Cayman Islands: Cayman Islands Closed-Ended Funds

This Briefing Note provides an overview of the process and legal considerations connected with establishing and operating a closed-ended fund in the Cayman Islands.

This Note is intended to provide a general summary of the position in law as at the date of publication shown above, and is not to be taken as specific legal advice applicable to particular issues or circumstances. If such advice is required, please contact one of the Ogier partners.

Formation and statutory requirements

The most common form of entities used for Cayman closed-ended fund structures are exempted limited partnerships (ELPs), limited liability companies (LLCs) and exempted companies. For detailed guidance on the establishment and ongoing obligations for such entities, please see our Briefing Notes: Cayman Islands Exempted Limited Partnerships, Cayman Islands Limited Liability Companies and Cayman Islands Exempted Companies.

Private Funds Act, (Revised)

The Private Funds Act (Revised) (PF Act) applies to Cayman Islands closed-ended funds such as private equity funds. If such a fund falls within the definition of a 'private fund', the PF Act 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 Act and continue to be regulated under the Mutual Funds Act (Revised). See our Briefing Note Cayman Islands Open-Ended Funds.

The definition of 'private fund' covers any company, unit trust or partnership that offers or issues or has issued to investors its participating, non-redeemable investment interests, the purpose or 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 fund operator directly or indirectly.

Classification of an entity is often highly fact-sensitive, and related definitions, CIMA guidance and industry practice mean that it is essential to consider the particular features of each vehicle and structure with your Ogier attorney or other experienced Cayman counsel. Broad principles that may be relevant include:

(a) vehicles that only issue debt are not deemed to be issuing investment interests and so do not fall within scope of the PF Act;

(b) entities whose interests are held only by promoters, operators (e.g. directors) or by the founders, principals, owners or stakeholders of the entity or the entity's manager or adviser will be out of scope;

(c) the PF Act expressly exempts 'non-fund arrangements' including (amongst others) securitisation special purpose vehicles; structured finance vehicles; debt issuing vehicles; preferred equity financing vehicles; sovereign wealth funds; single family offices; joint ventures; proprietary vehicles; holding vehicles; officer, manager or employee incentive, participation or compensation schemes and programmes or schemes to similar effect; individual investment management arrangements; arrangements not operated by way of business; and funds whose investment interests are listed on a stock exchange specified by CIMA, CIMA has provided helpful industry guidance as to the scope of any such 'non-fund
arrangements';

(d) vehicles which are intentionally established for only one investor will generally be outside the scope of a 'private fund' as there will be no 'pooling of investor funds'; and

(e) vehicles that are set up to hold only a single investment are likely to be in-scope as are co-investment vehicles, alternative investment vehicles (AIVs) and master funds.

Registration requirements

Timing

A private fund must submit an application for registration to CIMA within 21 days of its acceptance of capital commitments, and in any event before accepting capital contributions from investors in respect of investments.

Documents to be filed

An application for registration as a private fund must be submitted electronically on CIMA's secure portal (REEFS) and must be accompanied by the following:

(a) a completed prescribed application form;

(b) a copy of the offering document or marketing materials and/or a summary of the fund's terms;

(c) auditor's consent letter;

(d) administrator's consent letter (if applicable);

(e) structure chart; and

(f) prescribed details relating to the fund's anti-money laundering officers (see 'Anti-money laundering legislation' below).

Operating requirements

The PF Act seeks to ensure that there is transparency and proper documentation of a private fund's core operations and processes. The PF Act achieves this though audit, valuation, custody, cash monitoring and securities identification requirements:set out in the PF Act and in Rules and Guidance issued by CIMA. The fund's policies and procedures should be reviewed on a periodic basis to ensure continued compliance.

The applicable operating requirements may be summarised as follows:

Audit - audited financial statements, signed-off by a CIMA-approved Cayman Islands auditor, must be submitted to CIMA within six months of a private fund's financial year end, although CIMA may allow limited extensions (up to a maximum of an additional three months) in certain circumstances. The PF Act expressly permits a private fund to prepare and file combined/consolidated financial accounts in certain circumstances (including consolidation with non-Cayman funds). Accounts are filed electronically through CIMA's REEFs portal, supported by a Fund Annual Return (FAR) which provides CIMA with certain details regarding the private fund and its 'related fund entities' (such as parallel funds, co-investment funds and AIVs) on an annual basis.

