The Claimant sought injunctive relief in the form of an interim freezing order and disclosure orders from the High Court against a number of defendants as part of his attempts to recover cryptocurrencies which had been taken from him fraudulently. The Claimant was the victim of a scam which induced him to transfer approximately 2.1M USDT and approximately 230,000 USDC from his personal wallets.

The Claimant believed that the website ‘www.tda-finan.com’ (the “Website”) (which is no longer available) was affiliated with TD Ameritrade (which is a regulated entity in the United States) due to the deliberate misuse of a corporate logo which was designed to make the Website appear legitimate. As a result of this deception, the Claimant deposited USDT and USDC into a number of digital wallets associated with the Website and also purported to make certain trades through his account. So as to prolong the appearance of legitimacy, the Claimant’s account appeared to reflect those trades.

In February 2022, the Claimant’s open trades on the Website were abruptly closed without any input from him. The Claimant naturally became suspicious and unsuccessfully attempted to withdraw funds from his account. The Claimant’s account was then blocked, and after a number of exchanges by email with a representative of the Website, it became apparent to the Claimant that he had been defrauded.

The Claimant instructed counsel and engaged an ‘intelligence investigator’ in an attempt to recover his assets. The investigators were able to trace, approximately, 2.175M of USDT and USDC to a number of addresses maintained with a number of large crypto-exchanges (all of which were named as defendants to the case) (the “Crypto-Exchanges”).

The Claimant sought to bring the following claims:

• a claim of fraudulent misrepresentation, deceit, unlawful means conspiracy and unjust enrichment against those who had operated the Website; and
• a claim in constructive trust against both those who had operated the Website and each of the Crypto-Exchanges, given they control the exchanges into which the misappropriated cryptocurrency had been transferred.

In order to proceed with these claims, the Court had to consider whether the freezing order and disclosure order should be granted, and if they should, whether the Claimant’s application to serve notice of proceedings outside of England and Wales (with English law being the governing law of the claim) using an alternative method of service, should be permitted.

Whilst the location of the fraudsters was unknown (albeit there was some evidence to suggest they were based in Hong Kong), the Crypto-Exchanges were located in the Cayman Islands, Panama, the Seychelles and Thailand.

The Court was satisfied that there was a serious issued to be tried in England and Wales on the basis that; (i) the misrepresentations regarding the Website were made to the Claimant in England and (ii) that (applying the principle in Ion Science Limited & Duncan John v. Persons Unknown, Binance Holdings Limited, Payment Ventures Limited[2]) the lex situs of the crypto assets that were the subject of the fraud is the country where the rightful owner is domiciled (in this case England). Finally, the Court concluded that the governing law of the claim was also English law on the basis that the loss sustained by the Claimant took place in England.

The Court also concurred that the Claimant had a prima facie case against each of the Crypto-Exchanges as constructive trustees as they had control of the exchanges to which the missing assets had been traced by the Claimant’s investigator.

The Court conceded that damages would not have been an adequate alternative remedy for the Claimant, because awarding damages would not prevent the further dissipation of the Client’s assets. Mr. Justice Trower noted that the “balance of convenience” came down “firmly” in favour of granting the relief sought.

On the topic of disclosure orders against the Crypto-Exchanges, the Court made the requested orders having considered that the disclosure of the information sought had a “real prospect” of helping the Claimant recover his crypto-assets and also noting that the order should be granted notwithstanding any duty of confidentiality owed by the Crypto-Exchanges to any third parties.

The Court then considered the means by which notice of the orders made would be served on the fraudsters. Counsel for the Claimant had requested service by email and also by NFT in the form of an airdrop into the accounts associated with the Website, into which the Claimant first deposited his crypto assets. The Judge, Mr. Justice Trower, was bold in his assertion that there “could be no objection” to the request, noting that service by this means would “embed the service in the blockchain” and would only enhance the prospect of the fraudsters being made aware of the Court orders and the proceedings more generally. However, Mr. Justice Trower did observe that it was important that service was also made by email and that he might not have been content to order alternative service solely by NFT.

The decisions in this case are to be welcomed as they only serve to enhance the prospects of recovery of lost assets for victims of fraud. The willingness of the Court to embrace the benefits of blockchain technology to serve notice on those who seek to hide behind its anonymity should be applauded and we can only hope that the Court will continue along this trajectory.

Indeed, as fraudulent activities in respect of cryptocurrencies and other digital assets are on the rise, the frequency of such applications will likely only increase and it is surely only a matter of time before crypto businesses established in the Cayman Islands are dealing with such matters on a regular basis.

The case also serves as a warning to those who operate crypto exchanges that the Courts are more than willing to entertain claims based on constructive trust where the misappropriated assets are traced to accounts hosted by them. One can only hope that this will spur these organisations into action to take all necessary steps to combat fraudulent activities, such as freezing the accounts into which misappropriated assets are transferred on receipt of notice.

[1] [2022] EWHC 1723 (Ch)

[2] (unreported) [2020] (Comm.)

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This publication is not intended to be a substitute for specific legal advice or a legal opinion. For specific advice on Digital asset litigation, please contact your usual Loeb Smith attorney or :

Robert Farrell
E:robert.farrell@loebsmith.com
T: +1 345 749 7499

The Report found that the most common jurisdictions where crypto open-ended funds are domiciled are:

Cayman Islands – is the preferred place with almost half of the market (49%).

British Virgin Islands (“BVI”) with 13%. The BVI has overtaken the United States as the second most popular location. Each location saw its share of the market increase slightly year on year, Cayman Islands from 48% to 49% and British Virgin Islands from 11% to 13%.

The United States saw their market share reduced from 46% to 10% during 2021.

The Report lists factors which influence the decision on crypto hedge fund domiciles and the most popular answers were due to ‘crypto friendly’ (22%), ‘regulations’ (20%) and ‘fund friendly’ regulations (17%). This indicates that as many governments and authorities still take a rather unfriendly or indifferent approach towards the crypto industry, or rather are still trying to figure out the correct mix of regulations, other jurisdictions like Cayman and the BVI have stepped up and provided solutions that appear to tick most of the boxes for making them attractive as domiciles for these types of investment funds.

As per the Report, the total assets under management (“AUM”) of crypto open-ended funds increased by 8% to about $4.1 billion in 2021, compared to $3.8 billion reported by respondents to the Report in 2020. According to the Report, there were fewer funds with lower levels of AUM at the end of 2021, while at the other end of the spectrum, the number of funds managing larger amounts of assets was considerably higher.

A significant detail shown in the Report is that 89 hedge funds accounted for an estimated US$436 billion in AUM.

According to the Report, the average management fees for 2021 in crypto open-ended funds remained the same (2.2%). The lack of significant change in management fees is likely to reflect the fact that running costs could have remained at a similar level in relation to previous years. The average performance fee slightly decreased (from 22.5% to 21.6%). The decreased performance fees are likely to be a result of competitive pressures starting to increase, as more funds enter the cryptocurrency space and compete to attract new investors, leading to slightly lower overall fees.

The Report raised concerns regarding the upcoming higher organizational cost of crypto open-ended funds as worldwide regulations are becoming more detailed and investors are demanding more professional and institutional set-ups.

The Report identified High-net worth individuals (“HNWI”) as the most common investor type in crypto open-ended funds, with more than 80% of surveyed funds stating them as their usual type of investor. HNWIs are followed by family offices accounting for 66% and fund-of-funds representing just over 53% in third place, where HNWIs are also the largest investors within these fund-of-funds.

Having in mind that the Report surveyed retail crypto open-ended funds, the average number of investors per fund is 54. However, a more representative value could be the median number of investors, which is 30.

The Report found that the average investment made into crypto open-ended funds is $1.63M but most funds have a ticket size of less than $0.5M.

