The Waystone Guide to Cayman Islands Investment Funds for Fund Managers in Asia

Thank you, everyone, for joining. We’re delighted to welcome you all to the Waystone Guide to Investment Funds in the Cayman Islands for Fund Managers in Asia. I’ll pass it over to my colleague, Connie Wong. Thank you, Connie.

Hello, and welcome, everyone. Thank you for joining us for today’s webinar, The Waystone Guide to Investment Funds in the Cayman Islands for Fund Managers in Asia. My name is Connie Wong, and I’m the executive director at Waystone. Waystone is the leading provider of institutional governance, risk, and compliance services to asset management industry. We’re now supporting asset managers with more than 1 trillion USD in the AUM. We’re very delighted to have two of my colleagues from Cayman office speaking with us this morning, Don Ebanks and Claris Ruwende.

Don is the managing director and global head of regulatory advisory at Waystone and is based in the Cayman Islands. Don has a broad expertise in the governance risk and compliance space, drawing on his over 20 years of financial service experience including governance, investment management, financial products, regulatory matters, and distressed/restructuring scenarios. Previously, Don was employed as executive director of Secretariat of the Portfolio of Finance & Economics within the Cayman Islands Government where he provided policy advice to the financial secretary and cabinet ministers. Don was the first head of the compliance division at the Cayman Islands Monetary Authority, CIMA, a division which he established after initially serving as the deputy head of the Investment Services Division.

Claris is an independent director with Waystone. Based in the Cayman Islands office, Claris provides independent director services to investment funds with a range of structures and strategies. Previously, Claris held the position of chief analyst at the CIMA where she led the security supervision division team in carrying out a full range of supervisory and regulatory functions to ensure the compliance of the licensees and registrants.

Now, without further ado, today’s topic. We would like to give managers an overview of the current regimes in the Caymans. The latest regulatory and compliance requirements, the filing deadlines and administrative fine regime. We’re keeping this one short and sweet, within half an hour. And if you have any questions during the presentation, please put them into the question box in your control panel and we’ll address the questions individually post the webinar. So, Don, over to you to share with us the current regimes in the Cayman. I know you wanted to share with us a little bit of a variety of topics here. So over to you, Don.

Current Regimes in Cayman

Thanks very much, Connie, and thank you, everyone, for taking the time to speak with us. So, I think everyone knows that Cayman is leading funds domicile. And what that means is that there’s been a fair bit of innovation over time. You will see that, for example, in Europe, some jurisdictions have recently implemented a limited partnership structure which is suitable for, you know, private equity and real estate funds, but such structures have been available for many years in the Cayman Islands, and there are, in fact, about 30,000 limited partnerships that are used in financial services and all related areas already. And we also have well over 10,000 hedge funds and slightly more on the private equity real estate and direct lending side of things. I think this is a strong endorsement of Cayman in terms of the number of entities that are in existence and in active use because of the breadth of industry in Cayman. And we have all the Big Four accounting firms and quite a few large and expert firms in legal counsel. And the industry is quite mature as well as the jurisdiction. I mean, for example, I’m familiar with a former head of litigation from one of the large law firms. And retired, became a judge for financial services matters, and then retired from that post as well. So, Cayman has been around for people to sort of go through the process and it really speaks to the level of expertise that you’ll find in all areas of the government-private sector in regulating.

Mutual Funds Act Cayman

I can speak specifically a little bit about what is available in terms of our regulatory regimes when you set up funds. For a few decades, we’ve had in place the Mutual Funds Act, the Mutual Funds Law as it was previously. And this covers hedge funds, any fund with redemption rates is covered basically by this piece of legislation. And it provides for certain elements such as annual filing of your auditors/managers statements and some statistical returns. And there are certain enforcement powers that are granted to the regulator once you are registered and regulated under this piece of legislation. So, this is relatively straightforward and has been in existence for quite some time.

