Legal firms in the Cayman Islands are in confident mood as clarity around European Union and US regulation looks likely to give the jurisdiction more opportunities than cause for concern.

At first glance little has changed in Cayman’s law firms. Look a bit closer and it is clear there has been a collective sigh of relief. The European Union’s alternative investment fund managers (AIFM) directive is clearer, albeit still a bit murky as the details are hammered out. US regulation, as expected, is benign towards the islands.

Things could have been much worse for Cayman. Many had feared a draconian regime from the EU in particular could seriously damage the future of the domicile. Over 2009 and most of 2010 threats still lingered and many wondered if European investment managers would want a Cayman-domiciled fund or opt for the ‘safer’ onshore products offered in Europe, particularly Ucits vehicles.

The fears seem unfounded. “I think that we will see increasing signs of activity,” says a confident Tim Clipstone, a partner at Harneys. “We’ve already seen a large number of start-ups and lots of new managers wanting to set up, establish a good track record and subsequently attract institutional investment. We’re seeing a lot of established managers looking to launch new funds or restructure existing ones. They continue to be attractive to the investors they have and fit with the strategies they want to follow,” he confirms.

“I think we’ll still see a continuation of some liquidations and potential litigation in relation to the funds that continue to be locked up,” he continues, noting that almost three years after the crisis there are still some funds that may need to be wound up or go into liquidation. “But let’s hope not too many of those.”

He, like many in the islands, does not think Cayman should rush into any changes or modifications to its regulations. Most believe the numbers speak for themselves. With almost 60 net registrations every month, and expected to rise more this year, the jurisdiction is close to surpassing its own high water mark. This, believes Clipstone, is testimony to the fact the Cayman model has worked well and come through the crisis with little damage.

Every law firm is adamant that the ‘Cayman brand’ is the preferred structure for investment managers looking to start new funds or launch more from existing houses. They point to the figures to confirm this as well as the fact that confidence in the Cayman structures has continued throughout the crisis with little or no drop-off from US managers and an increasing number of emerging market promoters turning to Cayman products.

“In terms of the suite of funds and the regulatory package, I think the suite works very well for the industry,” says Clipstone. “It’s evolved over time to meet manager and investor needs.” But he cautions that changes may be needed as it is still not clear where the EU and US regulation will eventually land. “That will be the only real driver of change. I think the products we have here and the services we can provide are very relevant and market leading.”

He, like others, expects Cayman to keep its head and not have a knee-jerk reaction to changes onshore. “I don’t know whether we’ll need to increase regulation,” ponders Clipstone. If investors and managers need changes, there may be pressure for change, he admits. “I would hope the current regulatory set-up we have is not only adequate but appropriate and proportional and that will be recognised by the EU and also by the US. I don’t think there will be any question as relates to the US,” he says, adding, “There may be a marketing advantage to being more regulated. But it will be market led. I don’t know what the future will hold.”

Clipstone is “quietly optimistic”. He says the industry in general is “back on track and we’re seeing a whole range of new fund enquiries and lot of start-up enquiries” although he admits it is still difficult for managers to find capital. He is confident Cayman will “survive and thrive”.

At Maples and Calder global managing partner Henry Smith takes a similar view. The law firm, present in Cayman for over 40 years, is the largest office in the Maples group and is regularly consulted by the Cayman government on offshore initiatives. Smith does not think Cayman will be prepared to change rules without good cause.

However, he does expects to see a little bit of change, probably in response to litigation around some funds, particularly on redemption issues and soft wind-down of funds. Documents will need to be tweaked but he confirms the overall structures are resilient. He believes change may be needed to accommodate the US Foreign Account Tax Compliance Act (Fatca). This legislation is aimed at flushing out US tax evaders worldwide. It was enacted after investigations by the US Senate of foreign banks that conspired with high net worth US clients to evade taxes.

Although most of the burden of complying with the act will fall on fund administrators, Smith says some changes may be needed to documents in order to deal with issues if a fund falls foul of the withholding tax. How a fund deals with an investor that may have caused a penalty in relation to other investors may mean “tweaking the documents”.

Smith is also seeing a “lot more underflow deal activity” on alternatives in general and hedge funds in particular. Opportunities are opening up, says Smith, as pension funds and others look for higher returns. “The long-term macro trend for institutional investors and pension funds is to become more alternative orientated,” he says. “They must do this in order to reach targets.”

This means more money into funds overall and although the past year has been dominated by flows into single managers with $1 billion or more of assets under management, Smith predicts that smaller funds will start to get more capital flows in 2011 and beyond. “Twelve to 18 months ago the focus was on big ticket and quality. Now investors are also looking for alpha.”

