Registration and Compliance Obligations are Reality for Private Funds in the Cayman Islands

In keeping with those reforms, on February 7, 2020, the legislature in the Cayman Islands enacted the Private Funds Law, 2020 and the Private Funds (Savings and Transitional Provisions) Regulations 2020 (collectively, the Private Funds Law), which require private funds that carry on or attempt to carry on business in or from the Cayman Islands to register with the Cayman Islands Monetary Authority (CIMA), unless an exemption applies. This Alert summarizes key provisions in the Private Funds Law.

1. Which funds are subject to registration under the Private Funds Law? As the title of the law suggests, only “private funds” are subject to the registration requirements of the Private Funds Law.  Private funds are companies, unit trusts or partnerships (i) that are in the principal business of offering and issuing their interests for the purpose or effect of pooling investor funds to share investment risk and enable investors to participate in profits and gains from acquiring, holding, managing or disposing of investments, (ii) where the investors do not control the day-to-day operation of the private fund (directly or indirectly), and (iii) where the investments of the private fund are managed as a whole by the operator of the private fund for compensation based on the assets, profits or gains of the entity constituting the private fund. The Private Funds Law applies only to closed-end funds. Open-ended funds, such as hedge funds, are “mutual funds,” which are not covered by the Private Funds Law. Mutual funds continue to be regulated by the Mutual Funds Law.
2. What does it mean to carry on a business or attempt to carry on a business in or from the Cayman Islands? A private fund is deemed to carry on or attempt to carry on business in or from the Cayman Islands if it is (i) established in the Cayman Islands or (ii) established outside the Cayman Islands and makes an offer of its interests to the public in the Cayman Islands and (iii) in receipt of capital contributions from investors for the purpose of making investments. Offers to sophisticated or high-net-worth persons are among those deemed not to be offers to the public in the Cayman Islands.
3. What documents are required to be filed to register a private fund? CIMA has a secure electronic filing system, the Regulatory Enhanced Electronic Forms Submission web portal, which is to be used to file registration applications and related materials. The following documents should be filed to register a private fund: (i) an application for registration; (ii) organizational documents of the private fund; (iii) the private fund’s governance documents; (iv) the private fund’s offering memorandum, summary of terms or marketing materials, as applicable; (v) a consent letter from the private fund’s auditor; (vi) a consent letter from the private fund’s administrator, if there is a third-party administrator; and (vii) a chart depicting the private fund structure.
4. What other requirements must be satisfied? Auditors to private funds registered under the Private Funds Law must be approved by CIMA and have an office located in the Cayman Islands. If the auditor has not been appointed at the time the application for registration is filed, the auditor’s consent letter may be filed later, but in any event prior to the time the first audited financial statements are filed with CIMA. Registered private funds are required to notify CIMA if there is any change that materially affects information submitted pursuant to applicable law, a change of the fund’s registered office or a change of the location of the fund’s principal office. Notice of any such change must be provided within 21 days of the later of the date on which the change occurs and the date on which the fund becomes aware of the change.
5. Are existing private funds required to register? Private funds that were carrying on business in the Cayman Islands before the effective date of the Private Funds Law must register prior to August 7, 2020 (such period between the effective date and August 7, 2020, the Transition Date). Private funds that begin to carry on a business in the Cayman Islands after the effective date of the law but prior to the Transition Date must register by the Transition Date.
6. By when must a new private fund be registered? A newly formed private fund that is required to register must do so within 21 days after it accepts capital commitments for investments.
7. What fees must be paid in connection with registration? Existing funds that register before the end of the Transition Date will not be required to pay an annual registration fee at the time of registration, but must pay an application fee in the amount of US$366. Private funds that register after the Transition Date must pay an annual registration fee of US$4268 and an application fee of US$366 at the time of registration. On or before the 15^th of each January after the Transition Date, registered funds must pay an annual registration fee in the amount of US$4268. If some or all of the annual registration fee is not paid on or before the due date, an additional fee equal to 1/12^th of the unpaid annual registration fee will accrue each month until the fee is paid in full.
8. When is the application for registration effective? CIMA will provide notice of its decision regarding the application for registration as soon as reasonably practicable after receiving the application.
9. What operating conditions apply to registered private funds?
   
   (i) Annual Audits. Registered private funds must have their financial statements audited annually by a local Cayman auditor approved by CIMA. Financial statements must be prepared in accordance with International Financial Reporting Standards or Generally Accepted Accounting Principles of the United States, Japan, Switzerland or other non-high-risk jurisdiction. Audits must be conducted in accordance with International Standards on Auditing or Generally Accepted Auditing Standards of the United States, Japan, Switzerland or other non-high-risk jurisdiction. Audited financial statements must be submitted to CIMA annually, along with a Fund Annual Return (FAR), within six months after the end of the preceding financial year, unless extended with CIMA’s consent. The FAR must be submitted by the fund’s auditor.
   
