In the face of economic sluggishness and regulatory change,
the Cayman funds industry has marched steadily on—and
looks set to prosper for many years to come, says Jarrod Farley
of Carey Olsen.
Tax Compliance Act (FATCA) and its global cousin, the OECD’s
Common Reporting Standard (CRS).
The Cayman Islands, having no system of direct taxation, and
therefore no existing architecture for tax reporting, was forced
to develop an infrastructure from scratch to deal with FATCA/
CRS reporting. This was followed by the UK-imposed initiative on
beneficial ownership reporting, the OECD’s base erosion and profit
shifting (BEPS) project which led to country-by-country reporting
requirements and the EU-imposed substance legislation, all of which
required considerable expertise, government commitment and
industry involvement to navigate.
Close to the US
The resilience of the Cayman funds industry has many underlying
causes, some of which relate to the inherent strength of the
jurisdiction, some to the attractiveness of its fund products or
regulatory regime, but arguably the most significant factor is its close
alignment with the US.
This is most easily demonstrated in the case of regulated hedge
funds, where the Cayman Islands Monetary Authority (CIMA) gathers
and publishes annual statistics. Around 70 percent of the assets
managed by Cayman hedge funds are managed by US managers, US
investors are the largest investor group, and securities of US issuers
are the largest asset class.
The picture for private equity funds is naturally more opaque, but US
alignment is evident from the popularity of certain Cayman vehicles
designed to mirror US vehicles, particularly the exempted limited
partnership and the limited liability company.
As a jurisdiction, Cayman offers the global funds industry a taxneutral
environment for the pooling of investment capital, along with
a variety of vehicles specifically designed for their purposes and a
bespoke regulatory regime. The Exempted Limited Partnership Law
(ELP Law) and the Mutual Funds Law (MF Law) in the late 1990s were
twin catalysts for the growth of the Cayman private equity and hedge
fund industries. Based largely on the Delaware limited partnership
law, the ELP Law provided a vehicle familiar to US fund managers and
investors, ideally suited to the pooling of investor capital.
Its similarities to the Delaware law meant that the limited
partnership agreement of a Cayman vehicle could closely mirror
that of a Delaware fund, making Cayman the ideal location for US
funds to establish offshore parallel vehicles (where a separate
set of investors invest in parallel with the main fund in every
investment) or alternative investment vehicles (AIVs), where some
of the main fund’s investors are put into a separate vehicle for a
particular investment to avoid a specific tax or regulatory difficulty
that might otherwise arise.
The Cayman funds industry has been quietly and steadily
continuing its growth trajectory over the past decade,
shrugging off the temporary effects of the global financial
crisis, despite ongoing sluggishness in the global economy.
This trend looks set to continue, notwithstanding a sense of
impending doom in the macroeconomic outlook, as the US engages
in the international trade equivalent of gunboat diplomacy, and the
EU fights a wave of popular nationalism that threatens its cohesion.
Pessimism may seem the order of the day, but the Cayman funds
industry is more mature and even more resilient than it was a decade
ago. Its professionals, its products and its regulator have all been
strengthened by the experiences of the past decade, and the demand
for Cayman funds has never been stronger.
The fate of the Cayman funds industry has broadly mirrored the
global alternative funds industry over the past two decades. Growing
rapidly from the late 1990s, Cayman became the leading jurisdiction
for alternative fund formations by the mid-2000s and is now the
domicile for around 70 percent of the world’s hedge funds and private
equity funds, with Cayman hedge funds managing total assets close
to $7 trillion by the end of 2017.
In the aftermath of the global financial crisis, as hedge funds
suffered massive redemptions and then struggled to outperform a
bull run in the equity capital markets, Cayman hedge funds suffered a
slow but persistent decline in numbers until 2018, when they gained
their first net increase in a decade (ignoring master fund registrations,
introduced in 2012).
Private equity funds, while suffering from a short-term drop in
commitments after 2008, soon recovered as the glut of distressed
assets allowed them to invest at lower prices, flattering their
performance in subsequent years. In Cayman, this is reflected most
obviously in the accelerating rate at which limited partnerships
(vehicles used almost entirely in private equity fund structures) have
been registered since 2015, with each year reaching new highs.
The survival and resurgence of the Cayman funds industry reflects
global trends, but also demonstrates an impressive adaptability, in
the face of an unceasing barrage of international tax and regulatory
initiatives in recent years.
On both sides of the Atlantic, alternative fund managers were caught
up in the inevitable regulatory backlash after the global financial crisis.
To combat perceived systemic risks, alternative fund managers in the
US were brought within the scope of US Securities and Exchange
Commission regulation and the Volker rule forced US banks to shed
their proprietary trading arms, while the EU added the Alternative
Investment Fund Managers Directive to an already crowded
regulatory environment. These measures were supplemented
by a series of ‘global’ initiatives, such as the US Foreign Account
CAYMAN FUNDS | 2019 49 Shutterstock / Mikhail Mishchenko