The British Virgin Islands (BVI) and the Cayman Islands remain among the most popular jurisdictions for incorporating cryptocurrency trading vehicles. For example, the bankrupt cryptocurrency exchange FTX Trading identified that 22% of its customer base is located in the Cayman Islands, with 11% in the BVI. This is unsurprising, given the considerable benefits of trading cryptocurrencies through offshore vehicles, including tax neutrality, high levels of confidentiality, and low incorporation and annual maintenance costs.

This article considers some tips and traps related to cryptocurrency trading vehicles incorporated in the BVI and the Cayman Islands.

Cost-sensitive clients typically opt to incorporate a company in the BVI because the annual government maintenance fees are lower. Provision of a non-PO Box address, which is required by many cryptocurrency exchanges, usually also escalates costs in the Cayman Islands, whereas most BVI-registered agents offer this service as standard.

The constitutional documents of a Cayman Islands company are confidential, while the memorandum of association and articles of association of a BVI company are a matter of public record. Therefore, those needing to include commercially sensitive provisions in their constitutional documents, such as pursuant to a shareholders’ agreement, may prefer to incorporate a Cayman Islands company.

Clients are advised to carefully review the terms of service of their preferred exchange. In the case of the bankrupt cryptocurrency lending platform Celsius Network, the US Bankruptcy Court, Southern District of New York, held that certain customers transferred ownership of coin deposits in their “earn accounts” to Celsius, rendering the assets presumptively property of the Celsius bankruptcy estate. Recovery by these depositors is, therefore, most likely limited to cents on the dollar.

It is worth noting that the court’s ruling was fact-sensitive and largely based on an ordinary construction of Celsius’ terms of service, pursuant to which ownership of cryptocurrencies is purportedly transferred. This leaves open the possibility that cryptocurrency depositors could – in the absence of any terms to the contrary – assert a proprietary claim over their assets on a cryptocurrency exchange, thereby taking the assets outside of the exchange’s insolvent estate.

This same issue arises in the chapter 11 bankruptcy proceedings of FTX, as its latest version of the terms of service specifically states that “title to … digital assets shall at all times remain with [the customer] and shall not transfer to FTX Trading”.

Certain cryptocurrency exchanges have established a practice of offering lines of credit to eligible depositors. These facilities are often secured with debenture-style security as part of the standard terms. Importantly, this may inhibit the company’s corporate flexibility depending on the agreed covenants and will at least necessitate the insertion of an entry in the company’s security register to comply with applicable law.

Cryptocurrency trading companies incorporated in the BVI or the Cayman Islands should carefully consider licensing, registration and other regulatory requirements. Compliance may be necessary under legislation regulating virtual asset service providers, mainstream financial services legislation, and provisions regulating anti-money laundering. Increasingly, the author sees banks and other service providers requesting a legal opinion to confirm that the relevant cryptocurrency trading company has complied with all applicable local law as part of its onboarding requirements.

Cryptocurrency trading vehicles should carry out an economic substance analysis to ensure no “relevant activities” are inadvertently being conducted, and that all economic substance filings are accurate and complete. In some instances, offshore companies trading cryptocurrencies have appointed C-level personnel theoretically giving rise to “headquarters business”. This could, in turn, oblige compliance with the economic substance test. The author has also seen filings by companies declaring they are conducting “holding company business”, while no relevant activities are being performed. This may give rise to penalties.

BVI and Cayman Islands companies must maintain records and underlying documentation in a form that is sufficient to show and explain its transactions, and enable its financial position to be determined with reasonable accuracy. In some cases, board and shareholder resolutions are also required to ensure due authorisation in accordance with the constitutional documents of the company.

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PETER VAS is a partner at Loeb Smith Attorneys in Hong Kong

This article was first published in the Asia Business Law Journal.

Contact details:
E: peter.vas@loebsmith.com

Loeb Smith is pleased to announce that Robert Farrell has been promoted to Partner in Loeb Smith’s Cayman Islands Corporate and Investment Funds team.