Private Funds Act Cayman

The Private Funds Act is much newer. This was only passed in February last year and became fully effective in August last year, where, as I noted, well over 10,000 closed-ended funds were actually registered. So, open-ended funds or hedge funds are registered under the Mutual Funds Act, and then closed-ended funds, such as private equity, real estate, venture capital, and direct lending funds are typically registered under the Private Funds Act. The Private Funds Act, due to international standards-setting mainly driven from the EU, has certain components in it which are new. So, you could regard the Private Funds Act as being a little bit more of a modern piece of legislation. In particular, it contains what you might call pseudo depository requirements because they’re somewhat similar to what you see in Europe around valuation, the safekeeping of assets, cash monitoring, and in certain record-keeping requirements, and these are basically investor protection requirements. And they are requirements which are mandatory, and they’re actually linked to the administrative fines regime that we’ll speak about lat

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Directors Registration & Licensing Act

Another key piece of legislation that you should be aware of is the Directors Registration and Licensing Act. And basically, what this means is that, if you’re going to be a director of a hedge fund that’s registered under the Mutual Funds Act, you actually do need to be registered under the Directors Registration and Licensing Act in advance. And so typically professional directors, like myself, inquirers, we’re already registered. So that’s really never an issue. But if you’re launching a new fund or perhaps, you know, some of your team had an investment manager previously work in a different fund structure and were registered before but perhaps some are new to this type of process, they may not have been registered. And once you register, which is mandatory, if you want to sit on the board of the hedge fund that is regulated, then you also have to be aware each year that you have to renew your registration and pay a nominal fee. And if you wish to no longer serve in this type of capacity because you’re changing employers, for example, it is very important to deregister. Just over the last couple of weeks, there was a decision notice issued by the regulator, which listed a very large number of people that were subject to enforcement action basically around deregistration. Which, you know, reflects poorly and they affect your ability to register in the future.

So, I think the overall theme is that over time, what we’ve seen is the evolution of regulation, beginning with the Mutual Funds Act, and which has certain basic components you might expect, and then with the Private Funds Act, we’ve seen further evolution. And also, we’ve had some new rules come into force, which are around evaluation and segregation of assets, which I won’t go into in detail. But basically, what this means is that you have to think very carefully about the fund itself. Sometimes, it’s easy to think only about the investment manager operations, and you don’t think so much about the regulatory requirements for the fund itself. But it is very important to consider these matters because now they’re subject to certain types of enforcement action, the administrative fines that I mentioned. And it is important to note that, because of the way the legislation was structured, it is always, what is called the operator that is responsible. And for a corporate entity, which is typically used for hedge funds, the directors of the corporate entity are considered to be the operators, which are the persons who are formally responsible for compliance. So, if you’re on the board of the hedge fund, the regulator considers you to be directly responsible for the conduct in business and, of course, compliance on an ongoing basis with the various regulatory requirements.

Anti-Money Laundering Requirements

So, I touched generally on some of the regulatory matters. And you know, some of these slides have a fair bit of content. So, they will be circulated later. So, you know, no need to be making notes or anything like that. But beginning with the Anti-Money Laundering requirements, basically, this is anti-money laundering, combating the financing of terrorism, and anti-proliferation measures. And basically, this is a bit of a summary of the regime in Cayman. So, the Proceeds of Crime Act criminalizes money laundering and the other sort of matters that I mentioned. There’s an anti-terrorism, a piece of legislation. There are also requirements around anti-proliferation. So that criminalizes those activities, the anti-money laundering regulations are similar to components of what you see in the Patriot Act in the U.S. in that it makes it a legal requirement if you participate in certain types of business. And certainly, the business of being an investment fund that is regulated in Cayman, that would fall into this type of category. This means that you have to have appropriate controls in place, and I’ll go into that a little bit more in a moment. And then we have the Guidance Notes. And the Guidance Notes basically are saying these are some ways that you can comply with the strict requirements of the Anti-Money Laundering Regulations. So, some people think of the Guidance Notes perhaps as red tape or a little bit too bureaucratic. But, for example, the concept of an eligible introducer only exists within the Guidance Notes. So, it actually gives you a kind of a shortcut that would not be available to you otherwise.