The Report states that 29% of the crypto open-ended funds surveyed have at least half of their daily cryptocurrency trading volume in Bitcoin compared with 56% in 2020.

The top three sectors that crypto hedge funds have invested into are Store of Value (Bitcoin and Litecoin) with 86%, DeFi (Uni, Aave and Sushi) with 78%, and Infrastructure (Ethereum) with 74% based cryptocurrencies.

In 2021 more altcoins have been traded by over 40% of the funds compared to last year where only one altcoin (Ethereum) was traded by more than 40% of the funds. 2021 shows that Ethereum (ETH, 83%), Solana (SOL, 51%), Polkadot (DOT, 48%), Terra (LUNA, 45%), and Avalanche (AVAX, 42%), were the top traded coins (stable coins were excluded).

However, the recent incident of the collapse of LUNA could become a setback for the general crypto industry in the short term.

Market Neutral: The most common (30%) investment strategy among crypto open-ended funds is Market Neutral. These funds aim to profit regardless of the direction of the market, usually using derivatives to mitigate or eliminate broader market risk.

Quantitative Long Short: This investment strategy makes up for a quarter of all currently active crypto funds with a 25%. Quantitative funds, also called quant funds, are investment funds where crypto are chosen based on numerical data compiled through quantitative analysis. Liquidity is key for these strategies and restricts these funds to only trading more liquid cryptocurrencies.

Discretionary long only: This investment strategy represents a 14% of all the crypto fund. For crypto open-ended funds involved in investing in early token and coin offering and investing and holding in other more liquid cryptocurrencies and digital assets.

Discretionary long/short strategy: This investment strategy represents a 12%. For crypto open-ended funds, discretionary long/short strategy involves buying cryptocurrencies and digital assets that are expected to increase in value and selling short cryptocurrencies and digital assets that are expected to decrease in value.

Multi-strategy funds: Lastly, the multi-strategy funds (a combination of all the above) represent a much smaller proportion with barely 12% of the market.

In terms of performance these strategies had very different results. Market Neutral funds gave an average performance of +37%, Discretionary Long an average performance of +420% and Quantitative Long/Short an average performance of +116%. Against the trend from previous years, the crypto hedge funds had a median performance of 63.4% in 2021, slightly outperforming BTC’s price, which went up about 60%.

Custodian: Interestingly, as the crypto ecosystem continues to mature and institutional investors’ demands are allocated, the Report shows that the digital asset custody market has expanded. This has led to the utilization of independent custodians. Compared to the 2020 data, the use of independent custodians has increased from 76% to 82%, with funds opting either for third-party, or exchange custodians. For example, quantitative fund, discretionary long/short and multi-strategy funds may have their cryptocurrencies and digital assets directly with the exchanges that they use to trade continuously. Therefore, having a well-defined and updated risk management policy is more important than having a custodian.

Independent Directors:  The Report reflects that in 2021, there has been an increase in the percentage of crypto open-ended funds with an independent director on their board from 38% to 51%. This number increased due to three main reasons:

A growing number of newly formed, governance-conscious funds driving demand for independent directors;

existing crypto hedge funds becoming more structured and financially capable of hiring senior talent; and

A growing supply of board directors possessing industry-specific expertise and knowledge as the industry further matures.

Administrator: 91% of the crypto open-ended funds surveyed for the Report have appointed and use independent third-party administrators. The main service required by these funds from the administrators is to independently calculate and verify the net asset value and prepare all the required information for the auditor.

Institutional and/or sophisticated investors are increasingly unwilling to invest in a crypto open-ended fund that has not appointed an independent fund administrator.

Regardless of the choice of fund administrator, the valuation policy needs particular focus. Most funds will have their valuation methodologies and frameworks set out in the Private Placement Memorandum (PPM). It is important for any fund to ensure that it complies with the key terms of the offering set out in its offering documentation.

Institutional and Sophisticated investors are familiarized with the Cayman Islands and BVI and the regulatory regime for open-ended funds. These investors feel more comfortable investing in crypto open-ended funds established in Cayman and BVI as these two offshore jurisdictions have a track record, infrastructure and regulation that facilitate the operation of these funds.

The investment funds industry is slowly starting to consider the cryptocurrencies and other digital assets as other underlying assets that an open-ended fund can invest in.

The tax neutrality of the Cayman Islands and the BVI provides the perfect location for crypto open-ended funds and investors to manage their tax affairs in the most effective manner.

The laws of the Cayman Islands and the BVI are a combination of common law and statute and are based heavily upon English common law. This gives Cayman Islands and BVI law and their respective legal systems a common origin with those of many of the jurisdictions of its users, including the United States. It also means that a fund registered in the Cayman Islands or the BVI and its participating shares are well recognised and accepted around the world.

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This publication is not intended to be a substitute for specific legal advice or a legal opinion. For specific advice on Crypto open-ended funds, please contact your usual Loeb Smith attorney or :

Santiago Mtnez-Carvajal
E: santiago.carvajal@loebsmith.com
T: +1 345 749 7593

The Grand Court of the Cayman Islands has recently offered additional, useful guidance in the growing jurisprudence on the insolvency of Segregated Portfolio Companies (“SPCs”). We have previously discussed the applicable test of insolvency that applies to the appointment of a receiver in respect of a segregated portfolio (“SP”) of an SPC here.

In this article, we will consider the recently handed down judgment in In the Matter of Performance Insurance Company SPC (in official liquidation)[1] and the implications of this for SPCs and SPs as well as the impact that the new Restructuring Officer regime might have in cases of insolvent SPCs and SPs.

An SPC is a legal entity incorporated pursuant to Part XIV of the Cayman Islands Companies Act (2022 Revision) (the “Act”). SPCs can create one or more SPs but crucially, whilst an SPC has its own legal personality, SPs do not.[2] However, the assets and liabilities of an SP benefit from a statutory “ring-fence” from the assets and liabilities of any other SPs of the SPC and from the general assets and liabilities of the SPC.[3] Therefore, a creditor of one SP, does not have any recourse to the assets of other SPs or, subject to any contrary terms in the SPC’s Memorandum and Articles of Association, the general assets of the SPC (and vice versa).[4]

To reinforce this principle, s.219(6) of the Act states that:

It shall be the duty of the directors of a segregated portfolio company to establish and maintain (or cause to be established and maintained) procedures –

a. to segregate, and keep segregated, portfolio assets separate and separately identifiable from general assets;

b. to segregate, and keep segregated, portfolio assets of each segregated portfolio separate and separately identifiable from segregated portfolio assets of any other segregated portfolio; and

c. to ensure that assets and liabilities are not transferred between segregated portfolios or between a segregated portfolio and the general assets otherwise than at full value.”

In the Cayman Islands, SPC structures are commonly used to establish investment funds, given their inherent flexibility to, among other things, facilitate the pursuance of multiple strategies and/or hybrid funds. For example, a single SPC could establish separate SPs to pursue multiple investment strategies or to invest in different asset classes (e.g. public securities, private equity and cryptocurrency).

However, this structure is not without its complexities, particularly in the event of insolvency. For example, if an SPC and some, but not all, of its SPs are insolvent, what is to become of those that are solvent and should their assets be available to affected creditors to make good any shortfall in the insolvent SPs? These issues were recently considered by the Grand Court in the matter of Performance Insurance Company SPC (in official liquidation).

The case relates to Performance Insurance Company SPC (the “Company”) and certain of its SPs, in particular Bottini SP (“Bottini”) and SSS SP (“SSS”). The Company was placed into voluntary liquidation in February 2021 after the Company and certain of its SPs (but not Bottini or SSS which both remained solvent and continued to operate as usual) were the victims of an alleged fraud.

