A captive insurance company is a wholly owned subsidiary insurer that provides risk mitigation services for its parent company or related entities. In its simplest form, the ‘captive’, wholly owned subsidiary is incorporated to insure against one or more risks to which its parent company is exposed. It is essentially a form of self-insurance, which is put in place within a group corporate structure for a number of reasons. Captives are usually established in the context of a company’s risk management strategy and are typically put in place because those risks that are looking to be insured by the captive are either non-insurable or priced too high in the current market.

The captive insurance industry in the Cayman Islands recorded 42 new international insurer licenses in 2025, which was the second year in a row at that number, according to fourth-quarter data released by the Cayman Islands Monetary Authority (CIMA).

The data released by CIMA showed that at the end of 2025, the jurisdiction reported 693 Class B licences, 16 Class C licences, and 11 Class D licences, with an aggregate total of 720 licensed insurance companies in operation. These entities collectively wrote $51.2 billion in premiums and held $176.2 billion in total assets. The data showed that the premium volume reflected a 24 per cent increase compared to 2024, while total assets rose by 15 per cent over the same period.

The 693 Class B licences (mostly captives) in 2025, represented an increase from 670 in 2024 and 658 in 2023. Accordingly, captives licensed in 2025 by CIMA accounted for 96.25 per cent of all international insurer licensees in the Cayman Islands.

The Cayman Islands has historically been a jurisdiction for captive insurance companies and is currently one of the leading captive hubs in the world, both in terms of number of companies and total assets under management. This is a result of Cayman’s world-wide reputation as a highly professional, yet business friendly and well-regulated environment, with a philosophy of imposing proportionate, risk-based regulations and rules backed by consistency of enforcement.

The growing popularity of the segregated portfolio (SPC) structure in the captive insurance industry is partly due to the fact that such structures allow insurers to add additional participants in a reinsurance programme without risk of cross liability. In fact, a distinctive feature of all SPCs is that the assets and liabilities of each segregated portfolio (also referred to as ‘cells’) are, as the name suggests, segregated from one another.  Each SPC cell, however, does not have legal personality. Ownership of the underlying assets in the cells is through classes or series of shares in the SPC which are designated to that particular cell.

The SPC structure is often seen in the context of the so-called ‘rent-a-captives’, whereby those wishing to reap the benefits of a captive insurance company (either for their own insurance or reinsurance) while minimising matters such as time, upfront costs, and maintenance, can simply become shareholders in an existing SPC and ‘rent’ a cell. The participants in a rent-a-captive structure pay premiums and service fees into the cell and in return they get access to the capital base they need to underwrite the risk, as well as an entitlement to any distributions made out of that cell. The SPC structure provides smaller businesses with a lower-cost entry point into the captive market, thanks to reduced premium thresholds and significantly lower formation costs.

There are also Portfolio Insurance Companies (PICs) which can be seen as a slight variation of the SPCs mentioned above. A PIC is similar to an SPC except that its cells have separate legal personality.

Other forms of captives include ‘Association Captives’, which are insurance companies owned by an association to meet the insurance needs of its members, and ‘Agency Captives’, which are insurance or reinsurance companies owned by one or more insurance agents, used to insure against the risks of those agents or any of their clients.

Cayman Islands domiciled captivesoperate primarily as Single Parent Captives (‘Pure Captives’), Group Captives, or Segregated Portfolio Companies (SPCs), allowing for bespoke insurance solutions. Businesses utilise them to manage complex risks, reduce reliance on commercial insurance, retain underwriting profits, lower insurance costs, enhance the ability to tailor coverage for hard to insure or emerging risks, enhance greater control over coverage and flexibility in managing risks, and increase the ability to allocate costs to different business units.

The continued growth of Single Parent Captives indicates that captives are increasingly being used by organisations to cover cyber risks that are difficult to place, expensive, or excluded in the traditional insurance market. By creating a wholly owned insurance entity, companies can customise policies to fit their specific risk profile, retain underwriting profits, and bridge gaps in standard cyber coverage. Group Captives act as a collaborative, accessible entry point for mid-market businesses seeking control over insurance costs and risk management, acting as an alternative to traditional insurance and costly single-parent captives. By pooling resources, members gain direct access to reinsurance markets, transparency in underwriting, and the ability to earn dividends on unused premium, particularly in casualty lines. Going forward, it is anticipated that economic uncertainty, rising premiums, and emerging risks, will drive more businesses to seek collaborative solutions that offer stability and cost efficiency.

A Class B(iii) Captive in the Cayman Islands is a specialised insurance company that writes 50 per cent or less of its net premiums from related business, requiring a minimum capital of US$200,000. These Captives are ideal for group risks, joint ventures, or scenarios with significant third-party business. They have the versatility of being suitable for complex risks that do not fit the 95 per cent single parent threshold of Class B(i) captives and can be structured as a standalone company or as an SPC.

This article was first posted in the IFC Review.

This publication is not intended to be a substitute for specific legal advice or a legal opinion. For specific legal advice on the subject matter of this Legal Insight, please contact: 

Partner: Gary Smith
E: gary.smith@loebsmith.com

The main fiduciary duty that a General Partner owes to the ELP and the ELP’s limited partners as a whole is the duty of loyalty and good faith. Under Cayman law this is expressed as requiring the General Partner to act in good faith in the interest of the ELP. There is no specific guidance in the ELP Act as to the full extent of this duty. There are no decisions of the Cayman Islands’ courts that have  determined the full scope of the duty. However, as in other areas of Cayman law, it is reasonable to assume that the Cayman courts would refer to the decisions in English and Commonwealth cases, which are of persuasive authority if not binding authority, for guidance.

Prior to July 2014, a General Partner was under an absolute duty to act in good faith in the interest of the ELP. This duty could not be restricted, limited or varied by the terms of the Partnership Agreement between the General Partner and the limited partners. The requirement to act in the interest of the ELP often raises the issue of conflicts of interest for the General Partner, particularly when it acts as General Partner to more than one ELP.