You may have heard that there was a review of Cayman by the Caribbean Financial Action Task Force and there was an outcome, which is basically place Cayman on an increased monitoring regime. This is basically just saying that Cayman should continue to do what it’s doing, and they will be observed over this period, but certainly, there’s no adverse outcome of this process. And in fact, the FATF does not recommend or require anything in terms of due diligence. So, it really doesn’t change the risk profile of any fund operating within the jurisdiction. And we review the matters carefully. And again, if you review this, you’ll see that Cayman actually ranks quite highly on the FATF 40 Recommendations. We have 39 of the 40, which is much higher than some of the large countries that you might know.

One of the things that’s important to mention is that any entity which is covered by the AML Regulations will have to actually appoint AML officers. The compliance officer, the money laundering reporting officer or MLRO, and the deputy MLRO. And these persons will have to be notified to the regulator in various filings. And when you change them, you would file updates. So, these are the persons that actually oversee the AML process.

Another thing that’s important to note is that with respect to the control environment for funds, funds don’t have their own staff and they don’t have really their own operations and employees. So how do you comply? We comply primarily by relying on the operations of others. In the hedge fund space, it’s almost universal that you have an independent fund administrator, who acts as the AML delegate. But for private funds, for closed-ended funds, such as private equity, yeah, this is not universally the case. So, if you’re doing the due diligence within your own operations, it’s important to understand the responsibilities of persons in this role and the sort of controls that you should have around investor due diligence because that process is highly specified in the regulations of the Guidance Notes. So, it’s important that you understand how this is all working. And specifically with respect to investment managers and advisors, the regulator will either conduct inspections or/and require you to retain a third party, such as one of the Big Four accounting firms or similar to conduct this type of audit of your AML internal control environment. So especially any management entities that you might have in Cayman, it’s important that they have operations, and policies, and procedures that are appropriate because it’s very likely that they will be reviewed.

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Amendments as General Practice Evolves

So, over the years, there are various amendments as the general practice has slowly evolved and just the different things develop. Sometimes you’ll see changes made.

One of the things that has changed is that there used to be the so-called Schedule 3 countries. So, you’d say, well, the U.S. is on Schedule 3, so we consider it to be an equivalent jurisdiction. That list has been removed and now each…and just prior to what I was saying about being careful that you understand your obligations, it’s important then that you have either an administrator and a compliance officer team that has sufficient expertise to assess country risk because that’s one of the important things that you’re responsible for, or you have the expertise in-house. But it’s important that that is carried out.

Beneficial ownership threshold is an interesting one because, for example, in Ireland, the threshold is 25% in terms of identifying beneficial owners, whereas in Cayman, it is a stricter 10%. And the regulator has clarified that no matter where the AML delegate is, they must use the Cayman rules if it’s a Cayman fund. So, this means that if you are based in Singapore or in Hong Kong, and you are running a private equity fund, and you’re doing your own fund accounting and investor due diligence you have to apply the Cayman standard if that is a private fund that is registered with CIMA. We talked about risk reporting. Ongoing monitoring is an important one to meet again if you’re self-administering the fund because large-fund administrators have a daily screening process where they check all the investors and key persons against the sanctions list. And it’s very important because compliance with the sanctions, avoiding doing business with sanctioned persons, these are strict requirements of the regulations and legislation. So, it’s important that you have that capability. So, if you do not have a fund administrator, you need to explore options to see how you can actually manage those properly.

will hand it over to my colleague, Claris, to cover FATCA and CRS protocols.

FATCA and CRS

Great. Thank you, Don. Okay, so other pieces of regulation and compliance here in the Cayman Islands that managers should always be aware of include the FATCA and the CRS. FATCA meaning Foreign Account Tax Compliance Act, and then the CRS is the Common Reporting Standard. And as many of you might already know by now, the FATCA relates for…mainly applies to U.S. investors, whereas the Common Reporting Standard is more global and applies to all CRS-participating jurisdictions. So, as a new manager, in terms of trying to set up a new fund, one thing you would want to be aware of is what sort of setups, operational setups you would have with the administrator to allow for information on investors to be shared with your accounting, your exchange, your AEOI delegate. Every fund will need to select an AEOI delegate, which basically means Accounting for Exchange of Information. So, once you have a delegate and is connected to the administrator, investor information is expected to flow to and from the administrator to the reporting entity so that information can be reported to the local department of taxes here in Cayman.