The Joint Official Liquidators (“JOLs”) of the Company intended to wind up the Company and the insolvent SPs. It was further intended that the solvent SPs (including Bottini and SSS) would be novated to new structures which they would themselves select. However, the JOLs would not permit such novation to take place unless and until the solvent SPs agreed to be responsible for a pro rata share of the costs and expenses of the liquidation, which amounted to hundreds of thousands of dollars.

The shareholders of Bottini and SSS therefore sought the appointment of an additional joint official liquidator (“AJOL”) as they considered the JOLs to be conflicted, and which was prejudicial to the interests of the solvent SPs. It was submitted that the nature of the conflict arose from the fundamental feature of SPCs that segregates assets and liabilities of each SP from other SPs, as the JOLs were effectively attempting to prioritize the funding of the costs of the liquidation over the interests and entitlement of the stakeholders in the solvent SPs.

In their submissions, the shareholders of Bottini and SSS cited s.223(1) of the Act which requires liquidators to “deal with the company’s assets only in accordance with the procedures set out in section 219(6)”, which is quoted above. It therefore follows, they argued, that a liquidator’s ability to pay an insolvent company’s liabilities and expenses (including the liquidator’s remuneration) does not automatically extend to the SPs of the company in question. They argued that to find otherwise would undermine this part of the Act and would render s.219(6) in particular, meaningless.

The Grand Court accepted the submissions of the shareholders of Bottini and SSS and ordered the appointment of the AJOL with their powers and those of the JOLs to be limited such that: (1) the JOLs were no longer empowered to act in respect of either Bottini and/or SSS; (2) the AJOL has sole and exclusive responsibility for Bottini and SSS; and (3) the fees and expenses of the JOLs are not the responsibility of Bottini and/or SSS, whose sole responsibility for costs is those of the AJOL.

Further, the Grand Court affirmed that the principles set out in s.219(6) of the Act (whereby the assets of SPs are not available to guarantee or ‘back stop’ the general liabilities and expenses of the SPC) apply equally where the SPC in question is in liquidation.

Commenting on the appointment of the AJOL, the Grand Court considered that it would be “necessary and appropriate” to make such an order in other cases where the joint official liquidators in question are “reasonably perceived to be conflicted” and where such conflict causes difficulties “in respect of the allocation of their fees and expenses as between the insolvent SPs and solvent SPs”.

In our view, the Grand Court reached the only logical conclusion based on the Act as it is currently drafted. This judgment is certainly welcome in casting light on the issue of conflicted joint official liquidators and illuminating the remedies that stakeholders in solvent SPs have available to them, should they consider that the liquidators in question are over-stepping.

We have previously considered the full implications of the proposed amendments to Part V of the Act here. The Restructuring Officer Regime will of course apply equally to SPCs and it will be interesting to observe how practice develops in this space, especially in circumstances similar to those described in Performance Insurance Company SPC (in official liquidation).

For example, if an SPC and certain (but not all) of its SPs are insolvent, what role will any solvent SPs be able to play in a restructuring? It would seem to be illogical to exclude them as this would be tantamount to splitting the SPC and its SPs up; but one can foresee that it will be easy for the waters to be muddied further between the solvent and insolvent SPs whilst the restructuring is negotiated and implemented.

Whilst in the context of joint official liquidators, it is, as we saw in Performance Insurance Company SPC (in official liquidation), sometimes ‘necessary and appropriate’ for an additional joint official liquidator to be appointed to address actual or perceived conflicts of interest, will it also be appropriate for an interim restructuring officer to be appointed in respect of solvent SPs for similar reasons where it is in the interests of the relevant SP to do so.

The clarity provided by Performance Insurance Company SPC (in official liquidation) and the procedural efficiencies which it is hoped and expected will be delivered by the Restructuring Officer Regime are welcome and possibly very timely.

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[1] FSD No. 70 of 2021 (RPJ).
[2] s.216(2) of the Act.
[3] s.216(1) of the Act.
[4] s.220 of the Act.
[5] Per s.91C of the Companies (Amendment Bill), 2021, Supplement No.1 published with Legislation Gazette No.58 dated 21 October 2021

This publication is not intended to be a substitute for specific legal advice or a legal opinion. For specific advice on insolvency of Segregated Portfolio Companies, please contact your usual Loeb Smith attorney or:

Gary Smith
E: gary.smith@loebsmith.com
T: +1 345 749 7590

Robert Farrell
E: robert.farrell@loebsmith.com
T: +1 345 749 7499

Regulatory framework and authorities

How is fund management regulated in your jurisdiction? Which authorities have primary responsibility for regulating funds, fund managers and those marketing funds?

The main regulatory body in the Cayman Islands that regulates open-ended investment funds, closed-ended investment funds, fund managers and parties marketing investment funds is the Cayman Islands Monetary Authority (CIMA). The main statutes from which CIMA derives its supervisory powers and duties in respect of investment funds are the Mutual Funds Act and the Private Funds Act, and in respect of fund managers, is the Securities Investment Business Act (the SIB Act).

Law stated – 22 April 2022

Fund administration

Is fund administration regulated in your jurisdiction?

A Cayman Islands-domiciled entity that carries on business as a mutual fund administrator is required to have a valid license for doing so and is required to be regulated by CIMA. There is more than one type of mutual fund administrator license and CIMA will assess, among other things, whether the applicant has sufficient expertise to administer regulated investment funds (both open-ended and closed-ended) and whether the business as a mutual fund administrator will be administered by persons who are fit and proper to be directors or, as the case may be, managers or officers in their respective positions.

Mutual fund administration is defined in the Mutual Funds Act as the management or administration of a mutual fund to provide the principal office of the mutual fund in the Cayman Islands or the provision of an operator to the mutual fund. An overseas fund administrator that is not established in the Cayman Islands is not regulated by CIMA and may be the administrator of a Cayman Islands investment fund if the administrator is authorised or otherwise permitted to carry out administration activities to investment funds in any non-high-risk jurisdiction.

Law stated – 22 April 2022

Authorisation

What is the authorisation or licensing process for funds? What are the key requirements that apply to managers and operators of investment funds in your jurisdiction?

The vast majority of open-ended funds will qualify as mutual funds under the Mutual Funds Act (as amended), which requires mutual funds to be licensed or regulated as such. Closed-ended funds (ie, funds that issue investment interests that are not redeemable at the option of the investor of record), which fall within the scope of the Private Funds Act, are required to register with, and consequently become regulated by, CIMA.

The authorisation process for an open-ended fund will depend on the regulatory category it chooses to register under (eg, a licensed fund under section 4(1)(a) of the Mutual Funds Act, an administered fund under section 4(1)(b) of the Mutual Funds Act, a registered fund under section 4(3) of the Mutual Funds Act, or a limited investor fund under section 4(4) of the Mutual Funds Act). For closed-ended funds, the authorisation process requires the private fund to:

submit an application for registration to CIMA within 21 days of its acceptance of capital commitments from investors for the purposes of investments;

file prescribed details in respect of the private fund with CIMA;

pay a prescribed annual registration fee to CIMA in respect of the private fund; comply with any conditions of its registration imposed by CIMA; and

comply with the provisions of the Private Funds Act.

A Cayman Islands-domiciled fund manager will have to either apply to CIMA for a license to undertake business as such under the Securities Investment Business Act (as revised) or apply to CIMA to be registered under a less regulatory onerous regime as a Registered Person. An overseas fund manager can provide services to a Cayman Islands investment fund and there is no requirement for the overseas fund manager to be licensed by or registered with CIMA unless that fund manager establishes itself in the Cayman Islands. Operators of mutual funds, such as directors, are subject to registration or licensing requirements under the Director Registration and Licensing Act (DRLA) and are required to register with CIMA.

