Establishing Hedge Funds in the Cayman Islands

Many investors and fund managers prefer to choose Cayman islands for registering hedge funds. Cayman has a leading position as a major hub for offshore investment funds. It is estimated that more than 75% of all the world's offshore hedge funds are registered here, representing a significant portion of the global market. These funds manage nearly half of the industry's $1.1 trillion in assets.

The publication provides an overview of the regulatory framework applicable to hedge funds in the Cayman Islandsthe main structures of funds and their features.

Advantages of Cayman Islands Investment Funds

The Cayman Islands has earned its status as one of the premier centers for the registration of investment funds, mainly due to its structural and operational advantages. Firstly, the Cayman Islands offers flexible and business-friendly laws and regulations. This allows funds to be created and managed with a high degree of operational freedom.

Secondly, the Cayman Islands has flexible options for structuring investment funds and a developed financial services infrastructure. The island has a large banking sector, including both local and international banks. Highly qualified specialists in the field of law, auditing, accounting, and asset management are concentrated here, which provides high quality service and support at all stages of investment funds. A high level of information infrastructure and a commitment to complying with international regulatory standards support the efficiency of financial transactions in the islands.

For those seeking to minimize their tax burden, setting up hedge funds in the Cayman Islands may be the best choice. The absence of direct taxation on income and capital gains creates significant benefits for investors, allowing them to maximize the return on their investments. Cost and tax efficiency are the main deciding factors for fund managers when choosing this jurisdiction, and company registration and administration costs are competitive with other jurisdictions popular for setting up investment funds.

The geographical location of the islands and the lack of capital controls also play an important role. Their proximity to the main financial centers of North and South America makes them an advantageous region for international financial transactions. Due to the absence of currency barriers, money can be easily moved to and from the Cayman Islands in any amount.

Image caption: CIMA official website.

Regulation of Hedge Funds in the Cayman Islands

Hedge funds are one of the most attractive ways of collective investment because they provide the opportunity to minimize financial risks through asset diversification. Hedge funds in the Cayman Islands are often set up in the form of partnerships, which are limited to a certain number of participants. One of the key conditions for hedge funds is a significant minimum initial investment from investors.

These funds are characterized by low liquidity, which means that investors must hold their own funds in the fund for at least one year before they can withdraw them. This structure aims to ensure capital stability and allows the fund to pursue long-term investment strategies.

One of the key features of hedge funds in the Caymans is that there are no residency requirements for founders, directors and other management persons. This means that you do not need to live on the islands to set up and manage a hedge fund in the Caymans. The organization, operation and regulation of hedge funds in the Caymans is carried out in accordance with the provisions of Mutual Fund Law (Mutual Funds Law, M.F.A.).

Generally, all open-ended investment funds established in this jurisdiction must be registered and regulated Cayman Islands Monetary Authority (CIMA). At the end of June 2023 (according to expert estimates), at least 12,995 open-end funds were registered or licensed with CIMA.

* A fund is considered open-ended if it issues “participatory interests” (for example, shares, partnership interests or units) that give the right to receive the profits and income of the fund, which can be redeemed at the request of the investor. This rule excludes the use of debt instruments such as warrants, convertible bonds and sukuk instruments, which require registration with CIMA.

The right to conduct activities can be granted in one of three ways. First, the fund receives a license directly from CIMA. The second is a CIMA-licensed administrator who provides the fund's head office in the islands. The third option involves either a minimum initial investment of USD 100k per investor, or listing the shares on a CIMA recognized stock exchange such as the LSE or ISE.

For hedge funds, generally the minimum initial investment amount per participant must be at least $100,000. However, an open-end fund with 15 investors or fewer who have the power to appoint and remove directors, although subject to regulation under the MFA, will not need to register with CIMA. Investments in hedge funds in the Caymans are most suitable for sophisticated and/or institutional investors who typically have sufficient funds, experience and capacity to fully assess risks.

For a fund registered in the Cayman Islands, it is necessary to appoint an administrator, an auditor, a custodian/broker and at least two directors, who may be non-residents. Hedge funds operating in Cayman are required to register an office on the islands.

Organizations subject to CIMA regulation can only begin operations once the following conditions are met:

Final approval of constituent documents ensuring compliance with legal and regulatory requirements.
Concluding agreements with service providers necessary for the regular functioning of the fund.
Prepare and submit to CIMA documentation reflecting the fund's proposal, as well as the necessary information, in accordance with established regulatory standards.

Establishing a fund in the Cayman Islands and structuring options

In the context of hedge fund structuring in the Cayman Islands, the following are available: structures:

Exempted Limited Company/Partnership;
Limited Liability Company;
Unit Trust;
Segregated Portfolio Company.

Registration of a fund in the Cayman Islands in the form of an Exempted Limited Company (ELC). ELC provides a unique combination of management control and business flexibility. Its directors play a key role in the management of the company, making decisions and being responsible for appointing investment managers.

ELC provides certain benefits, including the ability to ensure the confidentiality of business transactions as well as asset protection. This company form may have tax advantages and simplified reporting requirements.

Establishment of a hedge fund in the Caymans in the form of an Exempted Limited Partnership (ELP). ELP is an alternative form of hedge fund structuring that is based on an agreement between passive limited participants and a general partner. Under this structure, the general partner typically appoints an investment manager. This method provides certain advantages and opportunities for developing investment strategies.

Image caption: online service for business in the Cayman Islands.

Opening a hedge fund in the Caymans in the form of a Limited Liability Company. LLCs are a common choice for hedge funds. LLC registration in the Cayman Islands is intended for cross-border business and investment, often exempt from taxes for a limited or indefinite period. Once registered, an LLC is released from certain obligations. For example, there is no need to hold shareholders' meetings every year in this jurisdiction.

