Cayman Islands: Private Fund Structures And Regulation

Private Fund Structures

Private funds are collective investment vehicles that are not open for redemption at the option of investors. The PF Act defines a private fund as a vehicle that offers or issues investment interests, the purpose or effect of which is the pooling of investor funds with the aim of enabling investors to receive profits or gains from such entity’s acquisition, holding, management, or disposal of investments, where:

• The holders of investment interests do not have day-to-day control over the acquisition, holding, management, or disposal of the investments; and
• The investments are managed as a whole by or on behalf of the operator of the private fund, directly or indirectly.

Responsibility for regulation of private funds under the PF Act rests with the Cayman Islands Monetary Authority (CIMA), and there are currently more than 17,000 private funds registered with CIMA under the PF Act.[1]

The most common vehicles used in private fund structures in the Cayman Islands are:

• Exempted Limited Partnerships (ELPs): These are governed by the Exempted Limited Partnership Act (As Revised), and are similar to Delaware limited partnerships. ELPs have one or more general partners, who are responsible for the conduct of the business of the ELP, and one or more limited partners, who are passive investors with limited liability. ELPs have no separate legal personality are the preferred vehicle for private funds as they offer considerable contractual flexibility and administrative ease.
• Exempted Companies: These are governed by the Companies Act (As Revised), and are the most widely used corporate vehicle in the Cayman Islands. Exempted companies have a separate legal personality, limited liability for shareholders, and a simple and efficient incorporation process. Exempted companies are typically used as general partner, manager, blocker, or holding vehicles in private fund structures, or as feeder funds in master-feeder arrangements, where particular investors require a corporate vehicle through which to access the private fund structure.
• Limited Liability Companies (LLCs): These are governed by the Limited Liability Companies Act (As Revised), and are hybrid entities that combine features of both companies and partnerships. LLCs have separate legal personality, limited liability for members, provide flexible governance arrangements, and can have capital account mechanics in a manner similar to ELPs. LLCs are often used as general partner, manager, co-investment, or alternative investment vehicles, or as subsidiaries of ELPs or exempted companies.
• Unit Trusts: These are governed by the Trusts Act (As Revised), and are contractual arrangements between a trustee and one or more beneficiaries who hold beneficial interests in the trust property. Unit trusts are popular among Japanese and other Asian investors, as they offer tax and regulatory advantages, off-balance sheet treatment, and familiarity. Unit trusts structured as private funds generally have features similar to ELPs, such as capital call and defaulting investor provisions, and may invest through one or more investment subsidiaries.

Private Fund Regulation

The PF Act, which came into force on 7 February 2020, introduced a registration and regulatory regime for private funds in the Cayman Islands, under the supervision of the CIMA. The PF Act applies to: (a) Cayman Islands private funds; and (b) non-Cayman Islands private funds that make an invitation to the public in the Cayman Islands, in each case, unless they fall within certain exemptions, such as single investor funds, non-fund arrangements, or persons licenced or registered under other Cayman Islands regulatory laws.

Private funds registered under the PF Act are subject to certain operational requirements which include:

• Valuation of assets: A private fund must have appropriate and consistent procedures for the valuation of its assets. Valuations must be carried out at least annually by an independent third party, or by the private fund’s operator or manager (or their affiliate) provided the valuation function is independent from the portfolio management function and potential conflicts are properly managed and disclosed to investors.
• Safekeeping of fund assets: A private fund is required to appoint a custodian to hold its assets (generally in a segregated account) and to perform title verification of the private fund’s assets, unless it is neither practical nor proportionate to do so. Where no custodian is appointed, the private fund must appoint one of the following to perform the title verification function: (a) an independent third party; or (b) the private fund’s operator or manager (or their affiliate) provided the title verification function is independent from the portfolio management function and potential conflicts are properly managed and disclosed to investors.
• Cash monitoring: A private fund must appoint a person to monitor its cash flows, cash accounts, and receipts and payments, and ensure that all cash of the private fund is booked in cash accounts opened in the name of or for the account of the private fund.
• Identification of securities: 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 that it trades and holds, such as the International Securities Identification Number (ISIN) or the Legal Entity Identifier (LEI).

