The Cayman Islands has seen a significant rise in the number of fintech funds being established and is increasingly becoming the preferred jurisdictional choice for fund managers seeking to establish new funds investing in cryptocurrencies and blockchain products.
The Cayman Islands has been the leading offshore jurisdiction for the establishment of mutual funds and private funds for more than 30 years. Its’ phenomenal reputation has been due in part to the use of innovative legislation and the absence of taxation and exchange controls. This, together with the presence of sophisticated and professional service providers has resulted in the jurisdiction’s reputation for responsible supervision and regulation of funds. In addition, the Cayman Islands has introduced innovative legislation to regulate virtual asset service providers, opening the doors to this market.
It is no surprise therefore that when fund managers were looking for the best jurisdiction to establish new funds investing cryptocurrencies and blockchain products that the Cayman Islands was the jurisdiction of choice
Regulation of Crypto Funds
The Cayman Islands are home to both regulated mutual funds (open-ended) and regulated private funds (closed-ended) for which both are applicable to cryptocurrency and blockchain structures.
Mutual Funds are regulated under the Mutual Funds Act (the “MFA”).
The MFA applies to all open-ended funds (funds in which the investors have the right to redeem their interests at their option), except those specifically excluded from regulation.Therefore, Tokens which carry an entitlement to participate in the profits or gains of the company will require registration under the MFA if they are redeemable at the option of the holder.
There are at least six types of mutual funds that are subject to regulation and supervision under the MFA by the Cayman Islands Monetary Authority (“CIMA”) but the one most popular for Crypto Funds is the Registered Mutual Fund which has a streamlined registration procedure available where:
- the initial minimum equity interest purchasable by an investor is US$100,000; or
- whose equity interests are listed on an approved stock exchange such as the CSX.
Requirements for all regulated mutual funds
All mutual funds regulated by CIMA are required to:
- Submit to CIMA a current copy of the fund offering document. The offering document must describe the equity interests offered to investors in all material respects and must contain such information as is necessary to enable a prospective investor to make an informed decision as to whether or not to purchase the equity interests.
- Submit to an annual audit and file accounts within six months of the end of the fund’s financial year. This will involve appointing an auditor in the Cayman Islands. All of the major accounting firms are represented in the Cayman Islands.
- Pay a prescribed fee.
Private Funds are regulated under the Private Funds Act (as Revised) (the “PFA”). There are two types of private funds that are subject to regulation and supervision by CIMA, and the most popular structure for Crypto Funds is the Registered Private Fund. The PFA requires a private fund to ensure it has certain ongoing operating provisions in place relating to annual audits, annual returns, retention of records, valuation of assets, safekeeping of fund assets, cash monitoring and identification of securities.
Virtual Asset Service Providers. The Cayman Islands Government passed the Virtual Asset (Service Providers) Act, (as Revised) (the “VASP Act”) on 25 May 2020. The VASP Act applies to any persons involved in providing one or more ‘virtual asset services’.
Issuing tokens is a virtual asset service and any fund that wishes to issue tokens rather than shares will need to register as a virtual asset service provider. Further, any fund that accepts fiat as a subscription in kind and redeems out the investors with a token will need to consider registration as an exchange (this will also apply where tokens are used to subscribe and an alternative token or fiat are paid out on redemption of the shares).
In order to register with CIMA as a virtual asset service provider, a Crypto Fund is required to file with CIMA certain documents, declarations, an application form, the relevant fee and various policies which can be read in more detail in our article on VASPs here.
The Preferred Crypto Fund Structure and its Benefits
There are many vehicles available in the Cayman Islands through which to operate a mutual fund or private fund but the one which has found the most traction for Crypto Funds is the segregated portfolio company (“SPC”). An SPC is one legal entity with different “pots” or “pools” called “segregated portfolios” whose assets and liability are separated and protected (under Cayman Islands status) from the liability of all other segregated portfolios in the same SPC.
The principal advantage of an SPC over a standard exempted company is to protect the assets of one segregated portfolio from the liabilities of all other segregated portfolios. This has been particularly attractive for Crypto Funds where many classes of assets are traded and some have significantly more risk than others. The fund managers naturally wish to isolate the risk of the different strategies and the SPC structure provides the mechanism for this.
The Companies Act (as Revised) of the Cayman Islands (the “Act”) states that a creditor will only have recourse to assets from segregated portfolios with which it has contracted, and creditors will have no recourse to the assets of other segregated portfolios of the SPC which are protected under the Act. The Articles of Association of the SPC will have provisions which reflect the Act in this respect.
The benefit of SPCs highlighted above facilitates a more streamlined offering structure for certain mutual funds enabling SPC to be used to structure platforms from which multiple managers can be quickly onboarded into their own segregated portfolio in a structure that has all its service providers already selected and in place.
Read the article in full in PDF here: Crypto Funds in the Cayman Islands: Rise, Regulations and Structures
View article in the Legal500 Alternative Investment Funds Guide here.