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New Registration Requirements for Unregulated Investment Funds

On 7 February 2020, the Cayman Islands Government enacted  the Private Funds Law 2020 (PF Law) and an amendment to the Mutual Funds Law (2020 Revision) (MFL Amendment). The legislation is a result of certain EU and other international recommendations and has been developed to align the Cayman Islands investment fund regulatory regime with other jurisdictions. It is understood that an evaluation as to the equivalency of the new regime, and its sufficiency, will be undertaken and voted upon by the EU next week.

This advisory summarises key features of the PF Law and the MFL Amendment.

Private Funds PF Law 2020

Who is caught by the PF Law?

The PF Law applies to any Cayman Islands closed-ended fund. If such a fund falls within the definition of a "private fund", the PF Law provides for its registration with, and its regulation by, the Cayman Islands Monetary Authority (CIMA). "Mutual funds" such as open-ended hedge funds are not caught by the PF Law and continue to be regulated by the Mutual Funds Law.

The definition of "private fund" captures any company, unit trust or partnership whose principal business is the offering and issuing to investors of its participating, non-redeemable investment interests, the purpose or effect of which is the pooling of investor funds with the aim of spreading investment risks and enabling investors to receive profits or gains from such a vehicle's investment activity, where (a) the holders of investment interests do not have day-to-day control over the vehicle's investment activities; and (b) the investments are managed as a whole by or on behalf of the fund operator for reward based on the vehicle's assets, profits or gains. 

Vehicles that only issue debt or prescribed alternative financial instruments are not deemed to be issuing investment interests and so do not fall within scope of the PF Law. The PF Law also expressly exempts "non-fund arrangements" including securitisation special purpose vehicles, joint ventures, proprietary vehicles, holding vehicles, preferred equity financing vehicles, sovereign wealth funds and single family offices.

"Funds" which are established for only one investor will be outside the scope of a "private fund" given the "pooling of investor funds" requirement.

Is there a transitional period for private fund registration?

The PF Law provides that private funds covered by the legislation must be registered by 7 August 2020. This applies both to private funds which were carrying on business on the date of the commencement of the PF Law (being 7 February 2020) and private funds which commence business within the six month transitional period from 7 February 2020 to 7 August 2020. Private funds that launch on or after 7 August 2020 will need to comply with the registration timing requirements contained in the PF Law, as summarised below.

At what stage in the launch process must a private fund register?

The PF Law expressly permits a private fund to enter into agreements (which we understand would include subscription agreements, side letters and a partnership agreement) with investors and accept capital commitments from investors for the purpose of making investments before submitting its registration application to CIMA.

Subject to the transitional period referred to above, if any investor is not a high net worth or sophisticated investor, a private fund must submit an application for registration to CIMA within 21 days of its acceptance of capital commitments. Again subject to the transitional period, in all cases, a private fund must register with CIMA before accepting capital contributions from investors in respect of investments.

Does registration involve filing an offering document?

The PF Law does not include a specific requirement to have or file an offering document as part of the private fund registration process. "Prescribed details" will need to be filed. Exactly what this entails will be confirmed in separate regulations expected imminently.

What operating requirements apply?

The PF Law seeks to ensure that there is transparency and a proper papering of a private fund's core operations and processes. The PF Law achieves this though audit, valuation, custody, cash monitoring and securities identification requirements that will align with most private funds' current procedures:

Audit – audited financial statements, signed-off by a Cayman Islands auditor, must be submitted to CIMA within six months of a private fund's financial year end. The PF Law expressly permits a private fund to prepare and file financial accounts that are combined or consolidated with an alternative investment vehicle. Government is currently considering, but has not yet approved, concessions on the timing of the requirement to file the first audit following registration of an existing private fund which registers during the transitional period.

Valuation – valuations of the assets of a private fund must be carried out at a frequency that is appropriate to the assets held by the private fund. Generally, valuations will be required on at least an annual basis, however, the PF Law expressly empowers CIMA to waive the valuation requirements, either absolutely or subject to such conditions as it deems appropriate. To the extent valuations are not performed by an appropriately qualified independent third party, the valuation function established by the manager or operator (eg, general partner) of the private fund must be independent from the portfolio management function or the potential conflicts of interest must be properly identified and disclosed to investors.