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Robert joined Loeb Smith’s Cayman Islands office in 2021 and advises clients in respect of both Cayman Islands and British Virgin Islands matters. He brings a wealth of experience in complex, high value, cross-border transactions, specialising in (1) investment funds advising on formation and launch, portfolio investments and financing, (2) corporate – cross-border M&A, joint ventures, acquisitions, reorganizations, private equity and merger take privates; (3) banking and finance – acting for both borrowers and lenders with transactions ranging from international real estate finance and VC, private equity and general corporate and commercial lending; and (4) commercial – offering strategic advice on economic substance compliance, consignment agreements, services agreements, IP licensing, and general commercial advisory work.

Robert also has over 12 years’ prior experience as a finance lawyer in the UK, representing senior business leaders and financial institutions, often on high-profile, high-value transactions.

Considered “Very impressive on the commercial finance side of transactions” Robert is also praised by clients “for his ability to handle complex mandates” (Legal500).

Gary Smith, Head of Loeb Smith’s Corporate Group in the Cayman Islands commented, “Congratulations, Robert for joining the Partnership! I feel blessed to be working with our fantastic team and clients. Robert brings a wealth of international experience to the firm and is highly regarded by clients. Our commitment to deliver efficient legal solutions at competitive rates to our clients globally remains as strong as ever.”

“I am delighted to be joining the Partnership at Loeb Smith. I am very grateful for all of the guidance and support that I have been shown by colleagues since joining the firm in 2021 and I am very much looking forward to using the platform of partnership to provide a first-class service to our new and existing clients.”, said Robert.

Well done, Robert!

***

Tap the link to check Robert Farrell’s profile in Legal500:

https://www.legal500.com/firms/235334-loeb-smith-attorneys/234779-george-town-cayman-islands/lawyers/2323210-robert-farrell/

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1. Administrative Fines Regulations in respect of Cayman Private Funds

1.1.  The administrative fine regime in the Cayman Islands was implemented pursuant to the Cayman Islands’ Monetary Authority (Administrative) Fines (Amendment Regulations), 2020, as amended (“Administrative Fines Regulations”) and extend the application of the fines administered by CIMA from the Anti-Money Laundering regime, to all regulatory laws, regulations and any rules issued by CIMA thereto.

1.2.  The Administrative Fines Regulations categorize breaches as ‘minor’, ‘serious’ or ‘very serious’. For example, a Private Fund which accepts capital contributions from investors in respect of investment before it is registered with CIMA as a Private Fund is a “very serious breach”.

1.3.  The Administrative Fines Regulations impose a scale of fines dependent on the categorization of the breach as set out in paragraph 1.2 above, starting from an initial fixed fine of US$6,100 for a minor breach to a single fine up to a maximum of US$121,955 for individuals or US$1,219,515 for corporate bodies (e.g. exempt companies, SPCs, LLCs). Any administrative fines set out in the Administrative Fines Regulations which are applicable specifically to Private Funds, will be in addition to any fines which may be imposed on a Private Fund under the PFA.

What is the significance of the Statement of Guidance issued by the Cayman Islands Monetary Authority?

1. The Statement of Guidance is in line with international governance practices and re-affirms certain principles and practices that have been discussed in Cayman Islands case law in this area (e.g. in Weavering Macro Fixed Income Fund Limited .v. Peterson and Ekstrom [2011] 2 CILR 203).

2. The Statement of Guidance only applies to Regulated Mutual Funds. It does not extend to regulated entities in the banking and insurance sectors. It applies to all Regulated Mutual Funds (i.e. licensed funds, administered funds, and section 4(3) registered funds) irrespective of the manner in which they are regulated under the Mutual Funds Law.

3. The Statement of Guidance applies to all “Operators” of Regulated Mutual Funds wherever in the world they may reside. It does not apply solely to those Operators who are resident in the Cayman Islands. A Director of the Fund will be an “Operator” where the Regulated Mutual Fund is a corporate, a general partner will be an “Operator” where the Regulated Mutual Fund is an exempted limited partnership, and a trustee will be an “Operator” where the Regulated Mutual Fund is a unit trust.

4. The Statement of Guidance is not intended to be prescriptive or exhaustive as to CIMA’s expectations with regard to corporate governance of Regulated Mutual Funds.

