The Cayman Islands remains the offshore jurisdiction of choice for the formation of international investment funds (including hedge funds and private equity funds). It is also a leading jurisdiction for the formation of other business vehicles where structures are being established to efficiently structure international capital - including vehicles established for joint venture, portfolio investments, asset finance, CLO and insurance-related transactions.
A cornerstone to the success of the Cayman Islands’ financial services sector is its strong legal and regulatory system, which equally benefits managers and institutional investors. The jurisdiction is attentive and responsive to developing international trends. It continues to evolve to ensure it meets the requirements of finance sector participants, governmental and regulatory authorities. Against this context, there have been a number of noteworthy developments.
The corporate governance regulatory framework is a key focus for the Cayman Islands Monetary Authority (CIMA). CIMA undertook a broad-based consultation process during 2013, inviting stakeholders to provide feedback on a range of corporate governance topics relevant to Cayman Islands’ regulated mutual funds.
Subsequent to the consultation process, CIMA is considering various corporate governance developments and issued a draft Statement of Guidance on Corporate Governance for Regulated Mutual Funds (SOG) in January 2014.
The purpose of the SOG is to provide governing bodies and operators of funds, howsoever structured, with guidance on CIMA's minimum expectations for the sound and prudent governance of a regulated mutual fund. It is not intended by CIMA to be an exhaustive guide.
While the SOG is not directly enforceable by CIMA, CIMA might itself look to the SOG as a guide should CIMA need to consider whether the direction and management of a regulated mutual fund has been conducted in a ‘fit a proper manner’ pursuant to CIMA's powers to take action under applicable provisions of the Mutual Funds Law. Operators of regulated mutual funds are reviewing corporate governance arrangements and practices in light of the SOG, including with respect to:
(a) reviewing the frequency of meetings of the fund's governing body;
(b) assessing who should be responsible for preparing meeting minutes;
(c) scheduling regular check-ups on the activities of service providers;
(d) considering a service provider's attendance at meetings; and
(e) considering whether adequate disclosure as to conflicts and other matters has been made in the fund's offering materials.
There are other corporate governance developments under consideration, which are intended to further promote consistency, transparency and high standards of corporate governance, including a public database for regulated mutual funds and the licensing and registration of directors of regulated mutual funds.
In that context, as a matter of Cayman Islands law, directors of a Cayman company owe certain duties to the company and are responsible for supervisory oversight of a company's affairs, even where day-to-day functions are delegated to a service provider (such as an investment manager or administrator).
Director's duties are essentially imported from English common law and similar to those in all common law jurisdictions, with the most significant fiduciary duty being to act in the best interests of the company as a whole. In addition, directors owe a common law duty of care, diligence and skill to the company. The Cayman courts have held directors liable who have fallen short of this duty, such as in the widely reported Weavering judgment.
In line with these duties, it is recommended best practice for directors to fully, accurately and clearly record meetings and any material decisions and/or considerations and to regularly consult with a fund's service providers.
In this respect, the SOG enhances existing corporate governance requirements and the prevailing view is that the existing regulatory regime governing Cayman-domiciled vehicles and Cayman based industry participants is more than adequate. It is anticipated that additional enhancements to the regulatory framework will further consolidate the Cayman Islands' position as a premier international financial centre.
Transparency and Cooperation
The Cayman Islands government, through applicable regulatory agencies, continues to actively engage with counterpart international regulators (such as the SEC and FCA) and lead the way for international financial centres on evolving transparency and cooperation initiatives, particularly pertaining to the exchange of information on tax and regulatory directives such as the European Union's Alternative Investment Fund Managers Directive (AIFMD).
Exchange of Information on Taxation
In November 2013, the Cayman Islands signed a Model 1 intergovernmental agreement (IGA) with the United States, which provides a framework for the implementation of the US Foreign Account Tax Compliance Act (FATCA) in a favourable and cost-effective manner for Cayman-domiciled financial institutions, including collective investment funds. At the time of writing, Cayman legislation is being drafted in order for the terms of the IGA, and similar agreements entered into with the United Kingdom, to take effect in law in the Cayman Islands.
These developments are supported by a network of bilateral tax information exchange agreements (currently in excess of 30 with further agreements being negotiated) and adherence to multi-lateral conventions like the OECD/Council of Europe on Mutual Assistance in Tax Matters.
These initiatives further strengthen Cayman's regulatory reputation on cooperation matters and align its regulatory framework with a trend towards automatic exchange of information on tax. Cayman's evolving framework has been recognised in independent reviews. The OECD's Global Forum on Transparency and Exchange of Information for Tax Purposes Phase 2 Peer Review Report, released in 2013, concluded that Cayman has both the appropriate organisational processes and adequate resources in place to ensure that exchange of information takes place in an efficient manner and that timely responses are received, while also noting that a number of regulators praised the quality of cooperation and speed in response times.