Law stated – 22 April 2022

Territorial scope of regulation

What is the territorial scope of fund regulation? Can an overseas manager perform management activities or provide services to clients in your jurisdiction without authorisation?

The laws in the Cayman Islands (e.g., Mutual Funds Act, Private Funds Act and SIB Act) are not extraterritorial in scope and effect. An overseas fund manager can provide services to a Cayman Islands investment fund and there is no legal requirement for the overseas fund manager to be licensed by or registered with CIMA unless that fund manager establishes operations in the Cayman Islands.

Law stated – 22 April 2022

Acquisitions

Is the acquisition of a controlling or non-controlling stake in a fund manager in your jurisdiction subject to prior authorisation by the regulator?

There is no requirement for an overseas fund manager to be licensed by or be registered with CIMA unless that fund manager establishes itself in the Cayman Islands. Accordingly, there would be no need for any prior notification to, or authorisation by, CIMA of a change in controlling or non-controlling stake in a fund manager established overseas. A fund manager regulated in the Cayman Islands (ie, whether as a CIMA licensee or a registered person) under the SIB Act is prohibited from issuing, voluntarily transferring or disposing of any shares or partnership interests (as applicable) without the prior approval of CIMA, but CIMA may grant an exemption from this prior approval requirement where the fund manager’s securities are publicly traded on a recognised securities exchange.

Law stated – 22 April 2022

Restrictions on compensation and profit sharing

Are there any regulatory restrictions on the structuring of the fund manager’s compensation and profit-sharing arrangements?

There are no regulatory restrictions on the structuring of the fund manager’s compensation and profit-sharing arrangements.

Authorisation

Does the marketing of investment funds in your jurisdiction require authorisation?

Investment funds (whether structured as an exempted company or a limited liability company (LLC)) are restricted from making an offer of shares of the company or interests of the LLC to the public in the Cayman Islands to subscribe for such securities unless those securities are listed on the Cayman Islands Stock Exchange. This restriction on the public offer of securities is contained in the Companies Act and the Limited Liability Companies Act, but there are no similar restrictions in the laws governing limited partnerships or unit trusts. The term ‘public in the Islands’ excludes certain entities and residents, including other Cayman Islands exempted companies, LLCs, exempted limited partnerships, any exempted or ordinary non-resident companies, foreign companies registered in the Cayman Islands and foreign limited partnerships. The Private Funds Act separately states that the term ‘public in the Islands’ does not include sophisticated persons and high net worth persons (as defined under the SIB Act), which means that making an offer of securities to ‘private funds’ (as defined in the Private Funds Act) in the Cayman Islands is not restricted. Private funds would most likely qualify as sophisticated persons or high net worth persons, or both.

An overseas investment fund that wishes to make an offering of its securities to the public in the Cayman Islands will need to either (1) register with the Cayman Islands Monetary Authority (CIMA) as a mutual fund under the Mutual Funds Act or a private fund under the Private Funds Act or (2) market its securities through a person who is appropriately licensed or authorised by CIMA under the terms of the SIB Act (provided that the securities being offered to the public in the Cayman Islands are listed on a stock exchange approved by CIMA or the investment fund is regulated by a recognised overseas regulatory authority approved by CIMA).

Law stated – 22 April 2022

What marketing activities require authorisation?

Arranging deals in securities with a view to another person dealing in securities, or participating in the arrangements for dealing in securities are regulated under the SIB Act and, therefore, would require prior authorisation from CIMA.

Law stated – 22 April 2022

Territorial scope and restrictions

What is the territorial scope of your regulation? May an overseas entity perform fund marketing activities in your jurisdiction without authorisation?

An entity that is performing marketing activities for an investment fund from within the Cayman Islands is required by the terms of the SIB Act to obtain a license from, or otherwise register with, CIMA, prior to engaging in such activities.

Law stated – 22 April 2022

If a local entity must be involved in the fund marketing process, how is this rule satisfied in practice?

There is no legal requirement for a local entity to be involved in the fund marketing process.

Law stated – 22 April 2022

Commission payments

What restrictions are there on intermediaries earning commission payments in relation to their marketing activities in your jurisdiction?

There are no legal restrictions on intermediaries earning commission payments in relation to their marketing activities in the Cayman Islands.

Law stated – 22 April 2022

Available vehicles

What are the main legal vehicles used to set up a retail fund? How are they formed?

The statutory and regulatory frameworks that apply to investment funds in the Cayman Islands do not distinguish between retail funds and non-retail funds as the Cayman Islands is not primarily known as a retail fund jurisdiction. Its laws and regulations applicable to investment funds are geared mainly towards attracting institutional investors. Accordingly, the legal vehicle used for an investment fund is typically based on whether the fund’s strategy will be open- ended or closed-ended. The exempted company (which includes the segregated portfolio company) is the most commonly used legal vehicle for open-ended funds and the exempted limited partnership is the most commonly used legal vehicle for closed-ended funds. Both types of legal vehicles are formed by filing formation documents with the Companies Registry and paying the requisite government fee. There are no special requirements that apply to managers or operators of retail funds (which for present purposes are taken to mean funds that permit an investor to invest an initial minimum amount of less than US$100,000).

Law stated – 22 April 2022

Laws and regulations

What are the key laws and other sets of rules that govern retail funds?

The statutory and regulatory frameworks that apply to investment funds in the Cayman Islands do not distinguish between retail funds and non-retail funds. Under section 4(1)(b) of the Mutual Funds Act, a mutual fund can register with the Cayman Islands Monetary Authority (CIMA) and permit its investors to each invest an initial minimum amount of less than US$100,000. This type of fund is often referred to as a ‘retail’ fund. However, the regulatory framework that applies to this category of mutual fund (referred to as an administered fund) is pretty much the same as is applicable to other mutual funds registered with CIMA. Closed-ended funds that fall within the scope of the Private Funds Act and are, therefore, registered with, and regulated by, CIMA do not have a minimum initial investment threshold set by law and, therefore, investors will simply have to comply with the investment limits and restrictions set by the manager or operator of the fund.

The Retail Mutual Funds (Japan) Regulations are an exception to the above in that they effectively make a distinction between retail funds and non-retail funds by providing a compliance framework for certain licensed funds under section 4(1)(a) of the Mutual Funds Act that will market to retail investors in Japan, enabling these funds to automatically comply with the applicable securities laws and regulations in Japan. However, these funds are merely a sub-set of licensed funds, which themselves only comprise approximately 1 per cent of Cayman Islands’ mutual funds.

Law stated – 22 April 2022

Authorisation

Must retail funds be authorised or licensed to be established or marketed in your jurisdiction?

All mutual funds which fall within the scope of the Mutual Funds Act and all closed-ended funds that fall within the scope of the Private Funds Act are required to be registered with, and be regulated by, CIMA.

Law stated – 22 April 2022

Marketing

Who can market retail funds? To whom can they be marketed?

Investment funds (whether structured as an exempted company or a limited liability company (LLC)) are restricted from making an offer of shares of the company or interests of the LLC to the public in the Cayman Islands to subscribe for such securities unless those securities are listed on the Cayman Islands Stock Exchange. There are no similar restrictions in the laws governing limited partnerships or unit trusts. The term ‘public in the Islands’ excludes certain entities and residents, including other Cayman Islands exempted companies, LLCs, exempted limited partnerships, any exempted or ordinary non-resident companies, foreign companies registered in the Cayman Islands and foreign limited partnerships. It also excludes sophisticated persons and high net worth persons (as defined under the Securities Investment Business Act (SIB Act)), which means that making an offer of securities to ‘private funds’ (as defined in the Private Funds Act) in the Cayman Islands is not restricted. Private funds would most likely qualify as sophisticated persons or high net worth persons, or both. An overseas investment fund that wishes to make an offering of its securities to the public in the Cayman Islands will need to either (1) register with CIMA as a mutual fund under the Mutual Funds Act or a private fund under the Private Funds Act or (2) market its securities through a person who is appropriately licensed or authorised by CIMA under the terms of the SIB Act (provided that the securities being offered to the public in the Cayman Islands are listed on a stock exchange approved by CIMA or the investment fund is regulated by a recognised overseas regulatory authority approved by CIMA). However, there is no legal requirement for a local entity to be involved in the fund marketing process.