5. The Statement of Guidance is not mandatory but it does reflect CIMA’s expectations of what should be the minimum level of “sound and prudent governance” (rather than best practice) that should be in place for Regulated Mutual Funds. Though the Statement of Guidance is not mandatory, it will most likely become a benchmark against which investors, CIMA, service providers, and Courts measure actual practices of Regulated Mutual Funds. Accordingly the corporate governance principles set out in the Statement of Guidance should be reviewed by Operators of Regulated Mutual Funds and, at the very least, become the minimum standards for corporate governance arrangements and practices for Regulated Mutual Funds.

Oversight Function

The Statement of Guidance states that a Regulated Mutual Fund’s “Governing Body” (that is, the board of directors where the Regulated Mutual Fund is a corporate, the general partner(s) where the Regulated Mutual Fund is an exempted limited partnership, and the trustee(s) where the Regulated Mutual Fund is a unit trust) should:

i. monitor and regularly take steps to satisfy itself that the Regulated Mutual Fund is conducting its affairs in accordance with all applicable laws, regulations, rules, statements of principles, statements of guidance and anti-money laundering or combating terrorist financing requirements;

ii. regularly take steps to satisfy itself that the Regulated Mutual Fund’s service providers are monitoring compliance with applicable laws, regulations, rules, statements of principles, statements of guidance and anti-money laundering or combating terrorist financing requirements;

iii. request appropriate information from the Regulated Mutual Fund’s service providers and/or professional advisors to enable it to satisfy itself regularly that the Regulated Mutual Fund is operating in compliance with the applicable laws, regulations, rules, statements of principles, statements of guidance and anti-money laundering or combating terrorist financing requirements;

iv. where required, provide appropriate directions to the Regulated Mutual Fund’s service providers to rectify any non-compliance with the applicable laws, regulations, rules, statements of principles, statements of guidance and anti-money laundering or combating terrorist financing requirements;

v. require regular reporting from the Regulated Mutual Fund’s investment manager and its other service providers to enable the Governing Body to make informed decisions and to adequately oversee and supervise the Regulated Mutual Fund.

Conflicts of Interest

The Governing Body must:

i. suitably identify, disclose, monitor and manage all its conflicts of interest;

ii. document the disclosed conflicts of interest.

Board Meetings

The Governing Body should:

i. meet at least twice a year in person or via a telephone or video conference call;

ii. where the circumstances or size, nature and complexity of the Regulated Mutual Fund necessitates it, meet more frequently than the twice a year, so as to enable it to fulfil its responsibilities effectively;

iii. request the presence of the Regulated Mutual Fund’s service providers (e.g. representatives from the Regulated Mutual Fund’s administrator, investment manager, and auditor) at these meetings.

Operators’ Duties

i.Exercise Independent Judgment – There is no formal requirement in the Statement of Guidance for Regulated Mutual Funds to appoint independent directors. However it does require, among other things, that the Operator “must exercise independent judgment”. It could be argued that this requirement will be more often tested in Regulated Mutual Funds where all Operators are affiliated to the investment manager and/or there are no independent appointees.

ii. Act in the best interests of the Regulated Mutual Fund – taking into consideration the interests of its investors as a whole and/or, where applicable, the interests of the Fund’s creditors.

iii. Operate with due skill, care and diligence and act honestly and in good faith at all times.

iv. Sufficient capacity to apply mind to overseeing and supervising the Regulated Mutual Fund – The Operator must ensure that he/she has sufficient capacity to apply his/her mind to overseeing and supervising the activities of each Regulated Mutual Fund for which he/she is the Operator.

v. Ensuring that the Regulated Mutual Fund’s investment strategy and conflicts of interests policy are all clearly described in its offering document.

vi. Approving the appointment and removal of the Regulated Mutual Fund’s service providers and the terms of their contracts with the Fund; and ensuring that the Fund’s investors and CIMA are notified of these appointments/removals.

vii.Retain ultimate responsibility for functions delegated to the Regulated Mutual Fund’s service providers, and should regularly monitor and supervise the delegated functions.

viii. Ensure that the Regulated Mutual Fund’s service providers are performing their functions in accordance with the terms of their respective contracts and that their roles and responsibilities are clearly defined.

