Whilst there are no statutory requirements as to the type of legal entity that should be used in the establishment of a closed-ended fund pursuant to the Act, the type of entity most commonly used for this purpose is the Exempted Limited Partnership (“ELP”). Whilst other types of corporate vehicles can be used, such as a Cayman Islands Exempted Company, these are more commonly deployed in the context of an open-ended investment fund pursuant to the Mutual Funds Act (As Revised).

If a closed-ended fund (referred to under the Act as a private fund) is structured as an Exempted Company, it will be the directors of that company who run it. However, as part of the registration of the fund with the Cayman Islands Monetary Authority (“CIMA”), it will be necessary to ensure that there is a minimum of two directors appointed; this is known as the “four eyes principle” to ensure proper corporate governance and investor protection and is a prerequisite for registration as a private fund with CIMA.

If the fund is established as an ELP, the two-director rule does not apply directly to the ELP as ELPs do not have separate legal personality and therefore do not have directors. An ELP must, however, have a qualifying “general partner” who operates the ELP on behalf of the limited partners. It is at the general partner level that the “four eyes” principle will apply in this context and so a general partner must also have at least two directors.

Presently, it is not necessary for the directors of a private fund (or the directors of a general partner of an ELP which is registered as a private fund) to be registered pursuant to the Directors Registration and Licensing Act (As Revised).

Only closed-ended funds that fall within the definition of a “private fund”, as defined in the Act, will be required to register with CIMA under the Act as a private fund and will be regulated as such. The Act defines a “private fund” as:

“…a company, unit trust or partnership that offers or issues or has issued investment interests, the purpose of effect of which is the pooling of investor funds with the aim of enabling investors to receive profits or gains from such entity’s acquisition, holding, management or disposal of investments, where –

(a) the holders of investment interests do not have day-to-day control over the acquisition, holding, management or disposal of the investments; and

(b) the investments are managed as a whole by or on behalf of the operator of the private fund, directly or indirectly…”

It should be noted that the term “investment interest” is defined in the Act as an interest in the issuing vehicle which carries an entitlement to participate in the profits or gains of the vehicle and which interests are not redeemable or repurchaseable at the option of the investor.

Whether a particular structure will fall within this definition and be subject to regulation can be highly nuanced. We therefore recommend that you speak with an experienced Cayman Islands investment funds attorney to determine whether your proposed project would be regulated or whether an exemption from registration might be available.

For example, the Act itself contains a list of “non-fund arrangements” which are not considered to be “private funds”. The list of non-fund arrangements is extensive and quite broad in remit but we would specifically highlight the following non-fund arrangements:

• Joint ventures;
• Proprietary vehicles;
• Holding vehicles;
• Debt issues and debt issuing vehicles;
• Structured finance vehicles;
• Sovereign wealth funds; and
• Single family offices.

It should also be noted that single investor funds will also fall outside of the remit of the Act on the basis that where there is only one investor, there will not be any “pooling of investor funds” as required by the above quoted definition of “private fund”.

Where a particular project falls within the definition of a “private fund” and where it is not a “non-fund arrangement”, the corporate vehicle will be required to apply to CIMA for registration as a private fund under the Act.

In order to be registered under the Act, the fund will need to submit a completed application to CIMA via its online portal together with supporting documentation, including its offering document (which should contain, as a minimum, the information specified by CIMA in its Rules on Content of Offering Memorandum) and evidence of the appointment of an auditor and an administrator.

The application must (per section 5 of the Act) be submitted to CIMA (together with payment of the applicable registration fee) within 21 days after its acceptance of capital commitments from investors for the purposes of investments (although the application can be submitted at any time before capital commitments are received). The fund must be registered with CIMA as a private fund before it receives any capital contributions from investors.

In addition to the above, there are certain other key obligations with which private funds must comply.

Where the fund makes any change (or becomes aware of any change) which materially affects any information that was delivered to CIMA as part of the fund’s registration as a private fund, it must file details of the change with CIMA within 21 days of the change taking effect or of the fund becoming aware of the change. Whilst the Act only requires ‘material’ changes to be notified to CIMA, in practice CIMA tends to be notified of all changes given what is ‘material’ is open to interpretation.

Private funds must also file an annual return with CIMA and pay an annual registration fee in order to maintain its registration.

The Act requires that private funds have in place certain mechanisms and safeguards relating to an annual audit of the fund, the valuation of the fund’s assets, the safeguarding of the fund’s assets, cash monitoring and the identification of securities.