Law stated – 22 April 2022

Managers and operators

Are there any special requirements that apply to managers or operators of retail funds?

The statutory and regulatory framework that apply to investment funds in the Cayman Islands do not distinguish between retail funds and non-retail funds. There are no special requirements that apply to managers or operators of retail funds.

Law stated – 22 April 2022

Investment and borrowing restrictions

What are the investment and borrowing restrictions on retail funds?

There are no specific legal investment and borrowing restrictions on retail funds under Cayman Islands laws.

Tax treatment

What is the tax treatment of retail funds? Are exemptions available?

The tax treatments and exemptions available to non-retail funds apply equally to retail funds.

Law stated – 22 April 2022

Asset protection

Must the portfolio of assets of a retail fund be held by a separate local custodian? What regulations are in place to protect the fund’s assets?

There are no legal requirements in the Cayman Islands for assets of a mutual fund to be held by a separate custodian located in the Cayman Islands. Closed-ended funds that fall within the scope of the Private Funds Act are required to appoint a custodian:

to hold in custody, in segregated accounts opened in the name or for the account, of the private fund, the private fund’s assets that are capable of physical delivery or capable of registration except where the private fund has notified CIMA and it is neither practical nor proportionate given the nature of the private fund and the type of assets held to do so; and

to verify title to, and maintain records of, fund assets. However, there is no legal requirement for the custodian to be located in the Cayman Islands.

Where a private fund notifies CIMA of its intention not to appoint a custodian, the private fund is required to appoint one of the following persons to carry out the title verification:

an administrator or another independent third party; or

the manager or operator, or a person with a control relationship with the manager of the private fund, provided that:

the title verification function is independent from the portfolio management function; or

potential conflicts of interest are properly identified, managed, monitored and disclosed to the investors of the private fund.

Law stated – 22 April 2022

Governance

What are the main governance requirements for a retail fund formed in your jurisdiction?

Mutual funds regulated by CIMA must, as long as there is a continuing offering, update their offering documents and prescribed particulars within 21 days of any material change, and are required to file the updated offering document or the prescribed particulars with CIMA within this 21-day period.

A private fund is required under the Private Funds Act to notify CIMA of any change that materially affects any information submitted to CIMA and of any change of its registered office or the location of its principal office.

The private fund will have 21 days after making the change or becoming aware of the change to file details of the change with CIMA.

All funds regulated by CIMA (mutual funds and private funds) are required to have their accounts audited annually and such audited financial statements must be filed with CIMA within six months of the year end of the fund, along with a financial annual return form including prescribed details, signed by a director. These audited financial statements must be signed off by a CIMA approved Cayman Islands-based audit firm.

Law stated – 22 April 2022

Reporting

What are the periodic reporting requirements for retail funds?

Mutual funds regulated by CIMA must, as long as there is a continuing offering, update their offering documents and prescribed particulars within 21 days of any material change, and are required to file the updated offering document or the prescribed particulars with CIMA within this 21-day period.

A private fund is required under the Private Funds Act to notify CIMA of any change that materially affects any information submitted to CIMA and of any change of its registered office or the location of its principal office.

The Private Fund will have 21 days after making the change or becoming aware of the change to file details of the change with CIMA.

All funds regulated by CIMA (mutual funds and private funds) are required to have their accounts audited annually and such audited financial statements must be filed with CIMA within six months of the year end of the fund, along with a financial annual return form including prescribed details, signed by a director. These audited financial statements must be signed off by a CIMA approved Cayman Islands-based audit firm.

Law stated – 22 April 2022

Issue, transfer and redemption of interests

Can the manager or operator place any restrictions on the issue, transfer and redemption of interests in retail funds?

Restrictions can be contained in the constitutive documents of a fund or otherwise in the terms of issue of the relevant equity interests or investment interests of the fund.

Law stated – 22 April 2022

Available vehicles

What are the main legal vehicles used to set up a non-retail fund? How are they formed? Open-ended funds

Exempt companies

Exempt companies are the most common legal vehicle for open-ended funds. The exempted company limited by shares and the exempted segregated portfolio companies (SPCs) make up the overwhelming majority of open-ended funds and accounted for over 90 per cent of total open-ended funds registered with the Cayman Islands Monetary Authority (CIMA) as at 31 March 2022.

It is possible to incorporate an exempted company limited by shares (including an SPC) on either a standard basis (which takes four to five business days after submission of formation documents to the Registrar of Companies) or on an express (same day) basis subject to paying an additional express fee. Incorporation is effected by filing the company’s memorandum and articles of association and an affidavit sworn by the subscriber to the memorandum of association with the Registrar of Companies. Unless the company proposes to use a restricted word in its name (eg, ‘bank’ or ‘insurance’) no prior consent or approval is required from CIMA or any other government agency. The use of the word ‘fund’ in the name is not restricted. The memorandum of association must contain certain basic information about the company, including its registered office address, its authorised share capital and the objects for which it is incorporated. Shares can be denominated in any currency and denomination. There is no minimum or maximum amount prescribed for authorised, issued or paid-up share capital (although at least one share must be in issue at the time of incorporation).

LLCs

A limited liability company (LLC) is a corporate entity that has separate legal personality to its members. Formation of an LLC requires the filing of a registration statement with the Registrar of Companies and payment of the requisite government fee. The LLC must have at least one member and it can be member managed (by some or all of its members) or the LLC agreement can provide for the appointment of persons (who need not be members) to manage and operate the LLC. The liability of an LLC’s members is limited and members can have capital accounts and can agree among themselves (in the LLC agreement) how the profits and losses of the LLC are to be allocated and how and when distributions are to be made (similar to a Cayman Islands exempted limited partnership). An LLC may be formed for any lawful business, purpose or activity and it has full power to carry on its business or affairs unless its LLC agreement provides otherwise. An LLC may (but is not required to) use one of the following suffixes in its name: Limited Liability Company, LLC or L.L.C.

The LLC structure is an attractive option for certain Cayman closed-ended investment funds (eg, they facilitate aligning the rights of investors in onshore and offshore investment funds in a main fund and sub-fund structures) as well as for general partner entities and other carried interest distribution vehicles.

Limited partnerships

Exempted limited partnerships (ELPs) are most commonly used for closed-ended funds and, to the extent that they fall within the scope of the Private Funds Act, are required to be registered with CIMA.

Unit trusts

Unit trusts are based on English trust law, but are modified by the Trusts Act of the Cayman Islands for suitability as investment fund vehicles. Under a unit trust arrangement, investors contribute funds to a trustee that holds those funds on trust for the investors and each investor is directly entitled to share pro rata in the trust’s assets. An advantage of the unit trust is that it may be structured as an ‘umbrella’ unit trust so that different investments may be allocated to different ‘sub-trusts’ with investors subscribing for units in a particular sub-trust. Unlike SPCs, however, there is no statutory segregation of assets and liabilities of each sub-trust.

A unit trust is formed through a declaration of trust by the trustee alone or by a trust deed executed by both the trustee and the investment manager.