Examples of where conflicts of interests can arise for the General Partner include:

1. The General Partner causes the ELP to:
   • co-invest with other ELPs (in which it is also the general partner) in only certain transactions that benefit the General Partner; or
   • co-invest in disproportionate amounts, which causes its interests to be no longer directly aligned with those of the limited partners of the ELP.
2. The General Partner causes the ELP to invest in a portfolio company in which the person(s) who control and/or own the General Partner, for example, the director(s) and/or shareholder(s) of the General Partner, have a personal interest.
3. The General Partner causes the ELP to purchase securities from person(s) who control and/or own the General Partner, for example, the director(s) and/or shareholder(s) of the General Partner.
4. The General Partner is responsible for valuing assets of the ELP where carried interest payable to the General Partner are based on such valuations.
5. Treatment of limited partners: the General Partner owes a fiduciary duty to the limited partners of the ELP as a whole. Therefore the General Partner should treat each limited partner of the ELP in a similar manner. It should not benefit one at the expense of the others. Different treatment of limited partners sometimes arises in the context of default by a limited partner in performing its obligations under the Partnership Agreement. For example, where the limited partner fails to pay its contributions to the ELP when a call on its capital commitments has been made.

Often the Partnership Agreement provides that where a limited partner fails to perform any of its obligations under, or otherwise breaches the Partnership Agreement (for example, where a limited partner fails to commit additional capital when called on to do so), that limited partner may be subject to or suffer remedies for, or consequences of, the failure or breach specified in the Partnership Agreement. Such remedies or consequences can include, for example, reducing, eliminating or forfeiting the defaulting limited partner’s partnership interest in the ELP. The ELP Act confirms that those remedies or consequences in the Partnership Agreement will not be unenforceable solely on the basis that they are penal in nature. This confirmation by the ELP Act reduces significantly the risk of those remedies or consequences in the Partnership Agreement being subject to legal challenge in the Cayman courts on the basis that they are penalties (that is, remedies that go well beyond a reasonable assessment and measure of the loss suffered as a consequence of the default) and may be unenforceable as a matter of Cayman law generally.

However, there is a risk of legal challenge by a limited partner where a General Partner fails to apply a clear and consistent approach to implementing such remedies in the Partnership Agreement against defaulting limited partners. The challenge could be based on the ground that the inconsistent implementation of such default procedures benefits one limited partner at the expense of the others or vice versa.

The ELP Act modified the scope of the fiduciary duty of a General Partner to act in good faith in the interest of the ELP. There is still an absolute duty on the General Partner of an ELP to act in good faith on matters concerning the ELP. However, the duty to act in the interest of the ELP is now subject to any express provision in the Partnership Agreement to the contrary.

The Partnership Agreement can therefore stipulate the circumstances in which the General Partner may act in the interest of a party other than the ELP (for example, see above, Duty to act in good faith in the interest of the ELP). Including these circumstances in the Partnership Agreement should make it easier for the General Partner to manage interests that compete against the interests of the ELP.

However, where the Partnership Agreement has no express provision to state in whose interest the General Partner must act in given circumstances, then the default position is that the General Partner must act in good faith in the interest of the ELP (that is, in the collective interest of all limited partners of the ELP).

A General Partner’s powers derive from the ELP Act and the Partnership Agreement governing its relationship with the limited partners. The General Partner is under a fiduciary duty to exercise its powers for the purpose(s) for which they are conferred in the Partnership Agreement. The purposes in the Partnership Agreement can be stated in general terms, for example, to undertake any lawful activity under the ELP Act, or to act as an investment fund. They can also be expressed in specific terms, for example, to invest in a portfolio consisting primarily of securities of companies in the renewable energy, renewables, clean technology, environment regeneration sectors and to engage in all activities and transactions as may be necessary, advisable, or desirable to carry out these activities. Where the Partnership Agreement of an ELP is, for example, negotiated with a large institutional investor or seed capital investor, the investor will more than likely seek to have the purpose(s) of the ELP stated in more specific terms.

The ELP Act states that all “rights or property of every description of the [ELP], including all choses in action and any right to make capital calls and receive the proceeds thereof that is conveyed to or vested in or held on behalf of any one or more of the general partners or which is conveyed into or vested in the name of the [ELP] shall be held or deemed to be held by the general partner and if more than one then by the general partners jointly, upon trust as an asset of the [ELP] in accordance with the terms of the partnership agreement” (section 16(1), ELP Act).

As the General Partner holds the ELP’s assets on trust, it follows that it should:

• Not make any secret profits from such assets or, without express authorisation, appropriate any benefits or opportunities that derive from such assets for itself.

• Disclose personal interest in contracts involving the ELP.

• Apply the ELP’s assets for the purpose of the ELP.

A General Partner can minimise the risk of breaching its fiduciary duties to the ELP and thereby the risk of being sued by one or more limited partners by adopting some or all of the following:

1. Avoid conflict transactions or establish advisory committees (LPACs) or votes of limited partners to approve conflict transactions or waive conflicts. An ELP’s Partnership Agreement often provides for the establishment of an advisory committee of persons nominated by certain limited partners (LPAC) to adjudicate on, among other things, conflict situations involving the General Partner. The use of advisory committees is a good way of mitigating the risk of the General Partner being found to be in breach of its fiduciary duties for failing to deal with conflicts or dealing with them inadequately. The ELP Act confirms that, subject to any terms of the Partnership Agreement to the contrary, a member of the LPAC does not owe any fiduciary duty to the ELP or to the General Partner or to any of the ELP’s limited partners, in exercising any of its rights or otherwise in performing any of its obligations as a member of the advisory committee (section 24(2), ELP Act).
2. Clear and consistent policies. The General Partner should ensure that the ELP, where possible, adopts clear and consistent valuation policies approved by the ELP’s advisory committee. The General Partner should also ensure that the ELP, where possible, adopts clear and consistent policies for dealing with circumstances where limited partners default on their obligations in the Partnership Agreement (for example, failing to make contributions when a capital call has been made). An ELP which operates as a regulated investment fund registered with the Cayman Islands Monetary Authority is required to have policies and procedures for implementing and effecting good corporate governance. This can also help to mitigate risks of liability.
3. Internal compliance. The General Partner should establish clear internal procedures for identifying potential conflicts and dealing with them (for example, referral to the LPAC for consideration).
4. Restrict the scope of fiduciary duties by agreement. The Partnership Agreement can be drafted in such a way as to minimise or restrict the scope of certain fiduciary duties. For example, the ELP Act now permits the Partnership Agreement to set out circumstances in which the General Partner may act in the interests of parties other than the ELP (see above, Modification of duty to act in good faith in the interest of the ELP). The Partnership Agreement can also be used to clearly exclude fiduciary duty obligations of the General Partner in other areas but this will depend on the relative bargaining power between the General Partner and incoming limited partners and the degree of negotiation of the Partnership Agreement. However, the absolute duty on the General Partner to act in good faith in respect of the ELP cannot be excluded or eliminated.

