Tax transparency and cooperation with international regulators and governments to guard against tax evasion is something that the Cayman Islands takes seriously. It has, after all, Tax Information Exchange Agreements with all major developed countries and shares information with over 100 countries under the OECD’s Common Reporting Standard framework.
Specifically, Cayman has had a TIEA in place with The Netherlands since 2009. That The Netherlands has just decided to blacklist the Cayman Islands (along with 20 other jurisdictions) has understandably surprised people and one wonders what the problem is, given the island’s commitment to adhering to the OECD’s BEPS Inclusive Framework and the fact it has released a draft International Tax-Co-operation (Economic Substance) Bill, 2018.
As Jude Scott, CEO of Cayman Finance, commented on The Netherlands’ decision: “While discussions and negotiations relating to this and other blacklists are government-to-government processes with the Ministry of Financial Services taking the lead with regard to the Cayman Islands response to this development, Cayman Finance stands ready to support the Government as we protect, promote, protect, develop and grow this important pillar of the Cayman Islands economy.
“As such, we wholeheartedly reject this attempt to tarnish the reputation of the Cayman Islands and our financial services industry, which has been established as a premier global financial hub, efficiently connecting law-abiding users and providers of investment capital and financing around the world benefitting developed and developing countries.”
The draft Bill is the latest in a series of steps by the Cayman Islands to meet its 2017 commitment as an Inclusive Framework member under the OECD’s global Base Erosion and Profit Shifting (BEPS) initiative. It also reflects Cayman’s commitment to meet new European Union requirements modelled on BEPS Action.
As Cayman Finance wrote last month, those who establish Cayman structures do not do so to engage in base erosion and profit shifting activity but because Cayman “is an efficient neutral hub with key expertise in handling complex transactions”.
It added: “We anticipate that our sophisticated clients will adapt as required and take this in their stride. It is worth noting that all of Cayman’s main competitor jurisdictions are in a similar position as BEPS Inclusive Framework members.”
Ian Gobin heads-up the Cayman Islands investment funds team at Harneys. In his view, “economic substance” is going to be the buzz phrase of 2019 as users of international offshore centres and their professional service providers grapple with these new laws and await the regulations and guidance notes from their regulators.
“Of course, it is certainly going to have a huge impact on all international offshore centres, including the Cayman Islands, that’s the point. Call me an optimist, but I view this as a massive opportunity which will further cement the Cayman Islands as the global premier offshore jurisdiction,” remarks Gobin.
With the OECD economic substance regulations being discussed, and with this latest news of The Netherlands’ blacklisting, there is without doubt pressure on places like the Cayman Islands.
“What I think you are seeing is Cayman continues to position itself as the leader in terms of offshore jurisdictions,” says Benjamin Reid, Senior Business Development and Client Service Manager for LatAm, Maitland. “If you compare it to the other offshore jurisdictions, I do think Cayman is doing everything it can to differentiate itself and position alongside the European jurisdictions by saying, ‘Yes, we are an untaxed jurisdiction but we will adhere to your substance rules, we will adhere to whatever you need us to do, to enable us to stay attractive to the market’.”
As the economic substance regulation plays out it will mean that the days of corporates having a holding company without substance (letterbox entities) on Grand Cayman will end.
This is expected to have a huge impact on the number of people coming to Cayman as holding companies will need boots on the ground. Currently in Cayman there are 200 available properties to buy of the 60,000 people or so who live on Grand Cayman.
“All the jurisdictions are being pushed by the changes brought forth by Europe and the OECD – and working to keep up with all global transparency and governance initiatives. Cayman is certainly no exception – but I do think that Cayman is also taking this challenge one step further to position itself as the most attractive and business-friendly offshore jurisdiction,” adds Reid.
The Cayman Islands continues to work closely with the EU to bring its governance regime in line with regulatory expectations. Last year it announced it would be introducing the Data Protection Law to bring the jurisdiction to an equivalent level to the EU in terms of data protection and privacy (with respect to GDPR). And as mentioned in other parts of this report, CIMA has published new guidelines on its AML regime to redouble its commitment to investor protection.
