An auditor will not be permitted to submit a fund’s annual audit to CIMA without submitting the ereport form at the same time.
CIMA is very much aware that Cayman’s regulatory philosophy is a significant factor in Cayman’s success as a hedge fund jurisdiction, and CIMA has taken great care to ensure that e-reporting does not increase the scope of regulation. No new information is being asked for and all data requested can be sourced from any set of financial statements, or as an update to information generally found in a fund’s offering memorandum or registration documents. Fund or manager specific information will not be made available to the public, only aggregate industry statistics.
E-reporting is another example of how Cayman is leading the industry with innovative policies and processes. Cayman is the first offshore jurisdiction to collect and collate information of this type with an electronic system. CIMA’s regulatory philosophy towards hedge fund regulation remains attractive to all and continues to balance the needs of investors, promoters, operators, investment managers, prime brokers and fund administrators while increasingly finding favour with national and international regulators who have come to realise the benefits the hedge fund industry has to play in our global financial system.
Grant Stein is the Global Managing Partner for Walkers, the global offshore law firm of choice for investment banks, international law firms, collateral managers, and other financial institutions. Based in the Cayman Islands with offices in the British Virgin Islands, Dubai, Hong Kong, Jersey, London, and Singapore, Walkers provides clear, concise and practical advice based on an in-depth knowledge of the legal, regulatory and commercial environment in the Cayman Islands, the BVI, and Jersey.
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