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, although, the PF Act 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 (e.g. general partner) of the private fund must be independent from the portfolio management function or the potential conflicts of interest must be properly identified, managed, monitored and disclosed to investors (Conflicts Rule). Where the valuation is not carried out by an independent third party, CIMA may require the private fund to have its valuation verified by an auditor or independent third party.

CIMA's Rule on Calculation of Asset Values - Registered Private Funds (NAV Rules) requires private funds to establish, implement and maintain a NAV Calculation Policy (as defined in the NAV Rules) that ensures a private fund's net asset value (NAV) is fair, reliable, complete, neutral and free from material error and is verifiable. Such policy must be calculated in accordance with the International Financial Reporting Standards or Generally Accepted Accounting Principles of the United States of America, Japan or Switzerland or a non-high risk jurisdiction (being any jurisdiction that is not on the list of high risk jurisdictions issued by the Financial Action Task Force). The NAV Rules require, amongst other things, that the policy must be written and disclosed in the private fund's constitutional documents or marketing materials or other form of investor communication typically used by the fund. In addition to such disclosure, a private fund's constitutional documents or marketing materials or other form of investor communication must explicitly describe the limitations and conflicts of the NAV Calculation Policy, and any material involvement by the fund's investment manager/advisor in the pricing of the fund's portfolio, or otherwise in the calculation, determination or production of the NAV and any conflicts of interest caused by such involvement.

Custody - where it is both practical and proportionate to do so, having regard to the nature of the private fund and the type of assets it holds, a custodian must be appointed to:

(a) hold, in segregated accounts opened in the name, or for the account, of the private fund, the custodial fund assets;

(b) verify, based on information provided by the private fund and available external information, that the private fund holds title to any other fund assets and maintain a record of those other assets.

Where no custodian is appointed, the fund must notify CIMA of such fact. In such circumstances, a private fund must instead appoint a person to carry out title verification in line with (b) above. Such function may be performed by an administrator or another independent third party or may be performed by the manager (or a person who has a control relationship with the manager) or operator of the private fund subject to the Conflicts Rule.

Cash monitoring - a private fund must appoint a person to: monitor the cash flows of the private fund; including ensuring that all cash has been booked in cash accounts opened in the name, or for the account, of the private fund; and ensuring that all payments made by investors in respect of investment interests have been received. Such function may be performed by an administrator, custodian or another independent third party, or may be performed by the manager (or a person who has a control relationship with the manager) or operator of the private fund, subject to the Conflicts Rule.

Securities identification - a private fund that regularly trades securities or holds them on a consistent basis must maintain a record of the identification codes (for example, ISINs) of the securities it trades and holds and must make these records available to CIMA upon request.

The PF Act provides that where a private fund chooses to report consolidated or combined financial statements with an AIV, the AIV will not have to comply with these operating requirements. An AIV is defined as a vehicle that is formed in accordance with the constitutional documents of another private fund for the purposes of making, holding and disposing of one or more investments wholly or mainly related to the business of that other private fund and only has as its members, partners or trust beneficiaries, persons that are members, partners or trust beneficiaries of the private fund.

Segregation of Assets - CIMA's Rule on Segregation of Assets - Registered Private Funds (Segregation Rules) requires that private funds must establish, implement and maintain (or oversee the establishment, implementation and maintenance of) strategies, policies, controls and procedures to ensure compliance with the Segregation Rules consistent with the fund's offering document or marketing materials, as the case may be, and appropriate for the size, complexity and nature of the fund's activities and investors. The Segregation Rules state that all financial assets and liabilities of a private fund and any part thereof (including investor funds and investments) (Portfolio) must be accounted for separately from any assets of the manager, operator or custodian of the private fund. The Segregation Rules also provide that the overriding requirement of the Segregations Rules is that a private fund must ensure that no manager, operator or custodian of the fund uses the Portfolio to finance its own or any other operations.

The Segregation Rules state that the transfer and reuse of assets by a custodian, as consented to by or on behalf of the private fund (e.g. re-hypothecation), is not prohibited, provided that a description of the arrangements entered into with any custodian allowing for the possibility of such transfer and reuse (and the maximum level of such transfer and reuse) is disclosed in the offering documents or otherwise disclosed to investors before they invest, and that any material changes thereto are also disclosed to investors.