Like Harneys, Maples is relieved that the AIFM directive is not too restrictive. “There was a bit of relief when it was clear the private placement would continue for the next six to seven years. This means managers can go about business reasonably in the same way,” comments Smith, adding this also gives them a while to adapt to any requirements the EU may impose on fund managers based outside the union.

However, colleague Jon Fowler, a partner and head of investment funds, is worried there may be some “jurisdiction shopping” if managers want to go for a passport to allow them to sell a fund throughout the EU. This regime may come into effect after 2015 for managers based outside the EU. He wonders whether London will be the member state of reference for the majority of fund managers or if another member state may be chosen.

Maples is unusual among offshore law firms with a thriving practice in Ireland. “We have a significant Irish and a significant Cayman practice. We do not take one side over the other.” This perspective does give Maples an interesting outlook on onshore, regulated funds. “Irish funds and Ucits,” declares Smith, “are good products. There is a market for both and a lot of managers are looking at both. We try to give a ­balanced view.”

Another theme comes from emerging markets where there is a lot more activity on the hedge fund side than previously. Both Asia and Latin America are places where managers are emerging and generally choosing Cayman as a fund domicile. “We have been around 25 years in Hong Kong. Asia has always been important to us,” confirms Smith. “The Japanese use the Cayman unit trust and the Asian market recognised the value added from Cayman or the British Virgin Islands.”

Brazil, he says, seems to be the “flavour of the month” with a lot of interest in new managers as prime brokers and others open shop in the country.

Kieran Walsh, a partner, head of the BVI funds group and co-head of Maples’ Latin American practice group, says economic stabilisation in Brazil is “quite tremendous”.

“We see increased interest and consumer confidence in Brazil, with new fund managers setting up offices. Brazilian fund managers in particular are setting up Cayman or BVI funds for foreign investment into Brazil. The level of interest has increased and is significant with more large international players going in. It is very interesting to watch,” says Walsh.

Another Cayman law firm eyeing the possibilities of emerging markets is Conyers Dill and Pearman.

Gene DaCosta, partner and a member of the investment funds team, recently returned to Cayman following a year-long secondment to Conyers’ Hong Kong office where he provided Cayman Islands legal advice on investment funds and asset financing transactions. “We’re seeing a lot of interest from different fund managers to set up new structures into mainland China,” confirms DaCosta. Although private equity is more developed in mainland China, he believes there is scope for hedge funds, particularly in Hong Kong.

The law firm is rapidly expanding its ability to practice Cayman law in growth markets with a presence in Dubai, Mauritius, Moscow, São Paulo and Singapore.

Richard Finlay, partner and head of the Cayman Islands office, points out that Conyers has recently celebrated its 25th anniversary of its first office in Hong Kong. “This demonstrates our commitment to Asia,” confirms Finlay. Despite this interest in markets outside Cayman, Finlay says the firm’s focus is still mainly on the US market where the vast majority of hedge fund managers are based. He, like others, is also seeing an increase in business. “It is fair to say we are busier than last year with fund business.”

“We’re not just busy with restructuring; we’re busy with new deals, new products coming out of existing houses. Things look a lot more positive,” confirms DaCosta.

Finlay adds there is also a lot of work coming out of Asia and Hong Kong as there has been a “dramatic” increase in the first quarter of 2011 of fund managers from there choosing Cayman as a domicile. He is confident this will continue throughout the year.

This interest coupled with rising numbers from US and European managers leads Finlay to the conclusion that the efforts of the Cayman Islands government to raise the profile of the jurisdiction and educate politicians and others about the role of the domicile has been effective. He, like many others, believes the work of Cayman Finance and the IFC (International Financial Centre) Forum is ensuring that Cayman is represented positively to the outside world. “There is growing acceptance of the importance of offshore centres to the international economy,” he says.

Finlay also points to the fact that despite talk of hedge fund managers spurning Cayman, it has remained the “default setting”. “Seventy per cent of hedge funds still chose Cayman as a domicile,” he says, adding, “the strength of the industry is why it has attracted the lion’s share of hedge funds and is the centre of industry service provides. The key is a sensible level of regulation.”

Peter Cockhill, managing partner of the Cayman legal practice and co-head of Ogier’s global investment funds team, is also seeing increased business. “Turnover has gone up year on year. There is a mixture of work. It’s changed slightly with more crossover from corporate and private equity with hedge fund products,” he says. He has already seen an upturn, starting in October 2010 and “if it continues throughout 2011, it will be our best year yet”.