In addition to the operational requirements outlined above, registered private funds must also comply with the following regulatory obligations:

• Audit: The accounts of a private fund must be audited annually by an auditor approved by CIMA and submit the audited accounts and a Fund Annual Return (FAR) to CIMA within six months of the end of each financial year.
• Notification and annual filing requirements: CIMA must also be notified of any material changes to the information submitted to CIMA at the time of registration or any subsequent filings, within 21 days of the private fund becoming aware of the change. Additionally, a private fund is required to pay a prescribed annual registration fee to CIMA (currently US$4,268) in January each year.
• Corporate governance and internal controls: CIMA has issued Rules on Corporate Governance and Internal Controls that require private funds to establish and maintain a corporate governance framework and internal controls tailored to each fund’s profile.
• Anti-money laundering (AML) regulations: The Cayman Islands has established a comprehensive framework for AML that aligns with Financial Action Task Force (FATF) recommendations. All entities carrying ‘relevant financial business’ (which includes Cayman Islands private funds) are required to comply with the requirements of Cayman Islands AML regulations which include the requirement to appoint natural persons as the private fund’s AML officers and the maintenance of AML procedures that include investor due diligence, record keeping and monitoring of transactions for suspicious activities.
• Automatic exchange of information (AEOI) regimes: AEOI regimes of both the OECD Common Reporting Standard (CRS) and the US Foreign Account Tax Compliance Act (FATCA) have been implemented in the Cayman Islands. Private funds generally fall within the scope of these regimes, and are required to comply with the investor due diligence, notification, and annual reporting obligations to the Cayman Islands Tax Information Authority. 

CIMA has extensive powers under the PF Act to intervene in the operations of a regulated private fund under certain conditions. These conditions include where the fund is unable to meet its obligations as they fall due, is carrying on business fraudulently or in a manner detrimental to the public interest or the interests of its investors or creditors, is non-compliant with the PF Act or AML regulations, or is not being directed and managed in a fit and proper manner. In such cases, CIMA can take various actions to protect investors and creditors, such as notifying investors, appointing persons to advise the private fund on the proper conduct of its affairs or to assume control of or reorganise the affairs of the private fund, or even cancelling the private fund’s registration or initiating its wind-up through the Cayman Islands Grand Court.

In addition, CIMA is also able to impose administrative fines for non-compliance, with penalties based on the severity of the breach—minor, serious, or very serious. Fines can reach up to CI$5,000 for minor breaches, up to CI$50,000 for individuals and CI$100,000 for entities for serious breaches, and up to CI$100,000 for individuals and CI$1 million for entities for very serious breaches.

Outlook

Despite the ongoing volatility in the global macroeconomic landscape, marked by elevated interest rates, geopolitical strife, persistent inflation, and the upcoming US elections, the allure of the Cayman Islands as a premier destination for private fund establishment remains undiminished. This is evidenced by the steady increase in the number of private funds registered with CIMA, which climbed to 17,023 by the close of the second quarter of 2024, up from 16,551 at the end of the previous year, and significantly higher than the 15,854 recorded at the end of 2022.[2]  The jurisdiction’s appeal is bolstered by its tax-neutral stance, a sophisticated legal infrastructure, and a diverse array of investment vehicles designed to meet the specific needs of sponsors, managers, and investors across different asset classes and geographies. The jurisdiction’s demonstrated commitment to maintaining a high standard of regulation and supervision for private funds, in line with the international expectations and developments, are also pivotal in sustaining its role as a jurisdiction of choice for private fund structures. 

[1] Cayman Islands Investment Funds Statistics (cima.ky)

[2] Cayman Islands Investment Funds Statistics (cima.ky)