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This publication is not intended to be a substitute for specific legal advice or a legal opinion. If you require further advice relating to the matters discussed in this Briefing, please contact us.  We would be delighted to assist.

E: gary.smith@loebsmith.com
E: robert.farrell@loebsmith.com
E: elizabeth.kenny@loebsmith.com
E: vanisha.harjani@loebsmith.com
E: kate.sun@loebsmith.com
E: vivian.huang@loebsmith.com
E: faye.huang@loebsmith.com
E: yun.sheng@loebsmith.com

Parallel funds are investment vehicles structured to co-invest and divest alongside a main fund, with each structure being similar in many ways to the main fund in terms of strategy, investment policy, investment target, asset classes, risk management, etc. The major distinction between the different funds in the structure are typically the tax framework (capital gains, dividend, interest, etc.) or the intention of the investment manager to differentiate each fund vehicle based on their investor group.

For example, parallel funds may include an onshore fund or mid-shore (established in any jurisdiction, e.g. Singapore or Hong Kong) and a standalone Cayman fund, both being managed by the same investment manager, with similar investment objectives and strategies, making identical investments but having different structures and a different pool of investors (e.g. US investors in one Cayman structure or Delaware structure, Japanese investors in a Singapore domiciled fund structure, and other non-US investors based in Asia in another Cayman-domiciled fund structure), in order to cater for a tax efficient framework or regulatory requirements based on investors’ jurisdiction of domicile.

Parallel funds are often established by private equity (PE) fund managers to complement the main fund and address legal, tax, regulatory, accounting or other considerations from specific investors who are interested in the investment objective and strategy.

Parallel funds versus master-feeder funds. Parallel funds are distinguishable from master-feeder structures in that the feeder funds invest directly into the master fund, thereby pooling all investments in the master fund. With parallel funds, separate investment funds invest directly in the same investment deals or asset classes, but they are kept as distinct entities with no pooling of capital into a master fund.

What are the key benefits and advantages offered by parallel fund structures?

Using parallel funds provides a number of benefits to investment managers, including:

1. Flexibility, allowing investment managers to tailor investment strategies and structures based on investor profiles, offering different fee structures or liquidity terms;
2. Tax efficiency, providing a tax efficient way to invest without triggering adverse tax consequences in jurisdictions with stringent regulations; and
3. Regulatory compliance, allowing investment managers to adapt to varying regulatory environments, ensuring compliance.

However, it would be wise to note that parallel fund structures do not come without risks, including:

1. Operational issues – the investment manager may need to manage multiple funds across jurisdictions;
2. Different regulatory requirements – creating more administrative responsibility and complexities in terms of operations and compliance, increasing cost; and
3. Investor relations and fees – managing communications and reporting between different investor classes, and dealing with different structures and fees can cause confusion and increase the administrative burden.

When structuring parallel funds, consideration needs to be given to:

1. Investment strategy alignment to ensure that funds can invest in the same underlying assets without conflicts of interest;
2. Fund documentation, drafted to address the specific needs of each fund while ensuring consistency;
3. Management and fees, ensuring transparency; and
4. Legal and tax advice to ensure compliance with all relevant laws and regulations, and optimise the tax impact for investors.

When considering the Cayman Islands for a parallel fund structure, its robust legal framework, absence of taxes on investment funds and their investors, and flexible regulatory environment make it attractive for investment managers and investors alike.

This article was first published with Asia Business Law Journal. https://law.asia/cayman-islands-parallel-funds-growth-benefits/

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This publication is not intended to be a substitute for specific legal advice or a legal opinion. If you require further advice relating to the matters discussed in this Article, please contact us. We would be delighted to assist.

Vanisha Harjani
E: vanisha.harjani@loebsmith.com

An investor in a fund that is structured as an ELP is issued with limited partnership interests (“LP Interests”) in exchange for their capital contributions. The general partner of an ELP (“General Partner”) is required to maintain a register of partnership interests containing certain prescribed information in respect of each limited partner (“Register”).

Before a lender takes security over LP Interests, it must first undertake detailed due diligence in order to ensure that the security that is available matches its expectations.

First, it should review the relevant provisions of the limited partnership agreement relating to the ELP (“LPA”). LPAs usually contain either an outright prohibition on the creation of security over LP Interests or in the very least require the prior written approval of the General Partner to the creation and subsistence of the security. There is often no express contractual requirement for the General Partner to not ‘unreasonably withhold or delay consent”. Therefore, early and transparent engagement with the General Partner is essential.

A further consent may be required from the General Partner as LPAs also typically restrict the transfer of LP Interests without the General Partner’s consent. A lender will therefore wish to obtain consent upfront to any transfer of title in the relevant LP Interests in the event that the security is enforced.

In addition to reviewing the LPA, a well-advised lender will also insist on reviewing any side letters and the subscription application that may have been entered into by the limited partner with the ELP to ensure that the provisions to the LPA dealing with the creation of security have not been modified. To the extent that a side letter does not exist, the lender should obtain representations and warranties to this effect from the limited partner in the finance documents.

Finally, the lender should also review the Register (to ensure that the security provider does in fact hold title to the LP Interests that are to be the subject of the security) and, in the case of a corporate security provider, its register of security interests to ensure that no prior security interests subsist over the LP Interests. To the extent that any security interests are revealed to already exist, the prior security interests will need to be redeemed prior to concluding the funding. Alternatively, a deed of priority or intercreditor deed could be entered into with the other secured party.

In addition to legal due diligence, the lender should also make enquiries of the ELPs records of capital contributions to ensure that any and all capital commitments have been fully funded (or will be so funded with the financing to be provided).

