Chambers Global Practice Guide: Alternative Funds 2021 – Finance and Banking
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1.1 General overview of the jurisdiction
Over the past 40 years, the Cayman Islands has grown to become one of the world’s largest international financial centers, providing institution-driven services to a global clientele. The Cayman Islands’ competitive strength in financial services lies in their ability to provide an efficient, cost effective and tax neutral platform for international capital flows in an environment of legal, political and economic stability. The blend of flexibility and certainty in legal structures, compliance with international regulatory standards and a well-regarded corporate governance regime ensure Cayman remains at the forefront as a choice for investment funds, managers and investors. .
Respected legal system and political stability
The Cayman Islands are a British Overseas Territory and enjoy the security and stability traditionally associated with their status as such, while remaining responsible for their own internal affairs and government. The Islands have an independent judicial system based on a combination of English common law and local law. The final court of appeal is the judicial section of the Privy Council. The government and the private sector work closely together to ensure the continued development of the jurisdiction as a place where business can be conducted effectively and efficiently.
Client-centered structures, institutions and advice
The legal structures used for hedge funds provide flexibility for managers and are well understood by sophisticated investors. Such structures allow the management of entities with many investors and several levels of debt and equity. The jurisdiction benefits from the availability of a wide range of professional service providers from internationally renowned companies and institutions.
Transparency and regulatory regime
Regulations in the Cayman Islands focus on managing systemic risk, preventing money laundering, and promoting regulatory and financial transparency. A discussion of the regulatory regime is included later in this chapter.
Tax neutrality and transparency
There are no local companies, capital gains, income, profits, withholding taxes or inheritance taxes attached to vehicles established in the Cayman Islands, nor to investors in such vehicles. Taxes may be imposed on investors or investments by jurisdictions outside the Cayman Islands.
2.1 Types of alternative funds
Open-end funds and closed-end funds are generally established in the Cayman Islands.
The Cayman Islands has historically been the primary jurisdiction for the establishment of hedge funds, which are subject to the registration regime under the long-established Mutual Funds Act (MFA). More recently, a regime for the registration and regulation of private funds incorporated in the Cayman Islands has been introduced: the Private Funds Act (PFA) now sits alongside the MFA and promises to provide the same level of reasonable supervision and regulation and proportionality that the jurisdiction has brought to hedge funds for more than two decades.
2.2 Fund structures
There are four types of vehicles commonly used to establish alternative investment funds in Cayman Islands:
- exempt companies (including companies with separate holding companies);
- exempt limited partnerships;
- mutual fund; and
- limited liability companies.
These vehicles are used within a range of fund structures, the most common being stand-alone funds, master feeder funds, parallel funds, alternative investment vehicles (AIV) and umbrella funds. Fund structures in the Cayman Islands are flexible and are generally driven by onshore considerations such as taxation and investor qualification requirements.
While any type of vehicle can be used, the most popular vehicle for open-ended fund structures is the exempt corporation and the most popular vehicle for closed-end fund structures is the exempt limited partnership.
They are the simplest structures, being a single vehicle, generally with a single investment strategy. Funds of this nature are often used in start-up situations or when the target market does not require additional complexity. A stand-alone fund may itself invest as a ‘fund of funds’ in another fund, but for Cayman Islands purposes it will still be a stand-alone vehicle as it will operate independently, its investment strategy being to invest in other funds.
A master-feeder fund is typically structured such that the combined assets of two or more “feeder funds” (both Cayman Islands and onshore) are substantially invested in a separate vehicle known as the “master fund” and managed by the same investment manager. The pooling of assets then allows the master fund to be the investment vehicle of its feeders. Structurally, this is achieved by investors who buy shares or interests in the relevant feeder fund and the feeder fund, in turn, buys shares or interest for an equivalent consideration in the master fund. Although there may be direct investments in the master fund by investors, often the only investors in the master fund are the feeders.
Master-feeder structures offer some cost savings while allowing the investment manager to pursue the same investment strategy for both feeder funds. It also allows different categories of investors to invest through the structure. A Cayman Islands exempt corporation or partnership is often established as a feeder fund for non-US investors and US tax-exempt investors, and a Delaware limited liability company or partnership is established as a feeder fund for U.S. taxable investors. An investment manager may also choose to create a master fund as an onshore vehicle and then wish to admit a non-US or tax-exempt investor through a Cayman Islands feeder fund.
Parallel funds, co-investment funds and AIV
Parallel structures consist of unique investment vehicles that invest alongside each other. These can be used to meet the needs of a particular investor and can consist of Cayman Islands and land vehicles.
Co-investment funds are generally set up for a specific investment in order to invest alongside other alternative investment funds.
AIVs are often formed alongside major funds to facilitate structuring requirements for specific transactions and / or investors.
Umbrella funds are generally open-ended vehicles that pursue more than one strategy and offer investors the flexibility to invest in one or more strategies and change their investment strategy at particular times. For company vehicles, this can be achieved by using separate share classes and recording segregation in the relevant company documents (where possible), but separate holding companies provide a company vehicle. for funds of this nature with several separate portfolios having different strategies, achieving segregation on a legal basis. Investors in such vehicles may have the option of switching between portfolios (typically by repurchasing or repurchasing shares in a separate portfolio and re-issuing shares in another). Mutual funds are also commonly used for umbrella structures, with the terms of the trust documentation spelling out the separation and fund transfer agreements between segregated sub-funds. Umbrella structures are also used for multi-issue fund programs.
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