Investment Fund Regulation and Categories of Funds
While a Cayman company is the vehicle most commonly used for new hedge funds, the location of the investors the fund hopes to attract may have a bearing on the ultimate structure of the fund. For example, managers looking to raise money from Asian-based investors would be advised to consider using a unit trust structure as this product is particularly popular and tax efficient for Asian investors.
Managers looking to attract US-based investors will often be advised by US counsel to set up a master/feeder structure. A typical master feeder structure will have: an onshore feeder fund through which US taxable investors can enter the fund; an offshore feeder fund, generally based in the Cayman Islands, through which non-US and US tax-exempt investors can enter the fund; and a master fund through which all trading activity is carried out which will usually also be a Cayman vehicle. Because the onshore feeder fund is typically organised as a limited partnership (generally in Delaware) some US counsel prefer to mirror this structure by using a Cayman limited partnership for the master fund and/or the offshore feeder fund.
A manager looking to establish an “umbrella” fund may wish to use a Segregated Portfolio Company (“SPC”) as the fund vehicle. An SPC fund can create sub-funds in the form of individual segregated portfolios, the assets and liabilities of which are legally segregated from the assets and liabilities of the other segregated portfolios. The sub-funds are not individually regulated meaning new, legally segregated, sub-funds can be created within the umbrella fund for a fraction of the cost of setting up an entirely new hedge fund.
Regulation and Compliance
The Cayman Islands investment funds industry is governed by the Mutual Funds Law (as revised) (the “Mutual Funds Law”). Oversight falls to the Cayman Islands Monetary Authority (“CIMA”).
The Mutual Funds Law applies to companies, unit trusts and partnerships that issue “equity interests” for the purpose of pooling investment funds. It is important to note that the definition of “equity interest” excludes investment funds that are closed ended (i.e., funds that do not offer investors the right to redeem their investment). Managers that do not wish to grant redemption rights to their investors can therefore save considerable time and cost by using a closed-ended structure which will fall outside the scope of the Mutual Funds Law. It is also important to note that the definition of “equity interest” excludes funds that exclusively issue debt instruments such as bonds or notes.
Typical open-ended hedge funds fall within the purview of the Mutual Funds Law and have a number of compliance options:
Fifteen or Fewer Investors
Section 4(4)(a) of the Mutual Funds Law provides that a fund can operate in or from the Cayman Islands if its equity interests are held by 15 or fewer investors a majority of whom are capable of appointing or removing the fund’s operator (either the trustee, general partner or directors). Unlike other exemptions, a fund operating under section 4(4)(a) does not have to register with CIMA or submit audited accounts and is therefore largely unregulated.
This structure also allows master/feeder structures to avoid duplicating costs as the master fund will only have a handful of feeder fund investors, bringing it within s.4(4)(a).
Listed on Approved Exchange
According to section 4(3)(a)(ii) a fund can operate in or from the Cayman Islands if its equity interests are listed on a stock exchange that has been approved by CIMA.
The list of approved stock exchanges is available in Appendix G12 of CIMA's Regulatory Handbook available at www.cimoney.com.ky.
Minimum Initial Investment of US$100,000
The most common type of Cayman hedge fund is one that operates pursuant to section 4(3)(a)(i) of the Mutual Funds Law. Section 4(3)(a)(i) permits a fund to operate in or from the Cayman Islands if it has a minimum initial investment amount of at least US$100,000 or its equivalent in any other currency.
A hedge fund can operate in or from the Cayman Islands pursuant to section 4(1)(b) of the Mutual Funds Law without complying with any of the foregoing if it has a “principal office” in the Cayman Islands provided by a licensed mutual funds administrator.
All fund administrators in the Cayman Islands are required by law to be licensed so any of them can be approached about providing the principal office service. In addition to the normal fund administration services, an administrator that is providing a principal office will need to act as a liaison between the fund and CIMA, and certify to CIMA that it is acting as principal office.
Hedge funds that comply with the Mutual Funds Law by virtue of being listed on an approved exchange, by having a minimum initial investment amount of at least US$100,000 or that have a licensed mutual funds administrator providing a principal office in the Cayman Islands are required to register with CIMA and provide copies of the current offering documents. The fee for CIMA registration is currently US$3,658.54 upon registration and annually thereafter. A registered hedge fund is required to have its accounts audited annually by a CIMA-approved auditor with offices in the Cayman Islands. Copies of the audited accounts must be provided to CIMA within six months of the end of the fund’s financial year.
Mutual Funds Licence
Failing any of the above, a Cayman hedge fund can apply to CIMA for a Mutual Funds Licence. The requirements for obtaining a Mutual Funds Licence are considerably more onerous than compliance with the foregoing provisions and, not surprisingly, less than 1.5% of Cayman’s 9,438 hedge funds are licensed funds.
A licensed hedge fund is required to have its accounts audited annually and to provide copies of the audited accounts to CIMA within six months of the end of its financial year.
Set Up Process
Once the structure of the hedge fund has been determined, the fund’s legal counsel will draft the main offering circular and constitutional documents. In the case of a corporate structure the main constitutional documents of the fund will be the memorandum and articles of association; in respect of a unit trust this will take the form of a declaration of trust and for limited partnership structures it will be in the form of a limited partnership agreement. These documents will normally go through a number of drafts before being finalised.
Ancillary documents include the subscription agreement, redemption request form, and agreements with the various service providers including the fund manager and advisor. These will either be drafted by the fund’s legal counsel or provided by the relevant service provider.
Once the fund documentation is in order the fund’s legal counsel will form the fund vehicle either by incorporating the company, or registering the partnership or trust.
Once the fund vehicle has been formed or registered the fund’s legal counsel will, if required, file an application with CIMA to have the fund registered or licensed. Assuming the documents are in good order CIMA will normally approve applications within 10 working days, at which time the fund can begin taking subscriptions, issuing equity interests and implementing its investment objective.