The deadlines for FATCA and CRS reporting are 31 July 2021. So, the FATCA and CRS return should be filed by 31 July 2021. Although right now CRS reporting is not available on the portal, users are still able to log in and register new reporting entities or submit the new CRS Compliance Form and also FATCA returns. So basically, the framework for FATCA, in general, and CRS is driven by the need for exchange of information across jurisdictions to prevent tax avoidance.

I will touch more on the CRS Compliance Form just to give you a bit more background on what is required. On the 15th of April in 2020, the Cayman Islands Department of International Tax Compliance, which is the DITC, released a new CRS Compliance Form. And basically, with this form that needs to be filed every year, there’s additional information that is required. Again, you will get a copy of these slides and you’ll be able to look at this in more detail. But those three things are the major highlights, where you have to include financial account data, you have to include more information and reasons for the classification type of non-reportable accounts. So, if it’s CRS, so you would have to explain why an account is non-reportable, whether it be because it’s a U.S. investor account or whether the investor is from a non-reportable jurisdiction, that needs to be clarified in this form.

The other requirement would be also to state which entity it’s being relied on for AML and KYC purposes, which for funds, it will in most cases be the administrator unless you’re self-administered. And then the last thing is also that you would need to have written CRS policies and procedures and you would need to confirm compliance with such policies and procedures in this CRS Compliance Form. And the deadline to submit the form for 2019 has been extended to 15 September 2021. And that’s basically to extend the timeline to allow for the automation of bulk upload of CSV files onto the portal. The deadline for the 2020 CRS Compliance Form is also 15 September 2021. So, I guess those deadlines are the same for this year. And going forward, it’ll be September for all the other reporting years.

So, the background basically for this compliance form is that Cayman Islands has no direct tax system of its own. Therefore, it has very limited market data on financial institutions. So, this gave rise to the need for this compliance form, so that the local DITC or the Tax Information Authority would acquire the information required on financial institutions within the jurisdiction.

Okay, so FATCA and CRS, as you might have noted so far mainly relate to the fund themselves. So, the funds themselves have to make sure that for investors within the funds, FATCA and CRS is being complied with. Economic substance is more relevant to the investment manager itself. So, in 2019, the Cayman Island enacted the International Tax Co-Operation (Economic Substance) Law. And this was mainly driven by the standards established by the EU and the OECD for prevention of the base erosion and profit shifting. What managers have to be aware of on this is that if you are a relevant entity conducting relevant activities and earning relevant income, then you have to satisfy the 3-criteria economic test in relation to fund management business. So, going back a little bit, the relevant entities would be any corporate, any limited liability company, any limited liability partnership, that is incorporated in the Cayman Islands. And then Relevant Activities has a list of about nine activities that have been stated as being relevant. However, in this scenario, fund management comes up at the top as the most relevant, as it relates to the investment managers of funds. So, basically, the economic test, the 3-criteria economic test would be looking at whether or not the entity has been directed and managed in the Cayman Islands. It would be looking at whether or not the entity has conducted core income-generating activities in the Cayman Islands. And lastly, it would also look at whether there’s a proportionate operating expenditure, physical presence, and personnel here in the Cayman Islands that corresponds to the revenue that’s being generated. Again, this is all just for transparency so that the local Tax Information Authority is able to test that the revenue being generated by these entities that are Cayman-registered is actually coming from activities being conducted here in the Cayman Islands.