In a formal notice, CIMA has clarified that the Segregation Rules do not prohibit prime brokerage / custody arrangements that allow, in accordance with established and accepted industry practice, a custodian / sub-custodian to hold all client assets in a commingled client omnibus account along with the assets of other clients.

Marketing Materials - If the private fund prepares an offering memorandum and/or marketing materials (which encompasses any documents on the basis of which investors are solicited to purchase investment interests in the private fund), these must comply with CIMA's Rule on the Contents of Marketing Materials - Registered Private Funds (Contents Rule). Where the functions of valuation, title verification and/or cash monitoring are performed by the manager (or a person who has a control relationship with the manager) or the operator (e.g. general partner), this should be disclosed in accordance with the Conflicts Rules in any offering memorandum or marketing materials, and if none, by separate notification to investors. The detail of the Contents Rule is beyond the scope of this briefing note; please liaise with your usual Ogier contact for full details.

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 Act provides that CIMA's supervision and monitoring of private funds, including the above operating conditions, is risk-based.

Corporate governance

CIMA requires a minimum of two directors for private funds that are companies and will require a minimum of two natural persons to be named in respect of a general partner or corporate director of a private fund. Directors appointed to private funds are not currently required to be registered pursuant to the Director Registration and Licensing Act (Revised).

Ongoing obligations

Obligations under the PF Act

The PF Act imposes on registered private funds the following continuing obligations:

(a) to file with CIMA a copy of material amendments to its current offering document/summary of terms/marketing materials or prescribed details filed with CIMA and/or any changes to its registered office or principal office within 21 days;

(b) to have its accounts audited annually by an auditor approved by CIMA (unless CIMA grants an exemption whether absolute or conditional) and to file those accounts with CIMA within six months of the end of the private fund's financial year;

(c) to comply with the valuation, custody, cash monitoring and securities identification requirements set out under 'Operating requirements' above including the production of any periodic reports;

(d) to comply with the AML Regulations (see below);

(e) to maintain a minimum of two directors for corporate private funds and a minimum of two natural persons in respect of a general partner or corporate director of a private fund;

(f) to file a fund annual return (FAR) with CIMA. The FAR is usually submitted electronically by the auditor and its 'related fund entities' through the CIMA's REEFS portal and includes general information about the fund, operational information such as the nature of the investments held as well as financial information about the fund;

(g) to pay the prescribed annual registration fee to CIMA on or before 15 January in each year, failing which a penalty equal to one-twelfth of the annual fee is charged for each month or part-month of default; and

(h) to maintain certain records and books of account.

Other statutory obligations

For a detailed description of other statutory obligations for Cayman entities, including maintenance of statutory registers, changes to prescribed particulars and/or constitutive documents filed with the General Registry, corporate governance, obligations and liabilities please see the relevant Ogier client briefing: Cayman Islands Exempted Limited Partnerships, Cayman Islands Limited Liability Companies and Cayman Islands Exempted Companies. Cayman Islands Exempted Limited Partnerships, Cayman Islands Limited Liability Companies and Cayman Islands Exempted Companies.

Anti-money laundering legislation

The Proceeds of Crime Act (Revised) (PCA), the Proliferation Financing (Prohibition) Act, 2017 and the Anti-Money Laundering Regulations (AML Regulations) and Guidance Notes issued by CIMA together comprise the anti-money laundering regime of the Cayman Islands (AML Regime). Generally, whether regulated or not, Cayman investment funds, including private funds, will all fall within scope of the Cayman Island's AML Regime as they will be considered to be engaged in 'relevant financial business' as defined under the PCA.

The AML Regime requires that a private fund must maintain the following in accordance with the AML Regime (AML Procedures):

(a) investor identification and verification;

(b) adoption of a risk-based approach to monitor investors and financial activities including adequate systems to identify risk in relation to persons, countries and activities, including screening against all applicable sanctions lists;

(c) record-keeping procedures;

(d) risk-management procedures concerning the conditions under which an investor may invest prior to verification;

(e) observance of the list of sanctioned countries, published by any competent authority, do not sufficiently comply with the recommendations of the Financial Action Task Force;

(f) suspicious activity reporting procedures;

(g) procedures to monitor and ensure compliance with the AML Regime;

(h) procedures in place to test the anti-money laundering and countering terrorist financing and proliferation financing systems in place; and

(i) such other procedures of internal control, including an appropriate effective risk-based independent audit function and communication as may be appropriate for the ongoing monitoring of business relationships or one-off transactions for the purpose of forestalling and preventing money laundering, terrorist financing and proliferation financing.