   (ii) Valuation. Registered private funds must adopt and consistently apply appropriate valuation procedures designed to ensure valuations are made in accordance with the Private Funds Law. Asset valuations must be conducted as frequently as is appropriate, based on the assets held by the fund, but no less frequently than annually. Valuations may be performed by a qualified independent third party in a non-high-risk jurisdiction or the fund’s administrator. The general partner, manager or other operator of the fund also may perform valuations if (A) the valuation function is independent of portfolio management or (B) potential conflicts of interest are properly identified and disclosed to investors in the private fund. If a registered private fund’s valuations are not performed by an independent third party as provided in the Private Funds Law, CIMA may require the private fund to do so, or have the valuation performed by the fund’s auditor.
   
   (iii) Custody. A registered private fund generally must engage a custodian. Fund custodians must hold assets in segregated accounts in the name or for the account of the private fund and verify that the fund has title to the assets in custody. Custodians also must maintain records of the custodied assets. A registered private fund will not be required to engage a custodian if it is impractical or disproportionate to do so based on the nature of the fund or its assets and the fund has notified CIMA accordingly. In such event, the fund must appoint an administrator or other third party to verify title to the assets claimed to be owned by the registered private fund. The general partner, manager or other operator of the fund may verify title if the title verification function is independent of portfolio management or potential conflicts of interest are properly identified and disclosed to fund investors. CIMA may require title verification to be performed by an independent third party.
   
   (iv) Cash Monitoring. Cash flows of a registered private fund must be monitored and the books and records of the private fund must be reviewed to ensure cash has been accounted for properly. The cash monitoring function must be conducted by an administrator, custodian or other independent third party. Alternatively, cash monitoring may be performed by the general partner, manager or other operator of the fund if the cash monitoring function is independent from portfolio management or potential conflicts of interest are properly identified and disclosed to fund investors. CIMA may require an independent third party to verify a fund’s cash monitoring function.
   
   (v) Identification of Securities. A private fund (such as a hedge fund) that regularly trades or holds securities on a consistent basis must maintain a record of the identification codes of the securities traded or held and make the record available to CIMA for review.
10. What authority and power can CIMA exert over registered private funds? If CIMA determines that a registered private fund is (i) or is likely to become insolvent, (ii) carrying on its business fraudulently, (iii) winding up its business in a manner that is prejudicial to its investors or creditors, (iv) not in compliance with the Private Funds Law or the Anti-Money Laundering Regulations (2020 Revision), (v) being managed in a manner which is not “fit and proper” or (vi) operated or managed by a person who is not “fit or proper” to hold the position of operator, manager or officer, CIMA may take a number of punitive actions. Such actions include, canceling the fund’s registration, imposing additional conditions on the fund’s registration, appointing a person to advise the fund regarding proper conduct and requiring removal and replacement of the promoter, general partner, manager or other operator of the fund. Any operator appointed by CIMA will have all the power of the general partner, manager or other operator necessary to conduct the business and affairs of the fund in the best interests of the fund’s investors and creditors. The Cayman Islands Grand Court may grant CIMA authority to take other action deemed necessary to protect the interests of the fund’s investors and creditors. CIMA may communicate directly with the investors of a private fund, if it deems it necessary or appropriate and if practical. Costs associated with enforcement, including appointment of advisors and operators, are expenses of the private fund. General Partners, managers and other operators are responsible for compliance with the Private Funds Law.
11. What obligations does the private fund’s auditor have? An auditor is obligated by statute to notify CIMA if, in the course of conducting an audit of the financial statements of a registered private fund, it obtains information or suspects that the private fund is (i) engaged in any of the bad acts enumerated above in section 10, (ii) not keeping any or sufficient books and records or (iii) not in compliance with other specified laws. If CIMA determines that an auditor has failed to comply with its obligations to notify CIMA of any such events, CIMA may instruct the private fund to remove and replace its auditor.
12. Other than mutual funds, which funds are outside the scope of the Private Funds Law? The Private Funds Law excludes entities licensed or registered under certain other banking, insurance and other financial services-related laws. It also contains a list of “non-fund arrangements” which are outside its scope. Non-fund arrangements include, among others, (i) proprietary vehicles, securitization special purpose vehicles, structured finance vehicles and holding vehicles, (ii) “funds-of-one” and single family offices,
    (iii) joint ventures, (iv) pension funds and (v) sovereign wealth funds.
13. Considerations. The Private Funds Law imposes substantial new procedural and substantive requirements on private funds that carry on business in the Cayman Islands and grants CIMA meaningful authority over them. In connection with determining where a private fund should be formed, sponsors, general partners and managers now must consider the economic costs and administrative burden arising out of registration and compliance obligations under the Private Funds Law. Whether it is (i) supervision by another regulator, (ii) auditor, valuation and custody requirements, (iii) potentially different standards of conduct for fund operators under Cayman law or (iv) the prospect of operator removal and replacement by CIMA, general partners and fund managers should consider seriously their capacity to manage the additional responsibilities attendant with establishing investment vehicles in the Cayman Islands. Additional costs and obligations, of course, must be weighed against the tremendous benefits associated with tax transparency and a well-functioning, experienced, stable and secure funds industry in the Cayman Islands. The calculous may be difficult.
    
    For existing private funds, there is work to do to prepare for the Transition Date. Fund partnership agreements, unit trust agreements and other governance documents, risk factors and compliance policies and procedures should be reviewed carefully and revised, as necessary, to comport with the Private Funds Law. Pillsbury’s Investment Funds and Investment Management Team has substantial expertise to advise and assist with such analyses and any necessary amendments.