ix. Regularly monitor whether the investment manager is performing in accordance with the defined investment criteria, investment strategy and restrictions.

x. Review and approve the Regulated Mutual Fund’s financial results and audited financial statements and regularly monitor the Fund’s net asset valuation policy and check that the calculation of its net asset value is being done in accordance with this policy.

xi. Assess whether he/she has, together with any other Operator of the Regulated Mutual Fund, sufficient collective knowledge and experience to perform the duties imposed upon the Operator.

xii. On an on-going basis, disclose to CIMA (i) any matter which could materially and adversely affect the financial soundness of the Regulated Mutual Fund, or (ii) any non-compliance by the Regulated Mutual Fund with applicable laws.

Management

The Statement of Guidance specifies that an Operator should ensure that it provides suitable oversight of the risk management of the Regulated Mutual Fund, ensuring that the Fund’s risks are always appropriately managed and mitigated (with material risks being discussed at meetings of the Governing Body and the Governing Body taking appropriate action where necessary).

January 2014

The starting point to assessing the transferability of a loan portfolio is to review the loan agreement to identify any restrictions on the ability of a lender to effectuate a transfer of the relevant loan(s). For example, the borrower’s prior written consent may be required to the transfer of the loan(s) and the loan agreement may prescribe the circumstances under which the borrower may refuse to provide that consent. Furthermore, there may be restrictions on the transferability of certain types of loan portfolios, such as those including mortgages or consumer loans, and the transferor may also be subject to onerous internal confidentiality rules and data protection requirements. Although these are principally points of onshore law to be determined under the governing law of the loan agreement, to the extent that the borrower is incorporated in the BVI or the Cayman Islands and is a party to the transfer agreement(s), it is customary for offshore legal counsel to the lender to issue a legal opinion to confirm (among other things) that the relevant company has the requisite capacity and power to enter into the transfer agreement(s).

Most cross-border loans in Asia are supported by an offshore security package. A potential purchaser of a loan portfolio should therefore keep the following points in mind.

–  Careful consideration must be given to the method by which the outgoing secured party’s security interests are transferred to the purchaser or its nominee. For example, there is generally no way to assign legal title to a chose in action or other property right under BVI law. Therefore, if a party wishes to transfer legal title to a right in action under BVI law, this can normally only be accomplished by way of novation. However, it is possible for choses in action to be assigned in the BVI in equity, and this is the normal mechanism by which this is done.

–  Until the security provider is notified of the assignment, it may discharge any of its obligations for the benefit of (or making payment to, as the case may be) the original assignor. However, the assignment itself is valid between the assignor and the assignee, and the assignor may need to account to the assignee under the terms of the assignment. There is no requirement that notice to the security provider must be given in writing or that the security provider acknowledge receipt of the notice, although this is customarily done for evidential reasons.

–  If the security provider is a BVI company and has registered details of the security in its register of registered charges maintained by the BVI Registrar of Corporate Affairs (the “Registrar”), it must register a variation of charge with the Registrar to comply with BVI law. The Registrar will issue a certification of variation of charge and stamp the particulars of the variation of security as evidence that the variation has been duly registered.

–  If the security provider is a BVI company and has registered details of the security in its register of registered charges maintained by the BVI Registrar of Corporate Affairs (the “Registrar”), it must register a variation of charge with the Registrar to comply with BVI law. The Registrar will issue a certification of variation of charge and stamp the particulars of the variation of security as evidence that the variation has been duly registered.

In practice, a well-drafted assignment agreement will impose an express obligation on the relevant parties to complete all of the local law filings and register updates within a mutually acceptable timeframe. Offshore legal counsel should be retained to ensure that all such filings are correctly completed and that the transfer mechanics comply with BVI or Cayman Islands law (as applicable).

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This publication is not intended to be a substitute for specific legal advice or a legal opinion. For specific advice, please contact:

Peter Vas
Partner
Loeb Smith Attorneys
Hong Kong
E: peter.vas@loebsmith.com
www.loebsmith.com
Peter is recognized as a leading offshore lawyer in the Asia Business Law Journal A-List 2022 and Asian Legal Business Offshore Client Choice List 2022