Economic Substance Return Deadline: April 2021

So, the deadline for the Economic Substance Return is 30 April 2021. And the DITC portal is open for the filing of those returns. Now, the majority of the registered persons under the Securities Investments Business Act, which is most of the investment managers that we were referring to before have been registered with CIMA as registered persons on or after 1 January 2020. Therefore, the first deadline for filing that return would be 12 months after the period end date. So, the period end being your financial year-end date. In most cases, if your financial year-end is December, that would then be 31 December 2021. Now, there is some fines for failing to comply or failing to satisfy the economic substance test. And the first year, the fine is 12,500 USD, but if you’re a non-… Again, the fine increases to $125,000 in that second year. So, it is important to ensure that as a relevant entity conducting relevant activities within the Cayman Islands, you meet the deadlines for filing this Economic Substance Return. The precursor for filing a return, though, is to file an Economic Substance Notification. The notification is due every year on the 31st of January, and there is a grace period that you will still be in good standing if you provide the filing by the 31st of March. So, it’s important to know that there is the initial deadline for the Economic Substance Notification that comes before. You then have to file the return; the return becomes due 12 months after the end of the financial reporting period. Right, so I think that wraps it up on economic substance, FATCA, and CRS regimes. And I will now pass back to Don to talk us through the filing deadlines and administrative fines regime in Cayman Islands.

Filing Deadlines & Administrative Fines Regime in Cayman

All right, thanks, Claris. So, in a way, even though we have those as two separate items, filing deadlines and administrative fines are related to each other because in some cases, if you don’t meet a filing deadline, that might actually be a minor breach under the administrative fines regime itself. So basically, as I mentioned before, there was this review from the FATF, and just generally there are international standards that have to do with regulatory effectiveness. And effectiveness basically means enforcement activity. And the most convenient enforcement activity is the use of fines. Historically, we have seen very little use of fines in the Cayman Islands. There was only the ability, under the law, to take a regulated entity to court, and if you got found guilty of some breach that there would be a statutory fine that would be imposed. Starting in 2018, there was a completely new process instituted, and this is the administrative fines regime. And what this means is that the regulator themselves, without having to get approval from the court or anyone else, they may impose these fines. So, there are various regulations which specify the types of breaches. The initial breaches were only to do with anti-money laundering breaches, but then last year it was expanded to pretty much everything. And as I noted, in particular, if you’re running a private fund in Cayman, there are some specific requirements in Sections 16 through 19, and those breaches are considered to be very serious. So that, for a corporate entity is about 1.25 million USD. That’s the top level of the fine.

So, the fines are minor, serious, and very serious. Minor fines are basically automatic. If you get fined, there’s basically no appeal typically for an automatic fine, and it’s a fixed amount. The serious and very serious breaches, those fines are…they’re larger, but also, those are the maximum fines and they’re subject to a process of review. And, you know, there is a certain appeal, process where you can go to CIMA and say that, you know, you have a concern about the process and you don’t think the fine should be imposed, or at least it shouldn’t be at the level that it is. So, you know, failure to pay your fees, that would be one thing that’s minor. Failure to appoint AML officers would be considered a serious breach. And very serious breaches, I mean, transactions with shell banks. And interestingly enough, if you’re a director to what’s called a covered entity which includes the hedge funds registered under the Mutual Funds Act, you’re a director of that entity, then that’s a very serious breach. So, you could personally be subject to that kind of very large fine.

So, these are some of the filing deadlines. You’ll notice that January 15th is a very important date because your corporate filings with the government just to keep a company running, your CIMA registration, your registered persons fees, which is for the management entities that Claris was talking about earlier, and of course, the director registration fees, they’re all due on January 15. So that’s definitely something you should have in your calendar. And if you’re submitting your financial statements, you have six months after the financial year-end to submit your financial statements that are audited as well as what’s called the annual return, or fund annual return, which contains certain statistical information. And it’s important to note that for private funds, there is also what’s called a declaration of compliance. So, you’ll notice that I’ve been stressing Section 16 through 17, and 18 of the legislation for private funds. And in fact, you will be required to declare your compliance with those sections. So, that sort of shows you how serious this is all taken is that they’re specified in the legislation. Breaches of subsections are considered to be very serious under the legislation. And then you are actually required to sign a declaration of compliance with those sections. And then the end of January just for the standard corporate filings.

And I think on the next page, we have some information about us in more detail later on, but we’ll leave some space for Q&A. Thank you very much, everyone. And back to you, Connie.

Thanks, Don and Claris, and also everyone today for joining us. I hope you all found it useful. And we will be sharing our flyers after the webinar. If you do require any assistance of regulatory and compliance matters, please leave us a comment, and we’re more than happy to do it, talk to you for another separate conversation. And thanks again, and I wish you all a very good day.

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