Offshore hedge funds: Branching out

By Bryan Hunter, partner, Appleby Spurling Hunter

Last year was yet another record year for the hedge funds industry in the Cayman Islands. Approximately 1,750 funds were either registered or licensed with the Cayman Islands Monetary Authority (CIMA) in 2005, which represents a 25 per cent increase in the figures for the previous year. This follows a 112 per cent increase in the figures for 2004.

This continued growth solidifies the Islands’ dominant position as the jurisdiction of choice for offshore hedge funds, with some estimates placing the percentage of the world’s hedge funds based in the Islands at more than 80 per cent.

Although in a leading position, the Cayman Islands are not resting on their laurels. The jurisdiction is taking steps to correct any perceived deficiencies in its regulatory regime with respect to international standards and to ensure that CIMA maintains the level of service that industry has come to expect. This is consistent with the longstanding approach of CIMA and the government of attempting to strike the balance between an appropriate level of regulation and the need to maintain a dynamic and flexible industry. It should be noted that the International Monetary Fund (IMF) recently issued a report on the regulatory regime for hedge funds in the Cayman Islands in which it confirmed that such regime is regulated in accordance with international standards. Some of the steps that the Islands have taken, or are in the process of taking, in order to maintain their leading position are set out below.

A working group established by CIMA, consisting of both government officials and private sector representatives, has reviewed and made recommendations for amendments to the mutual funds law. Most of the recommendations have been accepted by the Cayman government and will be brought into effect later this year.

In order to address certain concerns that have been raised by the International Organisation of Securities Commissions and the IMF, the working group has recommended that four new categories of funds be created in order to clarify the distinction between public and private funds. These distinctions will make it more transparent to prospective investors what level of oversight CIMA will exercise in relation to each type of fund. While the government accepts the need to clarify the distinction between public and private funds, it has not accepted this recommendation out of concern that the costs to the industry of implementing it may outweigh the benefits. Instead, the government has indicated that it will be working with CIMA to identify other ways of clarifying the distinction between public and private funds, which will not involve significant amendments to the law.

The working group has also proposed that the minimum subscription amount for registered funds be increased from the current level of US$50,000 to US$100,000, in order to ensure that the minimum is consistent with other jurisdictions. Existing funds with a minimum subscription amount of less than US$100,000 would be ‘grandfathered’ (exempt from the rules).

Other notable recommendations include: amendments that would allow CIMA to waive the requirement to submit audited financial statements by a registered fund in certain limited circumstances, such as those in which a fund was never launched; and changes to clarify certain ambiguities in the law.

The authorities are also taking steps to ensure that CIMA’s responsiveness to registration and licensing applications is maintained at the level that the industry has become accustomed. For example, the government has recently authorised a nominal fee increase for mutual funds and has agreed to earmark those funds for the resource requirements of CIMA with a focus on the Investments and Securities Division and the Insurance Division. Over the past several years, both divisions have experienced significant growth in their respective workloads while maintaining relatively constant staffing levels.

Another step that CIMA has recently approved with the view to improving its efficiency is the implementation of a system of electronic reporting for all funds regulated by CIMA. In Cayman, each fund would be required to file electronically with CIMA, through its Cayman Islands-based audit firm, key data about itself and its audited accounts. It is expected that this system will be implemented later this year and will enable CIMA to carry out its existing supervisory responsibilities more efficiently and cost-effectively. It will also enable CIMA to regulate an increasing number of regulated funds without a proportionate increase in staff and other resources. As an additional benefit, electronic reporting should improve the quality of CIMA’s data on the funds industry and enable it to provide meaningful aggregate statistics on the industry to stakeholders, governments and international bodies.

In light of these proposed improvements to the regulatory regime, the Islands are poised to continue their dominant position as the jurisdiction of choice for offshore hedge funds.