Under Cayman Islands law, there are no prescribed particulars for how security over LP Interests is created and perfected. That said, the security document that will be entered into to create security over the LP Interests follows a format that will be familiar in finance transactions in other jurisdictions. In particular, the security document will:

• be in writing;
• be signed by the limited partner granting the security (usually as a deed);
• contain a full and detailed description of the LP Interests that will be the subject of the security. In addition to the LP Interests themselves, the security created will also extend to all ‘related rights’ to the LP Interests, such as rights to any distributions and the ultimate return of the invested principal;
• contain details of the amount to be secured by the document. Typically, this will not be a specific monetary amount but will instead be expressed to be either ‘all monies owing by the limited partner to the lender’, or ‘all monies owing by the limited partner to the lender under the finance documents’; and
• specify the powers and entitlements of the lender in the event of a default by the limited partner which results in the security becoming enforceable. The events of default themselves will typically be listed in the accompanying facility letter or loan agreement.

In addition to the security document, a limited partner providing security will also provide the required consent(s) from the General Partner (as noted above) and a signed, undated instrument of transfer relating to the secured LP Interests, with the transferee left blank. Any enforcement transfer remains subject to the transfer restrictions contained in the LPA and the terms of the security document.

A person granting security over LP Interests is required to provide written notice of the creation of the security to the ELP at its registered office. Such notice must specify the agreement pursuant to which security is granted, including its date, the names of the parties and details of the LP Interests that are the subject of security.

In practice, a well-advised lender will insist on the chargor having dialogue with the ELP prior to conclusion of the financing so that the form of notice is agreed in advance and promptly served. As between competing security interests over the same LP Interests, priority is determined by the time at which written notice of the security is received at the ELP’s registered office. The ELP is required to maintain a register of security interests in respect of each such notice that it receives.

The lender will also typically require a written acknowledgement from the ELP as confirmation this requirement has been met as well as a copy of the duly completed register (or an extract therefrom).

If the limited partner providing the security is itself a corporate entity or an ELP, depending on its jurisdiction of incorporation it may need to make filings and update registers of its own in order to remain compliant and to ensure the security remains valid and enforceable.

No stamp or other taxes are typically payable in respect of either the grant of security over LP Interests or any subsequent transfer of LP Interests where the security is enforced save where the document is executed in, or brought into, the Cayman Islands.

In the event of a continuing default by the chargor, the holder of the security over the LP Interests may enforce it in accordance with the terms of the security document. Security documents will usually permit the securityholder to sell the charged LP Interests or appoint a receiver in respect of the same.

However, the securityholder’s rights under the security documents are only part of the overall analysis. Well-advised lenders should, from the outset of the financing, carefully review whether the terms of the LPA adequately accommodate an enforcement scenario and, where necessary, seek appropriate amendments or consents.

LPAs are commonly drafted so as to restrict the transfer of LP Interests without the consent of the General Partner. A secured creditor will therefore typically require either: (i) the General Partner’s advance consent to transfers arising upon enforcement of the security; or (ii) sufficiently broad provisions within the LPA itself permitting transfers of LP Interests by a secured creditor or receiver on enforcement.

This issue is particularly important because, in an enforcement scenario, the General Partner may not necessarily take a position aligned with the interests of the lender. Lenders will therefore wish to ensure that the LPA does not confer overly broad discretion on the General Partner in a manner that could frustrate or materially delay the enforcement process.

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This publication is not intended to be a substitute for specific legal advice or a legal opinion. For specific legal advice on the subject matter of this Briefing, please contact:

Partner: Robert Farrell

E: robert.farrell@loebsmith.com

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 operate 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 are at least 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…”

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 re-purchasable 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; and
• Sovereign wealth funds.

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 (6) 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 function 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. Each private fund is 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.
• Beneficial ownership – The Beneficial Ownership Transparency Act (“BOTA”) requires Cayman Islands exempted companies, ELPs, and limited liability companies to maintain a beneficial ownership register unless an alternative route to compliance applies. Under the BOTA, alternative routes to compliance are available to categories of legal persons such as private funds and each private fund will be required to provide its corporate services provider in the Cayman Islands with:

1. written confirmation of the category into which it falls; and
2. the required particulars specific to it.

The private fund is required to appoint a principal point of contact (“PPoC”) who is responsible for responding to any request for beneficial ownership information received from the Cayman Islands Competent Authority (“Competent Authority”) in relation to the private fund. The PPoC must be licensed in the Cayman Islands and will be required to provide the requested beneficial ownership information to the Competent Authority within 24 hours of a request being made, or such other timeframe as may be stipulated in the request.

Each private fund must also appoint three (3) officers to assist with compliance with the AML Requirements; these are the anti-money laundering compliance officer, money laundering reporting officer, and deputy money laundering reporting 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, 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.

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This publication is not intended to be a substitute for specific legal advice or a legal opinion. If you require further advice relating to the matters discussed in this Briefing, please contact us.  We would be delighted to assist.

E: gary.smith@loebsmith.com
E: robert.farrell@loebsmith.com
E: elizabeth.kenny@loebsmith.com
E: vanisha.harjani@loebsmith.com
E: vivian.huang@loebsmith.com
E: faye.huang@loebsmith.com

Subscription credit facilities are secured credit arrangements that enable fund managers to access short-term financing (i.e. short-term loans) against the capital commitments of fund investors.

Unlike traditional fund financing, these facilities are typically structured as revolving credit lines, allowing funds to bridge capital calls, manage liquidity, or seize investment opportunities, therefore allowing quick access to cash for investment without having to call on capital commitments from investors immediately.