The Cayman Islands were further recognised by the Financial Stability Board as a jurisdiction that has sufficiently strong adherence to internationally agreed information exchange and cooperation standards in the areas of banking, insurance and securities regulation.
The EU's AIFM Directive
In early-2013, amendments were made to the Monetary Authority Law to facilitate the marketing of Cayman-domiciled alternative investment funds in the European Economic Area. CIMA has subsequently signed AIFMD-related memoranda of understanding with all European Union members, with the current exceptions of Italy, Slovenia and Spain.
These cooperation agreements permit Cayman-domiciled alternative investment funds to continue marketing under relevant national private placement regimes. There is continuing discussions with relevant European regulators to finalise remaining cooperation agreements.
Exempted Limited Partnership Law
At the time of writing, the Cayman Islands government has announced that the Exempted Limited Partnership Law is to be repealed and replaced with a comprehensively revised new law. It is anticipated that the revised law will be implemented towards the end of March 2014, simultaneously with an additional law recognising and giving effect to third party beneficiary rights.
The broad intention of the revised Exempted Limited Partnership Law is to codify the contractual freedom of parties to regulate their arrangements with appropriate statutory safeguards, promote consistency with equivalent onshore structures and to respond to certain issues that the market has requested in order to make Cayman limited partnership structures as straightforward and cost-effective as possible to establish and manage.
Salient revisions are as follows:
(a) Preserving the requirement of the general partner to act at all times in good faith, whilst enabling the partnership agreement to manage competing interests, for example, in the context of conflicts or allocations as between prior and successor funds.
(b) Permitting registration of foreign limited partnerships in the Cayman Islands in order to permit such partnerships to qualify as the sole qualifying general partner of an exempted limited partnership (in addition to those vehicles which are currently permitted to serve in such role, including foreign companies registered in the Cayman Islands).
(c) Providing that, subject to the partnership agreement, a limited partner does not owe fiduciary duties in exercising any of its rights or authorities or otherwise performing any of its obligations as a limited partner.
(d) Introducing additional provisions regulating boards and committees; including:
(i) Confirmation that, subject to the partnership agreement, an advisory board member does not owe fiduciary duties in exercising any rights or authorities or otherwise performing any obligations as a member.
(ii) Expansion of express limited liability ‘safe harbours’ with respect to membership and operation of boards and committees.
(e) Simplifying the formalities associated with the admission of new partners and the transfer of partnership interests.
(f) Streamlining financing procedures, for example, with respect to the creation of floating charges over a partnership's assets and the ability to assign the right to make capital calls.
(g) Acknowledging that commercially agreed default provisions will not be unenforceable solely on the basis that they are penal in nature.
(h) Simplifying the requirements of the statutory register by the insertion of new provisions relating to the maintenance of the register of partnership interests and recording of contributions and distributions.
(i) Clarifying clawback provisions to affirm that repayment of capital contributions will only be required if an exempted limited partnership is insolvent at the time the original distribution was made.
(j) Introducing a short-form strike off mechanism (equivalent to the procedure which already exists for Cayman Islands companies) in addition to efficient dissolution procedures.
Third Party Beneficiary Rights
Cayman Islands contract law observes the common law doctrine of privity; the core premise of which is that the rights, obligations, and liabilities arising from an agreement can only be enforced by the contracting parties. The effect of this approach is that persons who are not party to an agreement have historically had no direct rights or obligations under that agreement other than in limited circumstances (such as where rights have been afforded to a person under a deed poll).
The imminent implementation of the Contract (Rights of Third Parties) Law will allow an identified or identifiable third party to enforce the benefit of the terms of an agreement if expressly authorised to do so by that agreement. It will be of particular relevance in commercial arrangements where there is an express intention to make obligations directly enforceable by third parties; including indemnification and exculpation provisions.
The new law will be similar to equivalent legislation in other Commonwealth jurisdictions, such as England and Wales, but differs in certain key respects. Contracting parties must elect to opt-in to benefit from its provisions and only contractual terms which are expressed in writing to be capable of enforcement by the relevant third party will be so enforceable.
Generally, the new law will not have retrospective effect and a cause of action, which has accrued prior to the law coming into effect, will not be capable of being enforced under the new law.
The Cayman Islands has consistently adapted its regulatory and legal system to meet the demands of the finance sector and align with international best practice. As such, and in light of regular dialogue between government and the private sector, there will inevitably be further regulatory and legislative developments in 2014 as the Cayman Islands continues its role as a pre-eminent international financial centre.
Julian Ashworth is a partner in the Cayman Islands office of Maples and Calder. He specialises in private equity and hedge fund structures and investments. Julian has worked with sponsors and institutional investors advising on the structuring and formation of private equity, hedge and hybrid funds, portfolio investments, security arrangements, secondary transactions and fund restructurings. He advises sponsors and management companies on profit sharing and funding arrangements and Cayman Islands regulatory matters. Julian is also involved in corporate finance matters, including leveraged buyouts, joint ventures, co-investments and restructuring matters.
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