Closed-ended funds

The legal vehicles that can be used for closed-ended funds are the same as for open-ended funds. The most popular vehicle used for closed-ended funds is the ELP. Cayman ELPs are governed by a combination of equitable and common law rules (based on English common law) and also statutory provisions, pursuant to the Exempted Limited Partnership Act (as revised). An ELP may be formed for any lawful purpose to be carried out and undertaken either in or from within the Cayman Islands or elsewhere upon the terms, with the rights and powers, and subject to the conditions, limitations, restrictions and liabilities set forth in the Exempted Limited Partnership Act.

An ELP is a legal arrangement and does not have separate corporate personality. The terms of the ELP are set out in a limited partnership agreement and registered in the Cayman Islands by filing a registration statement with the Registrar of Exempted Limited Partnerships containing the following details:

the name of the partnership;

the general nature of the business and term of the partnership;

the address of the registered office of the partnership;

the name and address of its general partner; and

a declaration that the partnership shall not undertake business with the public in the Cayman Islands other than so far as may be necessary to conduct business outside the Cayman Islands.

Law stated – 22 April 2022

Laws and regulations

What are the key laws and other sets of rules that govern non-retail funds?

Open-ended funds

The Mutual Funds Act (for open-ended funds) and the Private Funds Act (for closed-ended funds) are the two main statutes relevant to the regulation of investment funds in the Cayman Islands. CIMA is the regulatory body responsible for compliance with these laws and related regulations and has broad powers of enforcement.

The Mutual Funds Act defines a mutual fund as ‘a company, unit trust or partnership that issues equity interests, the purpose or effect of which is the pooling of investor funds with the aim of spreading investment risks and enabling investors in the mutual fund to receive profits or gains from the acquisition, holding, management or disposal of investments…’ The reference to ‘equity interests’ means that debt instruments (including warrants, convertibles and sukuk instruments) are excluded and funds issuing such instruments will not be required to register with CIMA as a mutual fund. The scope of regulation extends to Cayman incorporated or established master funds that have one or more CIMA-regulated feeder funds and hold investments and conduct trading activities. Changes to the Mutual Funds Act introduced in 2020 means that certain mutual funds, which were previously exempted from registration with CIMA under section 4(4) of the Mutual Funds Act because they had 15 investors or less, the majority of whom have the power to appoint or remove the operators of the investment fund (the operator being the directors, the general partner or the trustee, as is relevant given the legal vehicle used for the fund), are no longer exempt from registration with CIMA. These limited investor funds are now required to be registered with, and are regulated by, CIMA and as at 31 March 2022 there were 667 limited investors funds registered with CIMA. As at that same date, there were 8,554 registered funds and 3,224 master funds registered with CIMA.

Each CIMA-registered mutual fund is required to have its accounts audited annually by a firm of auditors on the CIMA- approved list of auditors and file such audited accounts with CIMA within six months of the end of each financial year of the mutual fund (along with a financial annual return in CIMA’s prescribed form).

Mutual funds that are established for a sole investor and do not involve the pooling of investor funds fall outside the regulatory framework of the Mutual Funds Act. Nonetheless, a mutual fund with a single investor can apply for voluntary registration to, among other things, benefit from the status of being a regulated fund.

Cayman Islands laws and regulations do not impose restrictions on, or prescribe rules for investment strategies of open-ended funds, or their use of leverage, shorting or other techniques.

Closed-ended funds

The Private Funds Act requires the registration of closed-ended funds (typically, investment funds that do not grant investors with a right or entitlement to withdraw or redeem their shares or interests from the fund upon notice) with CIMA. The Private Funds Act applies to private equity funds, real estate funds, and other types of closed-ended funds set up as Cayman Islands limited partnerships, companies (including SPCs), unit trusts and limited liability companies. The Private Funds Act also applies to non-Cayman Islands private funds carrying on business or attempting to carry on business in or from the Cayman Islands.

In addition to registration with CIMA, the Private Funds Act also imposes the following regulatory requirements to be met by private funds.

Audit

Each private fund is required to have its accounts audited annually by a firm of auditors on the CIMA-approved list of auditors and file such audited accounts with CIMA within six months of the end of each financial year of the private fund (along with a financial annual return in CIMA’s prescribed form).

Valuation of assets

A private fund must have appropriate and consistent procedures for the purposes of proper valuations of its assets, which ensures that valuations are conducted in accordance with the requirements in the Private Funds Act. Valuations of the assets of a private fund are required to be carried out at a frequency that is appropriate to the assets held by the private fund and, in any case, on at least an annual basis.

Safekeeping of fund assets

The Private Funds Act requires a custodian: (1) to hold the private fund’s assets that are capable of physical delivery or capable of registration in a custodial account except where that is neither practical nor proportionate given the nature of the private fund and the type of assets held; and (2) to verify title to, and maintain records of, fund assets.

Cash monitoring

The Private Funds Act requires a private fund to appoint an administrator, custodian or another independent third party (or the manager or operator of the private fund):

to monitor the cash flows of the private fund;

to ensure that all cash has been booked in cash accounts opened in the name, or for the account, of the private fund; and

to ensure that all payments made by investors in respect of investment interests have been received.

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 and make this available to CIMA upon request.

Directors of mutual funds structured as exempted companies, managers of investment funds structured as LLCs and directors of general partners of investment funds structured as an exempted limited partnership (in each case, wherever in the world these persons are located, not just to Cayman Islands-based directors) regulated by CIMA are required to register with CIMA under the Directors Registration and Licensing Act (DRLA). The DRLA enables CIMA to verify certain information in respect of directors or managers of CIMA-registered funds. There is currently no requirement for registration of directors with CIMA under the DRLA who are directors of closed-ended funds that fall within the scope of the Private Funds Act. However, this may change in the future.

All investment funds are required to comply with Cayman Islands anti-money laundering legislation and regulations, including appointing an anti-money laundering compliance officer, a money laundering reporting officer, and a deputy money laundering reporting officer. The Cayman Islands government and CIMA actively work with the European Union, the Organisation for Economic Co-operation and Development, the Financial Action Task Force and regulators in numerous jurisdictions to observe and maintain international standards on transparency and good corporate governance.

Law stated – 22 April 2022

Authorisation

Must non-retail funds be authorised or licensed to be established or marketed in your jurisdiction?

The statutory and regulatory frameworks that apply to investment funds in the Cayman Islands do not distinguish between retail funds and non-retail funds. All mutual funds (except for those that are single investor funds) are required to be registered with CIMA and fall within its regulatory framework. Closed-ended funds that fall within the scope of the Private Funds Act are required to be registered with, and regulated by, CIMA.

Law stated – 22 April 2022

Marketing

Who can market non-retail funds? To whom can they be marketed?

Investment funds (whether structured as an exempted company or a LLC) are restricted from making an offer of shares of the company or interests of the LLC to the public in the Cayman Islands to subscribe for such securities unless those securities are listed on the Cayman Islands Stock Exchange. There are no similar restrictions in the laws governing limited partnerships or unit trusts. The term ‘public in the Islands’ excludes certain entities and residents, including other Cayman Islands exempted companies, LLCs, exempted limited partnerships, any exempted or ordinary non-resident companies, foreign companies registered in the Cayman Islands and foreign limited partnerships. It also excludes sophisticated persons and high net worth persons (as defined under the Securities Investment Business Act (the SIB Act)), which means that making an offer of securities to ‘private funds’ (as defined in the Private Funds Act) in the Cayman Islands is not restricted. Private funds would most likely qualify as sophisticated persons or high net worth persons, or both. An overseas investment fund that wishes to make an offering of its securities to the public in the Cayman Islands will need to either (1) register with CIMA as a mutual fund under the Mutual Funds Act or a private fund under the Private Funds Act or (2) market its securities through a person who is appropriately licensed or authorised by CIMA under the terms of the SIB Act (provided that the securities being offered to the public in the Cayman Islands are listed on a stock exchange approved by CIMA or the investment fund is regulated by a recognised overseas regulatory authority approved by CIMA). However, there is no legal requirement for a local entity to be involved in the fund marketing process.

