1.1 M&A Transactions and Deals
The use of Cayman Islands-incorporated entities in M&A structures by private equity fund sponsors is now well established. That is particularly so for fund sponsors based in North America and Asia, where Cayman is the default jurisdiction for international transaction structuring. There has also been encouraging growth in this area from European fund sponsors where there is an international element to the investor base or the underlying asset class: financial services, medical technology, property, mining and energy/infrastructure are noteworthy sectors.
The ever-more complex global M&A marketplace, in which most significant deals have multiple transacting parties and an international element, and the position of the Cayman Islands within that context, should ensure that this fastest-growing aspect of Cayman's legal economy continues to offer reasons for optimism. In a world of increasing uncertainty, the Cayman Islands offers certainty from a structuring perspective, and sensible outcomes to dispute resolution.
Sponsors are able to avail themselves of a flexible, commercially focused corporate governance regime that offers a variety of entity structuring options in a jurisdiction where familiarity of use lends itself to predictable outcomes. US-based sponsors used to dealing with LLCs and limited partnerships can use their Cayman equivalents to ensure that the fiduciary and economic matters are structured in familiar ways. Parties in the UK and Asia can exploit the certainty and commercial sensibility afforded by more than a century of English common law and its application to Cayman Islands companies. And because Cayman-incorporated entities are tax-neutral in the jurisdiction of incorporation, the use of the flexible, malleable and familiar corporate governance regime can be installed above a group of portfolio assets and operating companies without affecting the taxation of the structure.
1.2 Market Activity
Continued levels of robust activity in the public markets involving Cayman Islands entities has been of particular note.
Foreign issuers seeking access to the public markets in the United States will typically employ a Cayman holding company structure. From an Asian perspective, the ease of use of Cayman Islands structures and the familiarity of the SEC with such entities means that IPOs can be consummated quickly and efficiently.
For issuers based in Europe, the flexibility afforded by the use of Cayman entities means that sponsors and founders looking to raise public capital whilst retaining voting control are able to benefit from the acceptance in the US markets of bespoke and sophisticated multiple share class structures.
Recent years have seen a steady increase in the number of special-purpose acquisition companies (SPACs) formed by private equity sponsors in Cayman and listed in the United States. The last two years have been remarkable in terms of the consummation by Cayman-incorporated SPACs of substantive acquisitions and, in many cases, multiple acquisitions. The early signs are that these structures may have significant longevity: midmarket and smaller private equity sponsors are entering this market and the listing documents are being commoditised, both of which suggest sustained growth in the short to medium term./p>
Take-private transactions involving Cayman-incorporated companies listed in the USA and Hong Kong continue to keep corporate and dispute resolution counsel busy. There is a perception that foreign-managed companies are routinely undervalued in the US markets and this, coupled with pressure from sources such as the Chinese government to relist in markets in the PRC, continues to drive large volumes of work. These are often the transactions that give rise to the most complex Cayman legal questions, particularly in relation to the fiduciary position of board members and to questions of valuation in anticipation of action by aggrieved shareholders. The law in this regard is developing fast, with a number of matters currently before the Cayman courts, and it is an area where early engagement and the working relationship between Cayman counsel and onshore counsel is absolutely critical to successful outcomes.
Whilst it is a little foolish to make any predictions at all in the current environment, it is not unreasonable to envisage a scenario in the latter part of 2020/early 2021 where the markets correct and assets become more accessible to fund sponsors with dry powder to burn. When economies reset, private equity sponsors are usually in the avant garde.
As regards sector-specific activity, and in addition to the very broad spectrum of ordinary commercial M&A transactions that are consummated either using Cayman Islands acquisition vehicles or involving Cayman-incorporated targets, the following sectors are witnessing significant activity.
Cayman has long been a preferred jurisdiction for the establishment of acquisition structures intent on acquiring financial services assets. In the aftermath of the global financial crisis, trillions of dollars were raised using Cayman structures and deployed to assist in the stabilisation of the US banking system. The use by private equity fund sponsors of Cayman-registered companies, limited partnerships and trusts has afforded opportunities to achieve the sophisticated and highly bespoke transaction structuring that is often necessary for acquisitions on behalf of funds with multiple underlying investors of regulated financial assets.
More recently, the growth in the number of banks, insurance companies and corporate service providers registered and regulated in the Cayman Islands has translated into an encouraging stream of locally relevant M&A activity as such entities are bought and sold in the ordinary course. The growth of the Cayman-incorporated fintech industry – much of it located in the Special Economic Zone (SEZ) established by the Cayman Islands government to encourage the physical relocation of such businesses to the Cayman Islands – promises much in terms of Cayman-focused M&A activity in the future.