1. Security and collateral arrangements. The foundation of subscription credit facilities is the security interest over the fund’s unfunded capital commitments. Under Cayman Islands and BVI law, the enforceability of security interests such as a pledge and/or charge over unfunded capital commitments (as collateral for a loan) relies on the proper drafting of security agreements and registration procedures. It is crucial to clearly define the scope of security, including any guarantees or other security interests created to ensure priority and enforceability.
2. Intercreditor arrangements. Given that subscription credit facilities often coexist with other fund financing or investor arrangements, establishing clear intercreditor agreements is vital. Intercreditor agreements safeguard funds and investors by defining the payment hierarchy and security rights among multiple lenders. These agreements are essential for ensuring orderly enforcement and mitigating conflicts, particularly in multi-lender scenarios. Offshore jurisdictions facilitate sophisticated intercreditor arrangements, supported by well-established legal frameworks.
3. Fund governance and limited partnership agreements. Cayman Exempted Limited Partnerships (ELPs) or BVI Limited Partnerships (LPs) are the typical structure, offering flexibility and strong creditor protections. A fund’s constitutional documents determine the scope of authority its general partner or manager has. In the case of an ELP or LP, this is detailed in the limited partnership agreement (LPA).
   Accordingly, to ensure compliance and mitigate legal risks, a fund’s LPA must explicitly authorise the general partner or manager to pledge investor capital commitments as security. It is advisable to include provisions that address the express borrowing authority, mechanics of security, enforcement procedures and investor consent processes (such as through side letters) and any transfer restrictions.
4. Regulatory and Anti-Money Laundering (AML) considerations. The BVI and Cayman Islands have AML regimes requiring the appointment of AML officers. As subscription facilities often involve large capital commitments from institutional investors, enhanced customer due diligence may be required, in addition to measures such as verifying the source of funds, sanctions screening, record keeping and reporting obligations. Proper due diligence, know your customer procedures and compliance measures are essential to prevent regulatory issues and ensure legality of security interests and transaction structure.

Flexibility and speed. Offshore jurisdictions have efficient legal processes and flexible corporate structures, enabling funds to implement subscription credit facilities swiftly. This agility is critical in investment environments.

Tax neutrality and confidentiality. Both the Cayman Islands and BVI offer tax-neutral regimes and strong confidentiality protection, which are attractive for international fund managers seeking discreet and efficient financing arrangements.

Legal certainty and established frameworks. With mature legal systems, both jurisdictions provide a high degree of legal certainty for security enforcement, contractual validity and dispute resolution, backed by a wealth of case law and legal expertise. The final court of appeal for both is the Privy Council in the UK.

Tips for structuring

1. Draft clear security documents. Ensure security interests over capital commitments are precisely defined and properly registered.
2. Obtain investor consent. Incorporate provisions in the LPA or side letters to facilitate or confirm investor approval for security grants.
3. Plan for enforcement. Establish enforcement procedures like notice periods and rights of first refusal.
4. Co-ordinate with creditors. Negotiate intercreditor arrangements early to prevent conflicts.

Subscription credit facilities represent a powerful tool for offshore funds seeking liquidity and operational flexibility, offering a flexible and efficient mechanism aligning well with the governance and operational frameworks of private equity funds in the Cayman Islands or BVI.

The article was first published by Asia Business Law Journal – https://law.asia/cayman-bvi-subscription-credit-facilities/

This publication is not intended to be a substitute for specific legal advice or a legal opinion. If you require further advice relating to the matters discussed in this Legal Insight, please contact:

Partner:  Vanisha Harjani
E: vanisha.harjani@loebsmith.com

Fiat currency transactions
What rules and restrictions govern the exchange of fiat currency and cryptoassets?

Assuming the subject cryptoassets fall within the definition of “virtual assets” under the Virtual Asset (Service Providers) Act (As Revised) (the VASP Act), the exchange of fiat currency and cryptoassets will likely constitute a virtual asset service under the VASP Act and hence any person providing the service of exchange of fiat currency and cryptoassets in the course of their business will be a virtual asset service provider regulated by the Cayman Islands Monetary Authority (CIMA) under the VASP Act.

Furthermore, if the exchange of fiat currency and cryptoassets falls within one of the relevant financial businesses under the Cayman Islands’ Proceeds of Crime Act, the relevant service provider will be required to comply with the AML and KYC requirements under the AML Regulations, which include, inter alia, implementing client identification and verification, record-keeping, and internal reporting and control procedures.

Where are investors allowed to trade cryptoassets? How are exchanges, alternative trading systems and secondary markets for cryptoassets regulated?

There are generally no legal requirements or restrictions on where investors are allowed to trade cryptoassets in the Cayman Islands, so investors are usually free to trade cryptoassets wherever they desire.

Assuming the subject cryptoassets that are traded on the exchanges, alternative trading systems and secondary markets qualify as virtual assets under the VASP Act, such exchanges, alternative trading systems and secondary markets will have to apply for a licence with CIMA if either of them qualifies as a virtual asset trading platform under the VASP Act, which is defined as:

“a centralised or decentralised digital platform — (a) which facilitates the exchange of virtual assets for fiat currency or other virtual assets on behalf of third parties for a fee, commission, spread or other benefit; and (b) which — (i) holds custody of or controls virtual assets on behalf of its clients to facilitate an exchange; or (ii) purchases virtual assets from a seller when transactions or bids and offers are matched in order to sell them to a buyer, and includes its owner or operator, but does not include a platform that only provides a forum where sellers and buyers may post bids and offers and a forum where the parties trade in a separate platform or in a peer-to-peer manner.”

If the exchanges, alternative trading systems or secondary markets are licensed with CIMA as virtual asset trading platforms, each of them would be subject to various restrictions and obligations stipulated, inter alia, under section 11 of the VASP Act, such as being restricted from providing financing to its clients for the purchase of virtual assets unless disclosures are made to clients regarding the terms of, and the risk of, the financing, and being obligated to carry out reasonable due diligence procedures on virtual assets and their issuers that are listed on the platform.

Alternatively, the exchanges, alternative trading systems and secondary markets for cryptoassets may otherwise have to be registered or licensed with CIMA if its business activity constitutes any virtual asset service under the VASP Act.

At the same time, the exchanges, alternative trading systems and secondary markets for cryptoassets may be regulated by the Securities Investment Business Act (SIBA) if the subject cryptoassets fall within the definition of “securities” under the SIBA, and if they are engaged in certain securities investment business, which would mandate the registration or licensing with CIMA.

Furthermore, if the business of exchanges, alternative trading systems and secondary markets for cryptoassets falls within one of the relevant financial businesses under the Proceeds of Crime Act, they will be required to comply with the AML and KYC requirements under the AML Regulations, which include, inter alia, implementing client identification and verification, record-keeping, and internal reporting and control procedures.

How are cryptoasset custodians regulated?