He attributes some of this optimism on the clarity the publication of the final AIFM directive has brought. But unlike Maples, he does not think Ucits hedge funds will be dominant in future. “The siren claims that Ucits was the only way forward, the way to avoid catastrophe in onshore fund access, has proven to be bogus,” says Cockhill. Like others he believes that Cayman’s existing regulatory framework is robust but nevertheless took part with others in a detailed gap analysis to see where the jurisdiction may need changes in order to comply with the AIFM directive.

Like Conyers he also sees more business coming out of Asia as well as Brazil. However, the US is still the epicentre and Cockhill “can’t see this changing any time soon”. The US still dominates the world, London is the centre for European hedge funds but Asia is becoming more significant, admits Cockhill.

Looking at changes in documentation Cockhill says although everyone has had different experiences, with a variety of opinions on what is required on document structures, all law firms agree there is more power with investors and this will be reflected in documentation. “There are structural options in funds that were not there two or three years ago.”

“This is not a cookie-cutter business. But no one wants a Rolls-Royce if a Morris Minor will do. So if a legal platform works well, it is sensible to reuse. There is always some element of conformity in fund structures. What has changed is the nature of the funds. They are more attuned to levers in the fund so they are able to use them if needed, explicit items that can ensure wind-down, side-pockets and other issues. Many of these items three or four years ago were outliers and now they are standard provisions,” explains Cockhill.

At Appleby partner Bryan Hunter agrees. “There were a lot of changes to documents in early 2010 reflecting the lessons of the financial liquidity crisis. The pace of change in documents over the last six months has focused on changes in liquidity terms in some respect to make the more flexible and to allow suspension of redemptions without suspending net asset valuation,” he notes. Documents need to be explicit. Without something expressly allowed in the documentation, a manager could find his hands tied if there were a crisis.

However, Hunter says most of the changes were minor and were dealt with in 2010. The more recent changes are reflecting court decisions relating to winding up of a fund. Many of these are aimed at stopping shareholders petitioning for a winding-up during a valid suspension of redemptions.

He also believes there is more scrutiny of master/feeder structures “whereas back in early 2010 investors were looking more at us, focusing on service providers and lines of conflict”.

Hunter also agrees that US and EU regulations are “relatively neutral as far as Cayman is concerned”. He predicts more new business as the Volcker rule encourages spin outs from investment banks.

Like others Hunter believes only minor changes will be needed in Cayman regulation to accommodate the AIFM directive. “The government here is committed to do what is needed. They have in place co-operation agreements and continue to sign tax information exchange agreements that will allow Cayman funds to be distributed in the EU but as far as a legislation update, there are various proposals for changes to the company law and exempt partnership law. This is just housekeeping, tidying up measures. The only new bits of regulation that may be introduced could look at directorships.”

Another Appleby partner, Sabrina Leacock, thinks investors will be in the forefront in driving any regulatory changes in Cayman. She believes the jurisdiction needs to take its time in deciding any changes. “Anything we do could affect investors and could have a negative impact. Buyer beware is still valid,” she concludes.

Rod Palmer, head of Walkers’ global investment funds group, is quick to dispel the myth that the threat of the AIFM directive has caused an exodus from Cayman. The numbers confirmed by the Cayman Islands Monetary Authority (Cima) show that only four or six redomiciliations occurred during 2010. “We need to make sure the market knows there is not massive migration out of Cayman. There are a number of funds registering in Cayman with around 100 a month, which is in line with pre-boom numbers.”

While Palmer says he is “agnostic on jurisdiction” he believes European managers may have been tempted to start Ucits funds as a reaction to the uncertainty of the AIFM directive and to tap into new asset pools. “Ucits demands more transparency and liquidity but there is a trade-off with performance,” he says. Now that investors are less nervous, he says performance is the driver again. He does not believe large institutional investors will choose a Ucits product simply because of performance drag. Choice of domicile, structure and product are important but Palmer believes investors are gravitating back to high performance funds. “They want flexible funds, measured regulations that don’t impose restrictions on strategy,” he says, adding that under the constraints on Ucits few managers will be able to achieve ­outperformance.

His colleague Ingrid Pierce, head of the Cayman hedge fund practice at Walkers and a partner in the global hedge fund group, also believes transparency is still high in the minds of investors. “Transparency means having answers to questions. What are your position levels, for example. Some funds now give some comment,” she notes. Investors, says Pierce, want to know how risk is affecting them and the portfolio and they want to have the capacity to process what managers are telling them.