Law stated – 22 April 2022

Ownership restrictions

Do investor-protection rules restrict ownership in non-retail funds to certain classes of investor?

The legal requirement to be an eligible investor in a registered mutual fund with more than 15 investors is a minimum initial investment of US$100,000 (or its equivalent in any other currency); otherwise no other investor-qualification criteria apply to such funds. This minimum initial investment requirement does not apply to registered mutual funds with 15 or fewer investors and also does not apply to closed-ended funds falling within the scope of the Private Funds Act.

Law stated – 22 April 2022

Managers and operators

Are there any special requirements that apply to managers or operators of non-retail funds?

There is no requirement for the manager of a Cayman Islands fund to be resident or domiciled in the Cayman Islands. There are no Cayman Islands laws that seek to regulate overseas managers of Cayman investment funds. Fund managers established in the Cayman Islands need to comply with the provisions of the Securities Investment Business Act and such fund managers must either be licensed or registered with the CIMA. There are also economic substance requirements which must be complied with.

Directors of mutual funds structured as exempted companies, managers of investment funds structured as LLCs and directors of general partners of investment funds structured as exempted limited partnerships (in each case, wherever in the world these persons are located, not just to Cayman Islands-based directors) regulated by CIMA are required to register with CIMA under the DRLL. The DRLL enables CIMA to verify certain information in respect of directors or managers of CIMA-registered funds. There is currently no requirement for registration of directors with CIMA under the DRLL who are directors of closed-ended funds that fall within the scope of the Private Funds Act. However, this may change in the future.

Law stated – 22 April 2022

Tax treatment

What is the tax treatment of non-retail funds? Are any exemptions available?

Cayman Islands tax treatment is the same for both retail funds and non-retail funds. The Cayman Islands has no direct taxation of any kind. There are no income, corporation, capital gains or withholding taxes or death duties. It is possible for all types of Cayman legal structures (exempted company, LLC, unit trust and ELP) to apply to the Cayman Islands government for a tax undertaking that the legal structure will not be subject to direct taxation, for a minimum period, which in the case of a company is 20 years, and in the case of an LLC, unit trust and an ELP is 50 years.

Law stated – 22 April 2022

Asset protection

Must the portfolio of assets of a non-retail fund be held by a separate local custodian? What regulations are in place to protect the fund’s assets?

There are no legal requirements in the Cayman Islands for assets of a mutual fund to be held by a separate custodian located in the Cayman Islands. Closed-ended funds that fall within the scope of the Private Funds Act are required to appoint a custodian (1) to hold the private fund’s assets that are capable of physical delivery or capable of registration in a custodial account except where that is neither practical nor proportionate given the nature of the private fund and the type of assets held; and (2) to verify title to, and maintain records of, fund assets. However, there is no legal requirement for the custodian to be located in the Cayman Islands.

Law stated – 22 April 2022

Governance

What are the main governance requirements for a non-retail fund formed in your jurisdiction?

The Mutual Funds Act (for open-ended funds) and the Private Funds Act (for closed-ended funds) are the two main statutes relevant to the regulation of investment funds in the Cayman Islands. CIMA is the regulatory body responsible for compliance with these laws and related regulations and has broad powers of enforcement. Depending on the legal structure of the investment fund, there are also various continuing filing obligations and annual registration fees to be paid.

Law stated – 22 April 2022

Reporting

What are the periodic reporting requirements for non-retail funds?

Mutual funds regulated by CIMA must, as long as there is a continuing offering, update their offering documents and prescribed particulars within 21 days of any material change, and are required to file the updated offering document or the prescribed particulars with CIMA within this 21-day period.

A private fund is required under the Private Funds Act to notify CIMA of any change that materially affects any information submitted to CIMA and any change of its registered office or the location of its principal office.

The Private Fund will have 21 days after making the change or becoming aware of the change to file details of the change with CIMA.

All funds regulated by CIMA (mutual funds and private funds) are required to have their accounts audited annually, and these audited financial statements must be filed with CIMA within six months of the year end of the fund, along with a financial annual return form including prescribed details, signed by a director. These audited financial statements must be signed off by a CIMA-approved Cayman Islands-based audit firm.

Law stated – 22 April 2022

Structure

How are separately managed accounts typically structured in your jurisdiction?

Separately managed accounts are not typically structured using Cayman entities. The investment manager entity that provides managed account services may itself be a Cayman-domiciled entity and be regulated by the Cayman Islands Monetary Authority.

Law stated – 22 April 2022

Key legal issues

What are the key legal issues to be determined when structuring a separately managed account?

There are no specific Cayman Islands legal requirements to be determined when structuring a separately managed account unless the managed account is structured using a Cayman legal vehicle, in which case the same issues applicable to a mutual fund or a private fund may apply.

Law stated – 22 April 2022

Regulation

Is the management or marketing of separately managed accounts regulated in your jurisdiction?

The manager or entity marketing the separately managed account is regulated in the same manner as fund management.

Law stated – 22 April 2022

Proposed reforms

Are there proposals for further regulation of funds, fund managers or marketers of funds in your jurisdiction?

The requirement to register with the Cayman Islands Monetary Authority (CIMA), mutual funds that were previously exempted from registration, and (2) the registration of private funds with CIMA under the terms of the Private Funds Act have expanded the regulatory landscape for Cayman investment funds considerably. There will continue to be new laws and regulations introduced, for example, with respect to imposition of penalties and fines for non-compliance, in order to facilitate the enforcement of the regulatory laws.

Public listing

Outline any specific requirements for stock-exchange listing of retail and non-retail funds.

The listing of investment funds on the Cayman Islands stock exchange covers all types of legal vehicles (eg, exempted company (including segregated portfolio companies), limited liability company, unit trust or limited partnership) and every type of strategy (closed-ended funds, open-ended funds, stand-alone and master-feeder funds, real estate funds or umbrella funds) can apply to be listed. Funds based in both the Cayman Islands and in other jurisdictions are permitted under the Cayman Islands stock exchange listing rules to apply.

Law stated – 22 April 2022

Overseas vehicles

Is it possible to redomicile an overseas vehicle in your jurisdiction?

Yes.

Law stated – 22 April 2022

Foreign investment

Are there any special rules relating to the ability of foreign investors to invest in funds established or managed in your jurisdiction or domestic investors to invest in funds established or managed abroad?

There are no special rules.

Law stated – 22 April 2022

Funds investing in derivatives

Are there any special requirements in your jurisdiction relating to funds investing in derivatives?

There are no specific derivatives legislation in the Cayman Islands and no specific funds related legislation dealing with funds investing in derivatives.

Law stated – 22 April 2022

Recent developments

Are there any other current developments or emerging trends in your jurisdiction that should be noted? Please include reference to world-wide regulatory concerns, such as restrictions on foreign ownership in strategic industries, high-frequency trading, commodity position limits, capital adequacy for investment firms and ‘shadow banking’.

There are no updates at this time.