If the ten years following the global economic crisis saw the vast majority of specialist funds launched under the wing of much larger institutional fund sponsors, the last year or two has seen the coming of age of those specialist funds as they leave the nest in increasing numbers. This is interesting not only from a fundraising perspective, but also because the divestiture by fund sponsors of these structures gives rise to complex and unusual challenges from an M&A perspective. Working in tandem with investment funds and M&A transactional experts to realise significant value for outgoing institutional sponsors, and to generate exciting opportunities for the newly independent funds, has been especially rewarding.
Energy and Infrastructure
The employment of Cayman-incorporated structures to consummate oil and gas transactions is perhaps the longeststanding tradition in the Cayman Islands M&A industry. More latterly, that has translated into the robust infrastructure and renewables sectors. These are industries of critical importance to global security, stability and the macro economy, and they rely heavily on the long-term stability of Cayman as a jurisdiction of incorporation, on the ability to put in place robust and certain financing arrangements, and on the complete freedom from local political interference in these most sensitive of assets.
Aircraft and Other Structured Asset Financings
It seems inevitable that there will be a significant amount of work to be done in the aircraft industry when the dust of 2020 settles. Restructuring existing arrangements, and the introduction of new players and new technologies to the marketplace, mean that this already most international of businesses will require the introduction of nimble and robust products to survive the next decade. Innovation of this kind has always been at the core of what the Cayman legal infrastructure provides.
The cannabis industry is just one high-profile example of how Cayman-incorporated structures are employed by private equity fund managers to raise international capital in an efficient way that enables them to exploit new opportunities quickly. Whilst not without regulatory challenges, the Cayman Islands is the jurisdiction of choice for fund sponsors who are keen to raise and deploy international and tax-exempt investment capital in the US market. Strong valuations and the ready availability of cash has also meant that the cannabis enterprises themselves are becoming meaningful players in the investment market, and consequently a source of exit options for private equity fund sponsors.
2. Legal Developments
2.1 Impact on Private Equity
More detailed and specific law and regulation in relation to the formation of funds by private equity sponsors has been the story of the last few years, and the Cayman Islands has been no exception there. For the world's most prominent financial institutions and international investors, it is critical to remain relevant and innovative in response to market reality, as well as being credible, and that is why most see Cayman as the favoured tax-neutral jurisdiction for private equity funds. Key to this market is the existence of architecture that allows fund sponsors to structure and manage entities with many investors, a variety of strategies and multiple layers of debt and equity efficiently and effectively in a multinational environment.
In this context, Cayman legislation and regulation continue to be responsive to trends and challenges in current market practice, and to embrace transparency and anti-avoidance initiatives.
Foreign Account Tax Compliance Act (FATCA) and Common Reporting Standard (CRS) reporting processes, the broadening of practices and procedures in relation to anti-money laundering compliance and the like are all now well established. From an M&A perspective, it has meant that fund sponsors are required to be more conscious of such matters when engaging in due diligence on any target, and are required to include an antimoney laundering investigation as part of their due diligence: the material increase in the culture of compliance across the industry has been encouraging.
The Economic Substance (ES) regime is now more than a year into its application and, as with most law and regulation introduced in Cayman, shows the expected signs of being applied in a sensible and proportionate manner. The ES regime was introduced as part of the Cayman Islands' ongoing commitment to assisting global tax recovery efforts in combatting base erosion and profit shifting (BEPS). It is worth noting that BEPS relies for its effectiveness on the presence of two key elements:
- a system of taxation (ideally at a very low rate); and
- tax treaties that enable companies to exploit that system oftaxation.
Being tax-neutral and without tax treaties, Cayman is not a jurisdiction that offers much succour to any multinational organisation that is pursuing a BEPS strategy to reduce its tax bill. For that reason, the ES regime has had little meaningful impact on Cayman as a jurisdiction for structuring M&A acquisition vehicles. That is particularly the case for Cayman Islands structures employed by private equity fund sponsors, so it is not surprising that such structures are typically out of scope for the purposes of such economic substance law and regulation.
In the limited circumstances where Cayman Islands-incorporated entities are subject to economic substance requirements, and required to comply with them, it has not proven especially onerous to comply. Again, understanding that such entities are not typically engaged in BEPS, it is not difficult to see why this might be the case. The application of the law and regulation in this regard is in the very nascent stages: guidance notes published by the Cayman Islands regulator are in a state of development and specific outcomes will not be apparent for almost two years, when the first examinations by the Cayman Islands regulator are due to be completed.
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