These developments are placing added pressure on directors to Cayman funds but they are simply reflective of where global best practices have been headed. Any sign of shirking responsibilities will be disastrous for offshore jurisdictions given the political climate.
“Fund directors will have to make sure the fund is complying with its obligations as far as data storage and processing are concerned under GDPR,” explains Sean Inggs, Fund Director at International Management Services Ltd (IMS), one of the leading providers of directorship services in the Cayman Islands.
“This might require potential amendments of contractual arrangements with a fund’s service providers to make sure those responsibilities are properly covered off. Board members are going to be expected to ask the right questions of service providers who are holding client data and acting as data processors.
“Cybersecurity and technology risk has increasingly become an important consideration from a governance perspective. One only needs to remind oneself of the position the SEC has taken on this, for example requiring SEC registered investment companies and investment advisors to adopt written policies and procedures that address administrative, technical, and physical safeguards for the protection of customer records and information.
“When board meetings are held, cyber-related questions are frequently asked of the fund manager, the auditor, the administrator, including what relevant policies and protections they have in place.”
The raft of regulatory developments in Cayman last year were by and large introduced to enhance Cayman’s current laws to ensure they stay in line with evolving international standards rather than create unnecessary complexity for fund managers.
Cayman’s appetite and ability to stay at the forefront of these developments and ensure international standards are applied is enabling the jurisdiction to maintain its appeal and its reputation as a well-regulated jurisdiction, in the opinion of Joanne Huckle, Partner at Ogier.
She says that the revised AML regulations have been one area that has attracted particular attention from managers; particularly on the private equity side given some private equity structures were previously out of scope of the Cayman AML regime.
“On the hedge fund side, managers have had to take time over the last 12 months to ensure their outsourcing arrangements meet the required standards; ensuring they have AML officers appointed at the fund level, which is new, and to ensure they clearly document how they deal with AML risks that arise from their investment activities, as well as the Fund’s investor base. That has kept managers quite busy,” says Huckle.
She adds that in 2018 there were some changes to the Common Reporting Standards legislation, updates to the Ultimate Beneficial Ownership (UBO) regime, “and I think in 2019 Cayman (along with the rest of the world) can expect to see continued regulatory developments. The one big area of legislation that is very relevant right now is the economic substance requirements. This is in response to international requirements and is one of the steps Cayman is taking to meet a commitment it made in 2017 as part of the OECD’s BEPS initiative.
“This is not just the Cayman Government developing initiatives and trying to make things difficult, it is reflective of the world in which we live now. It means Cayman should be able to continue to enjoy a reputation as the go-to offshore funds jurisdiction. It is a positive step, and I think it is important not to lose sight of this.
“A lot of effort and focus has gone into the economic substance law, and perhaps in part as a result of this the Data Protection Law has been pushed back to later in 2019.”
As part of the revised AML regime, CIMA has provided clarification on the terms ‘delegation to’ and ‘reliance upon’ an outsourced party and its expectations where a delegation or reliance arrangement is entered into by a Cayman Islands financial service provider (FSP), such as a regulated or unregulated investment fund.
Reliance is the method most commonly used by Cayman Islands investment funds to meet their compliance obligations.
“It is very helpful that CIMA has clarified these terms,” says one Cayman lawyer. “The key difference is that where reliance is being placed upon someone (i.e. a financial service provider) then that person – the AML compliance officer – would be applying their own AML procedures. For example, if the fund was placing reliance upon the appointed fund administrator to perform part of the AML functions, the administrator would apply their own in-house procedures.
“In contrast, with delegation the relevant financial service provider to the fund would apply their own compliance procedures, which the appointed AML officer would need to adhere to.”
The other clarification is that there used to be a distinction between applying Cayman standards or those of an equivalent jurisdiction. If the latter were being relied on, a gap analysis had to be done between the Cayman regime and the fund manager’s home regime.
Now, if the manager operates from a country whose local regulatory standards are deemed to be lower than Cayman’s then they must adopt the Cayman standards, removing this need for a gap analysis.
Bringing the Cayman AML rules up to date is a positive step. All of the necessary appointments to regulated funds had to be made prior to 30th September 2018 and the actual filings with CIMA needed to be made by 31st December 2018.