Assuming the cryptoassets that are the subject of the custody service of the relevant cryptoasset custodians qualify as “virtual assets” under the VASP Act, such custodians will have to apply for a licence with CIMA if either of them provides virtual asset custody service under the VASP Act, which is defined as “the business of safekeeping or administration of virtual assets or the instruments that enable the holder to exercise control over virtual assets”. If the custodians are licensed with CIMA to provide virtual asset custody service, each of them would be subject to various restrictions and obligations stipulated, among other things, under section 10 of the VASP Act, such as being obligated to:

•maintain best technology practices relating to virtual assets held in custody;
• not encumber or cause any virtual asset to be encumbered, unless specifically agreed to by the beneficial owners of the virtual assets;
• ensure that all proceeds relating to virtual assets held in custody shall accrue for the benefit of the owner, unless otherwise agreed in writing;
• take such steps as may be necessary to safeguard the virtual assets held;
• have adequate safeguards against theft and loss; and
• enter into a custodial arrangement with the owner of a virtual asset, which includes the prescribed details set out in the VASP Act.

Furthermore, if the business of such cryptoasset custodians falls within one of the ‘relevant financial businesses under the Proceeds of Crime Act, they will be required to comply with the AML and KYC requirements under the AML Regulations, which include, inter alia, implementing client identification and verification, record- keeping and internal reporting and control procedures.

How are cryptoasset broker-dealers regulated?
Assuming the broker-dealer business of the relevant cryptoasset broker-dealers involves cryptoassets that qualify as virtual assets under the VASP Act, it is likely that such broker-dealers will have to be registered with CIMA and be regulated accordingly because such broker-dealer business typically involves either one or a combination of the following virtual asset services: transfer of virtual assets, virtual asset custody service, or participation in and provision of financial services related to a virtual asset issuance or the sale of a virtual asset.

At the same time, the cryptoasset broker-dealers may be regulated by the SIBA if the subject cryptoassets fall within the definition of securities under the SIBA, and if they are engaged in certain securities investment business (which would be likely in terms of dealing in securities and/or arranging deals in securities), which would mandate the registration or licensing with CIMA.

Furthermore, if the business of such cryptoasset broker-dealers falls within one of the relevant financial businesses under the Proceeds of Crime Act, they will be required to comply with the AML and KYC requirements under the AML Regulations, which include, inter alia, implementing client identification and verification, record-keeping and internal reporting and control procedures.

What is the legal status of decentralised cryptoasset exchanges?

Since the definition of “virtual asset trading platform” under the VASP Act also covers those trading platforms with a decentralised nature, the legislations and regulations mentioned above (see Exchanges and secondary markets) shall similarly apply to decentralised cryptoasset exchanges so long as the subject cryptoasset and business activities fall within the corresponding scopes.

What is the legal status of peer-to-peer (person- to- person) transfers of cryptoassets?

Assuming the cryptoassets that are the subject of the peer-to-peer transfers qualify as virtual assets under the VASP Act, if such peer-to-peer transfers are conducted in the course of the relevant party’s business, such peer-to-peer transfers may constitute a virtual asset service with respect to transfer of virtual assets under the VASP Act, which renders the need to be registered with CIMA.

Similarly, a party of peer-to-peer transfers of cryptoassets may be regulated by the SIBA if the subject cryptoassets fall within the definition of securities under the SIBA, and if that party is engaged in certain “securities investment business” (which would be likely in terms of dealing in securities), which would mandate the registration or licensing with CIMA.

Furthermore, if such peer-to-peer transfers fall within one of the relevant financial businesses under the Proceeds of Crime Act, the relevant party will be required to comply with the AML and KYC requirements under the AML Regulations, which include, inter alia, implementing client identification and verification, record-keeping, and internal reporting and control procedures.

Does the law permit trading cryptoassets with anonymous parties?

In general, there are no legal restrictions on trading cryptoassets with anonymous parties, unless such trades are considered to be conducted in the course of business of the relevant party and the relevant party is considered to be providing the services of transfer of virtual asset under the VASP Act, and/or carrying out the relevant financial business under the AML Regulations, in which the relevant party will then be subject to certain due diligence requirements of the transaction parties and/or customers, hence making it difficult for a party to keep itself anonymous.

(a) Are foreign cryptocurrency exchanges subject to your jurisdiction’s laws and regulations governing cryptoasset exchanges?

In general, the location of domicile of a foreign cryptocurrency exchange does laws and regulations may govern such exchange.

For the VASP Act, what matters is whether any virtual asset service is provided in or from within the Cayman Islands in the course of business, the affirmation of which will render the foreign cryptocurrency exchange to register or be licensed with CIMA.

In addition, SIBA also does not differentiate between the treatment for varying locations of domicile of a foreign cryptocurrency, and what matters is the actual business activity conducted by the relevant exchanges and whether the service is being provided in or from within the Cayman Islands.

(b) Under what circumstances may a citizen of the Cayman Islands lawfully exchange cryptoassets on a foreign exchange?

From the perspective of Cayman Islands laws, there is generally no legal restriction or requirement on how a citizen of the Cayman Islands shall exchange cryptoassets on a foreign exchange.

Do any tax liabilities arise in the Cayman Islands in the exchange of cryptoassets (for both other cryptoassets and fiat currencies)?

There is generally no Cayman Islands tax liability for the exchange of cryptoassets.

Has the Cayman Islands’ government recognised any cryptoassets as a lawful form of payment or issued its own cryptoassets?
No, the Cayman Islands government has not recognised any particular cryptoasset as a lawful form of payment, nor has it issued its own cryptoasset so far.

Does Bitcoin have any special status among cryptoassets in the Cayman Islands?
No, Bitcoin does not have any special status in the Cayman Islands as compared against other cryptoassets. So long as Bitcoin falls within the definitions of virtual asset under the Virtual Asset (Service Providers) Act (As Revised) (the VASP Act), it will be subject to the corresponding regulations under the VASP Act.

Do any Cayman Islands’ banks or other financial institutions allow crypto-currency accounts?

No, except for institutions that qualify as virtual asset service providers under the VASP Act such as cryptoasset exchanges, we are not aware of any bank or other financial institution in the Cayman Islands that allows crypto-currency accounts. However, we do note that an increasing number of banks and/or other financial institutions have been willing to allow cryptoasset-related businesses (e.g., exchanges or investment funds) to establish traditional bank accounts with them.

What is the legal status of crypto-currency mining activities?

There is currently no specific legislation or regulation in the Cayman Islands that regulates, restricts or prohibits cryptocurrency mining activities.