Palmer agrees and also believes the trend of investors to gravitate towards larger investors will continue although it is likely more investors will start looking at the smaller, more nimble funds. Some investors he says were looking for a lower return with less volatility and risk. The larger funds he believes are able to give the transparency and detailed reports many institutional investors are now demanding.

Pierce also believes it is becoming more difficult for start up funds to attract institutional investors. Not only do funds need to comply with new rules in the US and the EU, investors want to see robust operational risk systems in place from day one. “They need a lot of infrastructure to start up. We’ve only recently seen the level of activity really increasing. It remains to be seen how successful these new funds will be,” she cautions. She believes it is increasingly difficult to sustain a fund now with less than $100 million.

Palmer agrees. He believes it is not worth the effort for an institutional investor to “get on the aircraft to do due diligence” for a fund under $500 million. Investors are checking not only on the fund but also on service providers and this is an expensive and time-consuming exercise. Smaller funds could miss out even if they have the right infrastructure and service providers.

At Mourant Ozannes the focus appears to be more on building a different legal services model. According to managing partner Neal Lomax the emphasis of the newly merged law firm is to build a quality practice that is responsive to client needs. This means hiring “top qualified people and we give our clients partner access. The firm is made up of young, dynamic partners who still want to practice law,” says Lomax.

For Lomax this means not pushing daily client contact down to juniors but having partners take a “very active” part in discussion and billable work. “Our strategy is smart working, not flag planting.” This is particularly true in emerging markets where Lomax says the firm is considering expansion in future. The model, says Lomax, is “more Slaughter and May” in a reference to the international law firm with offices in Asia and Europe and employing over 700 lawyers.

This confidence in creating a new type of legal firm has manifested itself in a more physical form. Mourant Ozannes is building of an impressive office block in Camana Bay, a development stretching 500 acres from Seven-Mile Beach to North Sound.

Although still considered a relatively modest practice by Cayman standards, Mourant Ozannes has a strong international reputation in offshore investment funds. The firm has operations in Guernsey and Jersey as well as Cayman. Its presence in the Channel Islands was considerably strengthened with the merger with Ozannes over a year ago.

Looking at the latest trends in Cayman funds laws, Lomax agrees with others that subtle changes in documentation, evolving in response to Cayman litigation as well as onshore regulation, are impacting the funds sector. “It is not the case that the stand alone fund or master/feeder structure is bog standard. We are using different vehicles in a different way. Things are changing in reaction to a changing and different environment. Managers are more involved in how funds are set up. As it is still difficult to get money, investors are taking a lead, too,” says Lomax.

Partner Robert Duggan, newly joined from Walkers, confirms that his experience of managers is that they are “increasingly involved in fund products not just traditional portfolio product. They want to understand the business and are paying more attention to product. They want to see more links between the product and strategy, with liquidity with the underlying assets,” he says.

Another law firm that has a slightly different perception is Salomon Harris, with strong Swiss connections. Partner Paul Scrivener says he is seeing a modest pick-up in business following the declines of 2008 and 2009. “There is definitely progress and a quiet confidence of growth prospects,” he says. A change in the last quarter of 2010 has continued into 2011 with more hedge fund launches and more enquiries turning into instructions. “It’s not like pre-crisis but it’s encouraging.”

As a result the Cayman practice is expanding with the addition of more lawyers. Scrivener also believes Brazil will be a major area of business for the firm in future. “We’ve been doing work in Brazil for three or four years and it is expanding quite nicely. We have very good contacts.” He confirms that the firm is working closely with PricewaterhouseCoopers in São Paulo, particularly in the funds area. “We are continuing to develop that.”

Meanwhile new business continues to come mainly from North America and Europe. “These are still very important,” says Scrivener, adding that the firm is also attracting some Asian work, too. The firm works closely with Lyxor more in the Far East than in Europe, with various, mostly retail, product offerings in the Asian market.

Scrivener also sees more emphasis on structure. “In the old days managers did not worry so much about structure. They were mainly driven by tax considerations. But as time goes on, corporate governance has come more into focus. When things go wrong, people pay attention. They want to protect their interest in a fund.”

Perhaps one of the least known hedge fund law practices is Higgs and Johnson, one of the largest full-service corporate and commercial law firms in the Bahamas. The firm has over 50 years experience in the Bahamas and has been operating in the Cayman Islands for more than 35 years.

Philip Boni, country managing partner, says the firm has only recently become interested in hedge funds business and has been steadily building a practice, mainly specialising in emerging market managers. The success, however, has been impressive. Out of 10 lawyers in the Cayman office two are funds lawyers. The team is set to expand with up to two more lawyers added this year.