As one law firm confirms: “There was a huge volume of funds who needed to make those filings, which is why the deadline was extended to the end of last year in order to help CIMA’s reporting portal cope with the volume.
“Some fund managers have been able to identify the right individuals to put forward for the three different AML roles. Perhaps they have a dedicated compliance officer who will act as the AML compliance officer, they might than hire a deputy MLRO and use someone independent to act as the MLRO.
“Some people do not have the capacity within their fund businesses, however and do not want to take on those additional roles, preferring to outsource them to a service provider instead.”
Umbrella unit trusts
One area that service providers are seeing clients respond to, with respect to increased investor demand, is tailored solutions; specifically funds of one.
Very often, says Huckle, investors are asking for side letters in particular, they want Most Favoured Nations clauses and they are continuing to apply fee pressure.
“I have seen funds of one being used for traditional liquid strategies (such as equity long/short) but I have also had managers who have been looking outside of their traditional investor base to get capital from places like Japan, for example, and using alternative structures to accommodate their demands.
“Japanese investors tend to want more bespoke solutions. They have slightly different risk profiles, they do huge amounts of due diligence, so getting a product launched can take a lot longer. But the reward for managers that are willing to take the time is that there is a huge amount of capital in Japan,” says Huckle, adding that an optimal solution, whilst perhaps longer to create, is an umbrella unit trust.
“Umbrella unit trusts are ideal because once the umbrella is established, the manager can roll out different unit sub-trusts for different strategies, for different investors, for different terms or even for different service providers. It takes a while setting the umbrella up but I’ve had managers rolling out different sub-trusts quickly and economically as they’ve already got all the documents in place,” explains Huckle, adding:
“We also continue to see some of our hedge fund manager clients move into more illiquid assets. Some have formed hybrid vehicles, some have formed PE-style vehicles, locking investors in; generally investors are happy to be locked in if it means getting a higher return.
“In terms of strategies, I’ve seen a lot of credit strategies launch over the last 12 months, as well as direct lending strategies and real estate debt strategies.”
At Maitland, Reid views Latin America, in particular Brazil, as a key growth market for its Cayman fund administration business.
To realise this, Maitland has focused on ramping up its automation capabilities to support Brazilian fund managers, many of whom use their offshore funds to invest in global derivatives markets. When looking at liquid strategies, the main asset allocations in these funds are on the more exotic than plain vanilla side; options, swaps, swaptions, CDS, etc, as opposed to equities and bonds.
“For the liquid managers we are working with, to meet their reporting requirements, we have to produce the NAV daily by midnight. So, we have had to automate as much as we can. We have plugged in to all of the main brokers’ and order management systems and pricing vendors (Markit, Bloomberg), and it has involved an incredible amount of programming and automation from our side. We have also invested a lot in people, bringing highly skilled fund accountants from Brazil to Cayman to give managers the peace of mind that our team understand the product and can communicate in their native tongue.
“We have onboarded almost 10 new daily fund mandates in the last quarter, a number of which being some of the most prestigious names in the industry. We’ve been able to position ourselves against the bigger fund administrator names and given our approach and growing reputation, we find this resonating with managers who have appreciated our clear focus on high touch service, coupled with client support in the local language. The growing team of Brazilian staff here in Cayman has been a game changer,” confirms Reid.
Looking ahead for 2019, Reid is sanguine about Brazil’s economic recovery programme and future growth opportunities.
“With a stable government I think we will see great things from Brazil in 2019. With the Ibovespa riding high and the real finally falling against the USD, it only bodes well for the domestic market.
“As the private equity steamroller continues, we predict that the investor chain will come full circle and global investors are also going to start allocating back into the B in BRIC’s.”
Crypto and digital asset developments
Something that went largely unnoticed in 2017 was the addition of issuing electronic currencies to the list of relevant financial business in the Proceeds of Crime Law, which came into effect in May 2017.
What this means is that if someone launches an Initial Coin Offering (ICO) in Cayman, and issues an electronic currency in the form of tokens, they will automatically be caught by the AML Regulations and will be obligated to do proper KYC on the purchasers of said currency, as well as maintain proper records, etc.