What views have been expressed by the Cayman Islands’ government officials regarding cryptocurrency mining?

We are not aware of any particular view expressed by government officials in the Cayman Islands specifically regarding cryptocurrency mining.

Cryptocurrency mining licences – Are any licences required to engage in cryptocurrency mining?

Unless cryptocurrency mining is considered to be one of the virtual asset services under the Virtual Asset (Service Providers) Act (As Revised) (which is unlikely), there is no specific legislation or regulation in the Cayman Islands that requires a licence to be obtained before engaging in cryptocurrency mining.

How is the acquisition of crypto-currency by cryptocurrency mining taxed?

There is generally no Cayman Islands tax liability for the acquisition of cryptocurrency by cryptocurrency mining in the Cayman Islands.

Node licensing
Are any licences required to operate a blockchain/DLT node?

Assuming the subject cryptoassets qualify as virtual assets under the Virtual Asset (Service Providers) Act (As Revised) (the VASP Act), it is likely that operating a blockchain or DLT node in the course of one’s business may be considered as ‘participation in and provision of financial services related to a virtual asset issuance or the sale of a virtual asset’, hence qualifying such operator as a virtual asset service provider, which requires registration with Cayman I s lands Monetary Authority (CIMA) under the VASP Act.

Is the operation of a blockchain/DLT node subject to any restrictions (e.g., based on sanctions/AML/KYC/FATF rules and standards)?

There is no legal restriction in the Cayman Islands that is specifically directed towards the operation of a blockchain/DLT node. However, if the operator of a blockchain/DLT node is considered to be a virtual asset service provider under the VASP Act, such operator shall generally be subject to the various anti-money laundering (AML) and know your customer requirements stipulated by the VASP Act and by the AML Regulations.

What legal liabilities do the participants in a decentralised autonomous organisation (DAO) have?

A DAO or its participants generally are not subject to any legal liability in the Cayman Islands, especially when a DAO does not have any legal personality.

However, if a DAO has been established with a corporate legal personality (eg, in the form of a Cayman foundation company or an exempted company), depending on the type of activity it undertakes in the course of its business, it might be subject to various legal regulations or restrictions in the Cayman Islands, such as the VASP Act and the SIBA. For instance, if a corporate DAO’s issuance of any tokens qualified as an issuance of virtual asset under the VASP Act, the corporate DAO will be required to register with CIMA and obtain CIMA’s prior approval before the issuance, but it is also important to note the exclusion of virtual service token from the definition of virtual assets.

Who owns the assets of a DAO?

The ownership of assets of a DAO will generally depend on various factors such as the DAO’s specific structure and any rules encoded in the DAO’s smart contracts or protocols, and such ownership is typically distributed among the participants or token holders of a DAO.

However, if a DAO is structured as a Cayman foundation company and such foundation company has shareholders (which is not mandatory), such shareholders would then be the ultimate owner of the assets of the DAO.

Is DLT based on open-source protocols or software treated differently under the law than private DLT?

No, the Cayman Islands law generally does not impose different treatments to DLT based on open-source protocols or software and private DLT.

Are smart contracts legally enforceable?

Currently, there is no specific legislation or regulations in the Cayman Islands that govern the enforceability of smart contracts. However, the Electronic Transactions Act (As Revised) allows for the formation of a contract by electronic record, and it also recognises the validity of electronic signatures so long as such signatures satisfy the reliability requirement stipulated therein. Therefore, provided that all of the essential elements of a contract (ie, offer, acceptance, intention to be legally bound and consideration), are present, we are of the view that a properly executed smart contract will be legally enforceable in the Cayman Islands.

Can blockchain/DLT technology be patented?

There is no legislation or regulation in the Cayman Islands that prohibits blockchain/DLT technology from being patented. So long as the Patents Act (As Revised) of the Cayman Islands is complied with, the owner of the patent right of blockchain/DLT technology recognised in the United Kingdom may apply to extend such patent right to the Cayman Islands.

Recent developments
Are there any emerging trends, notable rulings or hot topics related to cryptoassets or blockchain in your jurisdiction?

The Mutual Funds (Amendment) Bill, 2026, the Private Funds (Amendment) Bill, 2026, and the Virtual Asset (Service Providers) (Amendment) Bill, 2026 (the “Bills”), collectively pave the way for tokenized funds in the Cayman Islands, by:

(1) materially revising the definition of “issuance of virtual assets” to exclude both (i) the issuance of equity interests under the Mutual Funds Act, and (ii) investment interests under the Private Funds Act, from the requirement to register under the VASP Act; and

(2) establishing specific registration requirements for tokenised funds. For example, a tokenised private fund that applies to CIMA for registration must (i) obtain and securely maintain all records relating to the issuance, creation, sale, transfer, and ownership of an investment interest that is represented by a “digital investment token”, including records containing any additional information which may be required by CIMA. These records must be made available to CIMA or any person assigned by CIMA within such period as may be specified. Licensed mutual fund administrators are required to be satisfied that tokenised mutual funds are compliant with the same obligations.

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

E: gary.smith@loebsmith.com
E: robert.farrell@loebsmith.com
E: elizabeth.kenny@loebsmith.com
E: vanisha.harjani@loebsmith.com
E: faye.huang@loebsmith.com
E: vivian.huang@loebsmith.com

A tokenised fund is simply an investment fund whose interests (whether participating shares or limited partnership interests) are issued, recorded or represented using distributed ledger technology. The investment objective and investment strategy of the fund need not have any other connection with financial technology or blockchain. Interests in investment funds whose strategy focuses on more traditional assets classes such  as real estate, private credit, private equity/venture capital and infrastructure projects are all being issued in tokenised form.

The difficulty with tokenisation from a governance perspective is that most of the legal risks in investment fund structures do not sit with the assets in which the fund invests. It instead sits with the relationship between the investment fund, the investment manager and the investors in the fund, and in the myriad of rights, obligations, discretions, constraints and disclosures that are set out in the offering documents (which are underpinned by the constitutional documents of the investment fund).

Despite its other advantages, tokenisation does not make those issues go away. It does, however, require those issues to be expressed and dealt with in a different way depending on the type of tokenisation adopted. Two models of tokenisation tend to dominate; the ‘digital receipt model’ and the ‘native token model’.