Benjamin Wrench, senior associate and head of investment funds, joined the firm in 2009 from the Channel Islands where he advised on open and closed-ended investment funds including hedge funds and funds of hedge funds. “We’re seeing more enquiries this year than last, mainly from emerging markets. While we do have US and UK-based investment managers, most of our work comes from emerging markets,” explains Wrench. Because of this, the firm has not seen much drop-off over the crisis years.

He believes the appeal of Higgs and Johnson is its modest size. He believes a lot of clients find the firm through the internet. Wrench is upbeat about the prospects of developing these markets further. He believes the increase in individual wealth and overall economic growth will make these markets even more attractive in future.

“Our focus is still on emerging markets where we have existing clients and this remains our best contact for new clients, recommended from others. The website is also important for emerging market managers. Investment managers know Cayman funds. Even if they do not know the Cayman fund structures it is not difficult to fund out through the website. This especially true of younger investment managers who are more familiar with contacting people through the web.”

Wrench believes the firm’s relationship with emerging managers is a strong one. “The emerging market managers are still a small part of the Cayman market. But as they grow, we will grow with them.”

The firm has gained a reputation in Cayman for knowledge and expertise in dealing with emerging managers and Wrench says some of the larger firms are referring work in emerging markets to Higgs and Johnson. “We can provide a fuller service at competitive prices to smaller, emerging managers and start up managers. We like to think they come to us because we are not one of the larger firms. We’re flying below the radar and we are cost sensitive,” he concludes.

Overview of Cayman's financial services industry

The Mutual Funds Law (2009 Revision), the Securities Investment Business Law (2010 Revision) and the rules and guidance issued by the Cayman Islands Monetary Authority (Cima) provide the framework for the regulation and supervision of the funds and securities industries.

In its 2009 assessment, the International Monetary Fund (IMF) noted that “the regulatory framework for the investment funds and securities market of the Cayman Islands exhibits high levels of implementation of the Iosco principles.”

The Cayman Islands is on the OECD white list of jurisdictions that substantially implement international tax standards and has entered into over 20 tax information exchange agreements (TIEAs) including ones with European Union member states Denmark, Finland, France, Germany, Ireland, the Netherlands, Portugal, Sweden and the UK.

The Cayman Islands is an active participant in the OECD Global Forum on Taxation and was one of the first non-OECD jurisdictions to adopt (in 2000) the principles of transparency and exchange of information.

Cima has a statutory obligation to co-operate with overseas regulatory authorities under the regime delineated in the Monetary Authority Law and has extensive powers in that regard.

Cima has signed 14 bilateral agreements with authorities in the UK, US, Canada, Malta, Argentina, Jersey, Brazil, Isle of Man, Bermuda, Jamaica, and Panama, one multilateral memorandum of understanding (MOU) with eight Caribbean regulators and is a full signatory to the Iosco MOU

Since 2000 Cima has handled over 990 requests for assistance from overseas regulatory authorities.

Inside Cayman regulation

Regulation of funds and fund administrators
The Mutual Funds Law (2009 Revision) (MFL) gives the Cayman Islands Monetary Authority (Cima) responsibility for regulating certain categories of funds operating in and from the Cayman Islands. The law also provides for the regulation of mutual fund administrators by Cima.
Not all mutual funds are regulated. The MFL specifies the categories of mutual fund that are exempt from regulation. Funds that meet the criteria set out in section 4(4) of the MFL are exempt. All other mutual funds are regulated.
The ongoing supervision of funds and fund administrators falls under the remit of Cima’s investments and securities division.

Common fund vehicles
The Cayman Islands has company, trust, partnership and related laws that allow a high degree of flexibility for establishing mutual funds. The four vehicles commonly used for operating mutual funds are the exempted company, the segregated portfolio company, the unit trust and the exempted limited partnership.

Exempted company
The exempted company may redeem or purchase its own shares and may therefore operate as an open-ended corporate fund. Closed-ended corporate funds can also be established using the exempted company and it is a relatively straightforward procedure to convert from one to the other.

Segregated portfolio company (SPC)
An exempted company can also be established as a SPC with protected cells or portfolios. The SPC makes it possible to provide a means for different groups to protect their assets when carrying on business through a single legal entity.
Unit trust
The unit trust is usually established under a trust deed with the investors’ interest held as trust units.

Exempted limited partnership
The exempted and limited partnership provides a second unincorporated vehicle and it can be formed as easily as the exempted company or the unit trust. Please contact the Registrar of Companies or your professional advisors for more information on structuring a fund in the Cayman Islands.
Source: Cayman Islands Monetary Authority