It is to Cayman’s advantage that CIMA hasn’t tried to push through ICO regulations like they have in certain other jurisdictions such as the Isle of Man.
“Cayman has always been a jurisdiction for institutional investors and we’d all like to keep it that way,” commented Jarrod Farley, Partner, Carey Olsen, in last year’s Cayman Islands report. “It gives us a sense that we are properly insulated from the dangers of dealing in an area that affects retail investors. It has worked for us, as a jurisdiction, for a long time and that is what makes us nervous about ICOs, in particular. People are going to lose money. If that’s the man in the street rather than sophisticated investors it is going to raise the issue to the level of national governments and the spotlight will fall on the jurisdictions and service providers that facilitated it. Cayman has to be careful in that regard.”
Admittedly, crypto had a challenging year in 2018; at USD3,645 (at the time of writing), Bitcoin is way off the high watermark it achieved at the end of 2017. But one should not confuse crypto prices with the digital asset arena, at large. In 2018, a number of digital asset projects launched using either stable coins or other security tokens with a pure utility or payment function, which were incredibly well thought out and structured.
“We’ve been working with clients that span everything from video game development through to stable coins for gold and silver, to US real estate,” confirms Gobin. “Instead of raising a fund issuing shares the fund promoter issues a token which is linked to the particular piece of US real estate.”
He adds: “I read recently that only about 1 per cent of capital in institutional portfolios is being used to invest in digital assets but I think that number will rise as the market continues to mature. 2018 saw the price of Bitcoin plummet but I think that fundamentally, investors have taken a long position on digital assets and a short position on crypto.”
Gobin is optimistic on what the opportunities could be for the Cayman Islands as it positions itself to support those developing digital asset projects over the coming years. Indeed, much has been written on the virtues of blockchain technology and how it could, over time, address many of the inefficiencies that exist in the financial services industry.
As more projects and ICOs come on stream, what will be necessary is for service providers (and investors) to exercise discretion.
“We still see a lot of people jumping on the bandwagon,” says Gobin, “when in actual fact it would be far easier and cheaper for them to issue shares or even take loans from investors than to issue tokens, using a mainstream fund structure. That said, from healthcare applications to restaurants and supermarkets – where the provenance from field to table can be demonstrated – and using smart contracts for shipping and logistics: there are many ways blockchain could be used as a solution.
“Some investors are beginning to take long-term investment decisions to invest in blockchain technology projects, as opposed to buying a huge amount of cryptocurrency.”
Given that there is still a question mark surrounding the safe custody of cryptographic assets and how and where the keys are held, cybersecurity is even more important for investment funds which operate digital asset strategies.
“For any of my investment funds which operate a digital asset strategy,” says Inggs, “I have to get comfortable with how the management team and their service providers are going to ensure that these assets are securely held; whether a fund manager is undertaking self-custody or whether they are relying on a third party custodian.
“Cryptographic keys getting stolen while held at either an exchange or a custodian can attract big headlines. Should a digital asset focused investment fund suffer a cyberattack (either itself or via its service providers), there is a real possibility of it being unable to retrieve its stolen digital assets.”
Inggs says that over the past 12 months at least one in five Cayman hedge funds that IMS has seen being set up are crypto related investment funds. One of the most important factors for fund managers to consider, from a corporate governance perspective, is putting the right people on the boards of these funds who have the relevant experience in the asset class of the fund.
With respect to new ICO activity, from a US perspective there remains uncertainty as to how future ICOs will be regulated. Various factors including the bear market that crypto is in right now and the regulatory uncertainty has thrown a huge question mark over whether these offerings will be regarded as securities for the purposes of US laws.
“In the Far East, China has banned certain aspects of cryptocurrency trading. Even though there has been a sharp drop in the number of new ICOs launching the rate of formation of Cayman-domiciled crypto funds remains steady,” says Inggs.
“The speculative nature of raising funds by issuing tokens to purchasers generally (via an ICO), on the premise that there may be a product to interact with in the future via the token, has fallen away somewhat and been replaced with entrepreneurs going back to more traditional methods of raising capital from VC managers and hedge fund managers.”
Via Press Release