In the ‘digital receipt’ model, the token is a digital representation of a traditional interest in an investment fund; e.g. a tokenised participating share or a tokenised limited partnership interest. The legal record and ‘one source of truth’ remains (as with non-tokenised funds) the register of members or register of limited partners that are maintained typically by the fund’s administrator.

In the “native token” model, the token itself is intended to be the legal interest, with the definitive record of ownership sitting on the blockchain ledger rather than in an administrator’s database. From a fund governance perspective, these two models are materially different.

Under the digital receipt model, very little changes either in substance or in practice. Any transfers of participating shares would, to the extent permitted, still need to comply with the transfer provisions in the  constitutional documents of the fund. Consents would still be required as they would be with a non-tokenised fund whilst any side letters providing bespoke terms to individual investors would operate in the same way. The general partner or board of the fund are still required to exercise the same discretions and they remain subject to the same fiduciary duties and contractual constraints. The tokenisation of the interests in the fund is, in legal terms, largely cosmetic and whilst it may improve the user experience, it does not displace the existing framework.

The native token model poses material challenges for this traditional approach, and it is perhaps for this reason that, to date, the digital receipts model is the preferred approach as whilst it embraces blockchain technology, it still feels familiar. However, where the token is the interest, then the rules governing admission, transfers, suspensions, side letters, redemptions (if any) and the enforcement of obligations must, to some degree, be reflected in the token architecture or the smart contracts that underpin it. The difficulty with this is that many issues that were previously ambiguous or subject to the exercise of discretion must now be treated in a binary way. For example, most fund documents are deliberately drafted with a degree of flexibility and in many cases ambiguity so as to give the general partner or board a degree of discretion. They allow managers to respond to tricky, real-world situations that can’t always be anticipated.

By way of example, the terms of a limited partnership agreement of a typical closed-ended private investment fund in the Cayman Islands will typically prohibit transfer of partnership interests without first obtaining the consent of the general partner, and that consent will almost always be exercisable in the general partner’s discretion. What isn’t clear is how that discretion will be implemented on-chain. If the token is freely transferable by design, a core governance control has been surrendered. If transfers are technically blocked unless a permission is toggled, then the system is, in substance, still centralised; just with a more elaborate wrapper.

The same issue arises when one considers that Cayman Islands investment funds are required to undertake anti-money laundering and ‘know your client’ checks on all investors. How can this be done effectively if fund interests are freely transferable on-chain in real time?

Similar issues arise in relation to defaults and the exercise of contractual remedies against investors. Again, these are rarely binary or mechanical decisions. They are governed by layered contractual provisions and, in practice, by judgement calls and a risk-based approach. Encoding that entire framework into smart contracts is not simply a technical exercise; it is a governance choice about which decisions are automated and which remain discretionary.

These issues become even sharper in the context of fund financing, and in particular subscription facilities. Subscription finance is, by design, “upward-looking”; the lender’s credit analysis is focused less on the fund’s assets and more on the legal enforceability of the investors’ capital commitments and the fund’s ability to call and collect them when they become due to secure the servicing of interest payments and repayment of principal.

From a lender’s perspective, the essential question is not whether interests are represented by certificates, entries on a fund’s register or tokens on a ledger. The question is whether the lender can obtain reliable security over the fund’s rights against its investors and whether, in a default scenario, those rights can be exercised quickly and predictably.

Under the digital receipt model, the analysis is largely conventional since, as noted above, the token does not displace the traditional legal infrastructure. The register remains the definitive record of investors. Capital call mechanics remain as set out in the offering documents. Security is taken over the usual rights of the fund (i.e. the right to call capital, the right to receive contributions and the right to enforce remedies against investors who default). From a security perfection and enforcement perspective, the “tokenised” aspect is, to an extent, irrelevant. It may affect how information is presented to investors and how they view their investment, but it does not change what the lender is really relying on.

The native token model is more challenging. If the token is the legal interest, the lender must understand, in detail, how that token carries with it the obligation to fund capital calls and how and when that obligation can be enforced. Immediate issues to consider would be:

Would the smart contract operate to automatically block transfers upon the occurrence of a default?

Can the smart contract automatically redirect distributions?

Does enforcement of these rights still require traditional steps, such as serving statutory demands and the exercise of contractual discretions by the general partner or board? If so, the lender is back in the familiar world of legal process but with an additional technical layer to navigate.

We would also note that there is a natural tension between secondary market liquidity and subscription finance. Subscription facilities typically restrict investor transfers without lender consent, often subject only to narrow baskets and defaulting investors would be prohibited from transferring. The commercially sensible reason for this is the lender underwrites subscription facilities based on a defined and screened pool of investors that have undergone the full credit underwriting process. A freely transferable token cuts directly across that model. In practice, a lender would be likely to insist either on tight transfer controls being written into the token mechanics or the underlying smart contract or on full recourse being preserved against the original investor, regardless of any secondary participation.

In practice, the more conservative digital receipt model fits far more comfortably with both existing governance frameworks and current fund finance structures. The administrator still controls the register. The general partner or board still controls admissions and transfers and the onboarding process thus ensuring AML/KYC compliance. The lender still takes security over recognisable contractual rights. The token becomes a distribution and record-keeping tool, not the legal source of truth. It embraces emerging financial technology which is appealing to many but it remains comfortably familiar.

The native token model may yet mature into something that lenders are willing to underwrite on its own terms. But that will require more than legislative tidying-up or more sophisticated smart contracts. It will require a re-engineering of fund documentation and credit structures so that discretion, enforcement and dispute resolution are coherently integrated with on-chain mechanics. The form that investments take may be evolving into a new form, but the commercial and credit risk, and the law that manages them, are not.

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This publication is not intended to be a substitute for specific legal advice or a legal opinion. For specific legal advice on the subject matter of this Insight, please contact: 

Partner: Robert Farrell
E: robert.farrell@loebsmith.com

Robert is a Partner in the Corporate, Funds & Finance Group.  Robert’s vast experience includes investment funds, banking & finance (for both lenders and borrowers), M&A (including cross-border, joint ventures, acquisitions, reorganisations and private equity).  He has also advised clients in key matters relating to Regulatory obligations and VASP legislation, securities and investment business legislation and economic substance and AML/KYC.