Custody – a custodian must be appointed to: custody, in segregated accounts, the custodial fund assets; verify that the private fund holds title to any other fund assets; and maintain a record of those other fund assets. A 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. In such circumstances, a private fund must appoint a person to carry out title verification. To the extent such verification is not performed by an independent third party, the verification function established by the manager or operator of the private fund must be independent from the portfolio management function or the potential conflicts of interest must be properly identified and disclosed to investors.

Cash monitoring – a private fund must appoint a person to: monitor the cash flows of the private fund; ensure that all cash has been booked in cash accounts opened in the name, or for the account, of the private fund; and ensure that all payments made by investors in respect of investment interests have been received. To the extent such cash monitoring function is not performed by an administrator, custodian or another independent third party, the cash management function established by the manager or operator of the private fund must be independent from the portfolio management function or the potential conflicts of interest must be properly identified and disclosed to investors.

Securities identification – a private fund that regularly trades securities or holds them on a consistent basis must maintain a record of the identification codes of the securities it trades and holds and shall make this record available to CIMA upon request.

Although not contemplated in the PF Law, CIMA has separately confirmed that it will require all private funds to have at least two natural persons acting as, or for, the operator (board of directors, general partner etc) of the private fund.

All operating conditions and procedures need to be appropriate and proportionate given the scale and operations of a private fund. Where independent third parties are not engaged to carry out the above functions, CIMA may require that third party verification be undertaken. The PF Law provides that CIMA's supervision and monitoring of private funds, including the above operating conditions, is risk-based. 

The PF Law provides that alternative investment vehicles will not have to comply with these operating requirements. An alternative investment vehicle is defined as a vehicle that is formed in accordance with the constitutional documents of a private fund for the purposes of making, holding and disposing of one or more investments wholly or mainly related to the business of that private fund and only has as its members, partners or trust beneficiaries, persons that are members, partners or trust beneficiaries of the private fund.

Does the PF Law contemplate different categories of private funds?

The PF Law contemplates a category of private fund, a "restricted scope private fund" which is defined as a private fund that is an exempted limited partnership that is managed or advised by a person who is licensed or registered by CIMA or authorised or registered by a recognised overseas regulatory authority and in which all of the investors are non-retail in nature, being either high net worth persons or sophisticated persons. Details as to the impact on the registration and ongoing obligations otherwise applicable to private funds under the PF Law for this category of private funds, are still to be determined.

The risk-based supervision requirement may allow for CIMA to adapt the registration and supervision requirements for funds with particular profiles.

What are the registration and ongoing annual fees for registered private funds?

Details of fees and prescribed forms will be covered by separate regulations, which are expected to be published imminently, and which may include a waiver of the first year's annual fee for existing private funds registered during the transitional period.

Mutual Funds (Amendment)  Law, 2020

Who is affected?

The MFL Amendment will affect open-ended funds carrying on business in or from the Cayman Islands that were previously exempt from CIMA regulation under section 4(4) of the Mutual Funds Law (s4(4) Funds) by virtue of the fact that the equity interests of the mutual fund were held by not more than fifteen investors, a majority of whom are capable of appointing or removing the operator of the fund.

What is required of affected funds?

Pursuant to the MFL Amendment, a s4(4) Fund will be required to register with CIMA by:

(i) filing a certified copy of their constitutive documents which specify that a majority of investors in number are capable of appointing or removing the operator of the fund;
(ii) filing such other information as may be required in the prescribed form; and
(iii) payment of the prescribed registration fee.

An s4(4) Fund registered under the MFL Amendment shall not be required to have a prescribed minimum initial investment amount nor is there any requirement to have or file an offering document.

Pursuant to the MFL Amendment s4(4) Funds will be required to have at least two natural persons acting as, or for, the operator (board of directors, general partner etc.), and that these persons will be required to register under the Directors Registration and Licensing Law (Revised).

What is the timing for the MFL Amendment?

The MFL Amendment came into force on 7 February 2020 and provides a six-month transitional period (to 7 August 2020) for compliance for those s4(4) Funds in existence on 7 February 2020. S4(4) Funds which commence business after 7 February 2020 will be required to comply with the registration requirements under the MFL Amendment from launch.

Will there be any audit requirements for s4(4) Funds?

An s4(4) Fund will be required to have its accounts audited annually by an auditor approved by CIMA. The MFL Amendment requires that the accounts be prepared and audited in accordance with International Financial Reporting Standards or US, Japanese or Swiss GAAP or GAAP of a non-high risk jurisdiction.

This article is provided as a general informational service and it should not be construed as imparting legal advice on any specific matter.

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