• Audit – the fund must engage an approved Cayman Islands auditor to prepare its audited financial statements annually. CIMA maintains a list of the approved auditor firms who are able to provide this service. Such audited financial statements must be filed with CIMA within six months of the end of each financial year of the fund.
•  Valuation of fund assets – the assets of a private fund must be valued periodically. What is considered to be an appropriate period between valuations will depend on the asset class(es) in which the fund is invested. However, valuations should, as a minimum, be carried out at least annually. Each valuation must be carried out by an independent and suitably qualified professional valuer who is familiar with the relevant asset class. If the valuer is not independent, then CIMA reserves the right to have the valuation independently verified at the cost of the fund. Otherwise, if the valuation of assets is carried out by the fund itself or by its investment manager, the valuation function must be independent from the portfolio management of the fund and any conflicts of interest are required to be identified, managed, monitored and disclosed to investors.
•  Safeguarding of the fund’s assets – private funds are, generally speaking, required to appoint a custodian to hold, in segregated accounts maintained in the name of the fund, the fund’s assets which are capable of physical delivery or capable of registration in a separate account except that the private fund shall not be required to appoint a custodian if it has notified CIMA and it is neither practical nor proportionate to do so, having regard to the nature of the private fund and the type of assets it holds. The duty of custodian appointed is to verify the fund’s title to its assets based on information provided by the fund together with any externally available information. If a custodian is not appointed, the verification of the fund’s title to its assets must be carried out either by the fund’s administrator or by the fund itself or its investment manager. In the case of title verification by the fund or its investment manager, the title verification function must be independent from the portfolio management of the fund and any conflicts of interest are required to be identified, managed, monitored and disclosed to investors in the fund.
• Cash monitoring – private funds are required to appoint any of an administrator, custodian or the investment manager to (1) monitor the cash flows of the fund; (2) ensure that all cash has been booked in cash accounts maintained in the name of the fund; and (3) ensure that payments made by investors to the fund for the purposes of investment have been received.If such monitoring is not undertaken by an independent third party, CIMA reserves the right to have the cash monitoring verified at the cost of the fund. In the case of cash monitoring undertaken by the fund or its investment manager, as above, the cash monitoring function must be independent from the portfolio management of the fund and any conflicts of interest are required to be identified, managed, monitored and disclosed to investors in the fund.
•  Identification of securities – if the private fund in question regularly trades securities or holds them on a consistent basis, it must keep records of the identification codes (such as ISIN codes or CUSIP codes) of those securities that it trades and holds and such records must be made available to CIMA on request.

In addition to its obligations under the Act and guidance issued by CIMA, private funds are also subject to other obligations under the laws of the Cayman Islands in relation to matters such as FATCA / CRS compliance and in respect of anti-money laundering legislation and regulations.

• FATCA / CRS – Private funds tend to be classified as ‘Reporting Financial Institutions” for the purposes of FATCA and CRS. Private funds are therefore required to undertake detailed due diligence on each of its investors (which is typically undertaken on its behalf by its administrator). The fund must also provide information to the Tax Information Authority of the Cayman Islands in respect of each of its investors who constitute ‘reportable accounts’.
• Anti-money laundering – Private funds conduct “relevant financial business” for the purposes of the Proceeds of Crime Act (As Revised) and the Anti-Money Laundering Regulations (As Revised) (being together the “AML Requirements”). Private funds are therefore required to have robust policies and procedures in place to ensure that the AML Requirements are adhered to. The fund must have a detailed Anti-Money Laundering Compliance Manual which contains detailed guidance on the policies and procedures that must be followed in carrying out the fund’s activities, ranging from the onboarding process for investors, record-keeping, processes for the reporting of suspicious activity and other risk management matters.

Each private fund must also appoint three officers to assist with compliance with the AML Requirements; these are the anti-money laundering compliance officer, money laundering compliance officer and deputy money laundering compliance officer.

On the basis that private funds are a form of ‘investment fund’, private funds that are registered under the Act are not ‘relevant entities’ for the purposes of the International Tax Co-operation (Economic Substance) Act (As Revised). Whilst, therefore, private funds will not be required to demonstrate the extent of their ‘substance’ in the Cayman Islands, they will nonetheless be required to make an annual notification under this legislation to confirm their status as an investment fund.

If you are considering establishing a private fund in the Cayman Islands, it is imperative that you have experienced Cayman Islands legal counsel by your side to assist you in navigating the legislative and regulatory and compliance landscape. We have a strong reputation for our technical excellence, responsive, forward-thinking and insightful approach to advising clients on offshore Investment Funds and would be happy to be your trusted advisor on the formation, launch and ongoing advisory of your Cayman Islands private fund.

View Full PDF

This publication is not intended to be a substitute for specific legal advice or a legal opinion. For specific advice on Private Investment Funds in Cayman Islands, please contact your usual Loeb Smith attorney or any of the following:

E: gary.smith@loebsmith.com
E: robert.farrell@loebsmith.com
E: elizabeth.kenny@loebsmith.com
E: wendy.au@loebsmith.com
E: cesare.bandini@loebsmith.com
E: vivian.huang@loebsmith.com
E: faye.huang@loebsmith.com

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.

View Full PDF

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.

View Full PDF

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/

View Full PDF

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