In addition, private funds must appoint named individuals to the roles of anti-money compliance officer (AMLCO), money laundering reporting officer (MLRO) and deputy money laundering reporting officer (DMLRO); the AMLCO and MLRO (or DMLRO) may be the same individual, but the same person cannot serve as both MLRO and DMLRO. The AMLCO will be responsible for overseeing the effectiveness of the private fund's AML systems, compliance with applicable AML legislation and guidance and the day-to-day operation of the AML policies and procedures. The MLRO/DMLRO must receive all reports of suspicious activity in relation to any aspect of the private fund and its activity; the MLRO/DMLRO should determine whether the information contained in any report supports the suspicion reported in order to determine whether, in all the circumstances, he/she in turn should submit a suspicious activity report to the Financial Reporting Authority of the Cayman Islands.

FATCA and CRS

Almost every Cayman private fund will be a Reporting Cayman Islands Financial Institution for the purposes of the US Foreign Account Tax Compliance Act (FATCA) and the Common Reporting Standard issued by the OECD (CRS).

As a result, a private fund will be required to:

(a) register with the US Internal Revenue Service in order to obtain a GIIN (a Global Intermediary Identification Number (GIIN) and, accordingly, give one or more individuals authority to complete such registration. Typically the private fund will authorise the manager to do this on the fund's behalf following incorporation of the fund;

(b) conduct requisite due diligence on all of its investors in order to identify the tax residency of each investor and to determine whether the interest held by that investor constitutes a 'reportable account' under the regulations issued in respect of FATCA and CRS. Generally, private funds address this by (i) seeking appropriate self-certifications and beneficial ownership information from investors at the time of investment, and (ii) engaging the fund administrator or another specialist provider to assist with the fund's FATCA and CRS due diligence and reporting obligations;

(c) provide notification to the Cayman TIA of certain prescribed details, and to identify a Principal Point of Contact and a Change Notice Person. This notification is generally required to be made by 30 April in the year following registration of the private fund;

(d) report the requisite information on each of its 'reportable accounts' to the TIA prior to the applicable deadlines. Reporting periods are generally calendar years, with the reports themselves generally due on or before 31 July in the year following the relevant reporting year;

(e) maintain written compliance policies and procedures in connection with the fund's compliance with its FATCA and CRS obligations (even where the fund has delegated performance of its FATCA and CRS obligations to a third party service provider and, in respect of the delegated services, is relying on the policies and procedures of that service providers); and

(f) in the case of CRS, file a CRS Compliance Form containing certain prescribed information by 12 September in each year (unless extended by the TIA, for example to 15 September 2021 in the case of filing due in 2020).

Obligations under Data Protection Act

The Cayman Islands Data Protection Act, 2017 (DP Act) provides a framework of rights and duties to regulate the processing of individuals' personal data broadly based on the same internationally recognised privacy principles that form the basis for other data protection laws globally. Under the DP Act, an entity established in the Cayman Islands that handles any individual's personal information has certain obligations with respect to that information and must ensure that such individual is formally apprised of by whom, and for what purpose, any of their personal data is being used.

A private fund will therefore be responsible for complying with the requirements of the DP Act and the data protection principles in respect of personal data processed by the fund or on behalf of the fund by any third party processors such as its administrator and other service providers. The private fund must ensure that investors are provided with an appropriate privacy notice and that contracts with service providers that process personal data on behalf of the fund comply with the DP Act.

Obligations under economic substance legislation

Private funds will be regarded as 'investment funds' for the purposes of the International Tax Co-operation (Economic Substance) Act (Revised) (ES Act) and are therefore excluded from the definition of 'relevant entity' under the ES Act and out-of-scope of such law. However, all Cayman Islands legal entities must make an annual notification filing to confirm such exempt status.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.