Creation of a hedge fund in the Caymans in the form of an Exempted Unit Trust. An exempt unit trust operates on the basis of an agreement between the unit holders and the trustee of the fund, which issues the units to investors. The trustee retains overall control of the trust and typically delegates management of the trust assets to the investor. to the manager.

Creation of a Caymanian fund in the form of a Segregated portfolio company (SPC). This status allows assets and liabilities to be divided among different hedge fund portfolios. This approach reduces investment risks and improves the overall performance of the fund, allowing investors to select portfolios that suit their investment goals and risk level, providing a flexible asset management strategy. It also helps manage liquidity and diversify the investment portfolio.

We also note that the investment strategies of hedge funds in Cayman are not subject to restrictions, nor are their use of leverage, short selling or other alternative methods.

Appointment of key managers of hedge funds in the Cayman Islands

A hedge fund in the Cayman Islands can be managed by an individual or a management organization from any country. This promotes international openness in fund management, providing investors with access to qualified fund managers. The manager can receive advice from local experts on choosing the optimal organizational structure and tax planning.

In the Cayman Islands, the hedge fund structure consists of several key individuals, each of whom performs specific functions.

Directors (at least two):

Development and implementation of investment strategies.
Making decisions about buying and selling assets.
Risk assessment and management.
Ensure compliance with regulatory requirements.
Preparation of financial reports and provision of them to investors.
Manage the operational aspects of the fund, including administration and compliance.

Fund administrator:

Responsible for monitoring and overseeing the day-to-day operations of the fund, such as maintaining the investor register, calculating net asset value (NAV) and profit distribution.
Must be licensed by CIMA.

Custodian:

Investment manager:

Develops and implements the fund's investment strategy.
Does not need to be licensed by CIMA, but must meet certain experience and education requirements.

Consultant:

Provides advice to the fund manager on various issues such as legal, tax and compliance.
Does not need to be CIMA licensed.

Prime broker:

Provides the fund manager with brokerage services such as trade execution and margin lending.
Does not need to be licensed by CIMA, but must meet certain capital and reserve requirements.

CIMA has issued a Statement of Guidance for Regulated Funds (Corporate Governance or SOG), which applies to all Cayman Islands investment funds regulated under the MFL.

Important! All management entities registered in Cayman are subject to the Securities Investment Business Law (SIBL). This law regulates a wide range of securities transactions, including their management, trading, dealing and advice.

How to open a hedge fund in the Cayman Islands?

The first step to be taken is to develop a basic investment strategy for the fund. Once you have a strategy in place, you can take the following steps to set up a hedge fund in the Cayman Islands.

Choosing a fund structure (LLC, ELP, etc.).
Preparation of the fund's constituent documents (i.e. Memorandum and Articles of Association), and the Draft Investment Agreement, which describes the various aspects of the hedge fund and how it will operate. For example, some of the items that should be covered here include the duties and responsibilities of the fund manager, the fund's fees and expenses, and the processes that will be used to report the fund's investments.
Submitting the required documents to CIMA for registration and licensing to operate a hedge fund in the Cayman Islands from the regulator.

Once a Cayman fund has been properly registered, the following must be prepared:

Fund Proposal Document.
Agreements for the provision of services, i.e. investment management agreements.
Form of subscription agreement concluded by fund investors.

Establishing hedge funds in the Cayman Islands: tax obligations and compliance with AML policies

In accordance with current tax laws, the local government does not impose any form of direct taxes on profits, income or capital gains, in the form of withholding on the payment of dividends or other distributions of income by hedge funds structured in the Cayman Islands. This provides flexibility in the investment structuring process. When it comes to unincorporated entities such as trusts, there are no estate taxes. However, investors are responsible for compliance with the tax laws in their jurisdiction and are required to comply with all applicable tax obligations.

Entities used to set up hedge funds in the Cayman Islands may also benefit from tax advantages over time. Although hedge funds in the Cayman Islands enjoy tax benefits, various registration fees are required, including an initial fee of US$735 to register a fund in the Cayman Islands.

The Cayman Islands is known for its regulators implementing best practices in AML/KYC and other due diligence measures. The Cayman Islands is a member of the Caribbean Financial Action Task Force (CFATF), a group of 24 states and territories. Through coordination and a common approach, CFATF member states work closely with international organizations and exchange information to effectively combat cross-border money laundering.

Image caption: CIMA AML Guide.

In October 2023, the Cayman Islands was formally removed from the FATF Gray List, reflecting its improved regulatory environment and responsible approach to fulfilling its obligations to detect and prosecute money laundering. This step is the result of intensive work to improve practices in the fight against financial crimes. These measures have resulted in a significant improvement in the reputation of the Cayman Islands and increased confidence among the international community and investors.

Support in the creation of funds in the Cayman Islands

The Cayman Islands plays a significant role in the international financial system, providing a favorable environment for the placement and management of large capital. A hedge fund is a financial institution that specializes in attracting investments from various investors for their further management in order to make a profit. Unlike traditional investment funds, hedge funds employ a wide range of investment strategies and tools.

These strategies include, but are not limited to, the use of financial derivatives such as options, futures and swaps, allowing them to effectively hedge risk and profit in volatile market conditions. In addition, hedge funds often use debt, or leverage, to increase their positions and potential returns.

We provide our clients with comprehensive legal advice on the regulation of hedge funds in the Cayman Islands and the regulation of fund management companies. Our consultants can provide comprehensive support in understanding the procedures and documentation requirements required to set up a fund in Cayman.