View Full PDF

Law stated – 22 April 2022

Jurisdictions

Cayman Islands Loeb Smith Attorneys

Germany POELLATH

Greece Souriadakis Tsibris

Ireland Dillon Eustace LLP

Italy Legance – Avvocati Associati

Japan TMI Associates

Luxembourg Loyens & Loeff

Malta Ganado Advocates

Monaco Gordon S. Blair Law Offices

Portugal VdA

Spain Alter Legal

Sweden Vinge

Switzerland Walder Wyss Ltd

Taiwan LCS & Partners

United Kingdom Morgan, Lewis & Bockius LLP

USA Morgan, Lewis & Bockius LLP

The information contained in this report is indicative only. Law Business Research is not responsible for any actions (or lack thereof) taken as a result of relying on or in any way using information contained in this report and in no event shall be liable for any damages resulting from reliance on or use of this information. © Copyright 2006 – 2022 Law Business Research

We will first consider the Foundation Company which was introduced by its own legislation – the Foundation Companies Act, 2017 and is a structure which has grown in popularity since 2017, particularly for use in the digital asset space (e.g. as a decentralized autonomous organization (“DAO”), service provider to DAO, treasury for fungible tokens, NFTs, and network for building digital asset ecosystems). As the name implies, a Foundation Company is a company and it therefore bears some similarities with more conventional types of company that are available in the Cayman Islands. A Foundation Company is registered with the Registrar of Companies, it has separate legal personality, it is incorporated with a memorandum and articles of association and it has a Board of Directors who are responsible for the day to day conduct of its affairs.

However, this is where the similarities with more conventional companies end as whilst Foundation Companies have some characteristics of a conventional company, practically they operate in a manner that is more akin to a trust. They therefore provide the functionality and flexibility of a trust but without any of the complexities associated with trust administration. Further, as they are a company with separate legal personality, this aids their recognition in civil law jurisdictions whose principles of ‘ownership’ mean that common law trusts often are not recognized.

Whilst Foundation Companies can (but don’t necessarily in practice) have shareholders, the shareholders in their capacity as shareholders are not entitled to receive dividends or other distributions. This can be contrasted with conventional companies whose shareholders participate in the profits simply by virtue of being a shareholder. Instead, Foundation Companies have a class of interested parties known as the “beneficiaries” and it is these beneficiaries who (depending on the applicable terms) are entitled to participate in any profits generated by the Foundation Company.

Further, whereas shareholders in more conventional companies have some ability to control the affairs of a company (e.g. by appointing or removing Directors or by passing (or refusing to pass) shareholder resolutions) and they have the right to access certain company records, the beneficiaries of a Foundation Company have no such rights. Beneficiaries’ rights, if any (including in relation to their right to distributions) must be expressly provided for in the Foundation Company’s constitution. Therefore, those who choose to establish a Foundation Company have considerable flexibility in determining what the rights of the beneficiaries will be and when they will arise and therefore careful thought needs to be given to drafting the constitutional documents to ensure that proper effect is given to the founder’s intentions.

Whilst the ownership structure of Foundation Companies described above undoubtedly has its benefits, the lack of shareholder oversight removes one of the important checks and balances from the corporate governance of a Foundation Company. It is for this reason that Foundation Companies are required to have a “Supervisor” whose role is to oversee, and hold to account, the Board of Directors. A Supervisor’s role can be greater, to the extent provided for in the constitutional documents and it is common for the constitution to provide for a number of ‘reserved matters’ in favour of the Supervisor, which can range from the right to appoint and remove the Supervisor, Directors and/or beneficiaries to the right to alter the constitution of the Foundation Company.

A Foundation Company is also required to have a secretary who is either licensed or permitted by the Companies Management Act (2021 Revision) to provide “company management services”. The Secretary must also provide the Foundation Company’s registered office in the Cayman Islands.

Foundation Companies can also implement a set of by-laws which can extend, modify or supplement the constitutional documents. By-laws can assist with the administration of the Foundation Company but since they don’t form part of the constitution, they are a document that remains entirely private.

As will be apparent from the above, those who choose to use a Foundation Company as their corporate vehicle have considerable flexibility in how the Foundation Company will be established, governed and what the rights of each person associated with it will be. It will therefore come as no surprise that the uses of Foundation Companies are just as varied.

Foundation Companies have proven to be popular with Family Offices and they have also been successfully deployed for philanthropic purposes and with estate planning more generally given the relevance of “beneficiaries” to the structure and the fact that such beneficiaries’ involvement in the Foundation Company beyond their financial entitlement is restricted. Foundation Companies have also been used to establish charitable / non-profit foundations whilst they have also been successfully deployed for purely commercial projects, particularly in the digital assets space (e.g. as DAOs, treasury for fungible tokens, NFTs, and network for building digital asset ecosystems).

STAR Trusts (meaning “Special Trusts – Alternative Regime”) are created pursuant to Part VIII of the Trusts Act (2021 Revision). STAR Trusts are typically discretionary trusts but crucially they can exist for either charitable or non-charitable purposes, provided that the purposes are “lawful and not contrary to public policy”. The ability to mix charitable and non-charitable purposes is a feature that is unique to the STAR Trust structure and underlines its inherent flexibility.

Further, unlike other trusts, the lifespan of a STAR Trust is not limited by the rule against perpetuities and so the usual position which limits their lifespan to not more than 150 years, does not apply – i.e. a STAR Trust can be of an unlimited duration.

The settlor of a STAR Trust has considerable flexibility when defining who, or what general purpose, will benefit from the STAR Trust and on what basis. Any beneficiary’s participation in the STAR Trust is strictly limited to the financial benefits that the terms of the trust grant to them. Indeed, similar to Foundation Companies, a beneficiary of a STAR Trust has no right to enforce the terms of the STAR Trust, whether by way of actions against the Trustee or by having access to information about the activities and current financial position of the STAR Trust.

As with Foundation Companies and because the beneficiaries of the STAR Trust have no rights of enforcement, the checks and balances on the administration of the STAR Trust are provided in a different way. The two key positions to be held in relation to a STAR Trust are (1) the Trustee; and (2) the Enforcer.

The Trustee performs the usual role of a trustee in an ordinary trust by holding the legal title to the assets of the STAR Trust on behalf of the beneficiaries. Unless a court order to the contrary is obtained, it is a requirement of a STAR Trust that the Trustee must be (or must include if there is more than one) a trust corporation, which is an entity that is licensed to conduct “trust business” within the Cayman Islands.

A STAR Trust is also required to have an “Enforcer”, who is the only person who has the capacity and power to enforce the terms of the STAR Trust and to hold the Trustees to account. The Enforcer can, but need not, also be a beneficiary. If they are also a beneficiary, they can only enforce the terms of the STAR Trust in their capacity as Enforcer on behalf of all beneficiaries and not in their capacity as an individual beneficiary.

As with Foundation Companies, the inherent flexibility of the STAR Trust structure means that it has been applied in many different ways since their inception in 1997. For example, they have been used (i) in ensuring an orderly succession of interests in family run businesses (with the limited rights of beneficiaries to enforce the terms of the Trust again being particularly useful), (ii) for philanthropic purposes, (iii) in substitution for an ‘ordinary trust’ in order to obtain the benefit of the unlimited duration of a STAR Trust and to restrict or limit the level of information to which beneficiaries would otherwise have an entitlement to access under an ordinary trust, (iv) in finance and investment transactions to facilitate “off balance sheet” or bankruptcy remoteness in holding assets, (v) in as a holding vehicle for valuable chattels such as artwork, jewelry and vehicles and as an alternative to a charitable trust (especially where the objects of the Trust might be a combination of charitable and non-charitable).

However, one limitation on this structure is that no land in the Cayman Islands (or any interest therein) can be held by a STAR Trust. It would, however, be permissible for a STAR Trust to have an interest in another entity which owns land in the Cayman Islands (or an interest therein) but only for the purposes of carrying on its business.

As will be apparent from the above, the two structures we have considered offer great flexibility for many different types of application. Whilst there is a considerable degree of overlap between the two, the purpose of the venture and/or the preference of those behind the project will dictate the use of one over the other.

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This publication is not intended to be a substitute for specific legal advice or a legal opinion. For specific advice on STAR Trusts and/or Foundation Companies, please contact your usual Loeb Smith attorney or:

E: gary.smith@loebsmith.com
E: robert.farrell@loebsmith.com