Private Funds Act 2020: Cayman Islands

Overview

How the Private Funds Act affects investment funds

The Private Funds Act, 2020 (the Act), which took effect 7 February 2020, requires certain Cayman Islands-domiciled, closed-ended investment funds to be regulated by the Cayman Islands Monetary Authority (CIMA). All private funds within the scope of the Act are required to register with CIMA and be subject to its regulation.

To help funds comply with the Act, EY offers a variety of services that enable our clients to outsource compliance and other relevant activities. Our deep fund experience, regulatory credibility and leading-edge innovation combine to reduce disruption to your business while addressing requirements related to valuation, audit and more.

CIMA has issued frequently asked questions to clarify certain key aspects of the Act to allow consistent application. We anticipate CIMA as the regulator will continue to update its FAQs to clarify its views and interpretations of the Act. 

What is a collective investment scheme?

Collective investment schemes have the following characteristics: (1) the undertaking does not have a general commercial or industrial purpose; (2) the undertaking pools together capital raised from its investors with a view to generating a pooled return for those investors; and (3) as a collective group, the unitholders or shareholders do not have day-to-day discretion or control over the private fund.

Such characteristics, if all of them are exhibited by an undertaking, should show that the undertaking is a collective investment scheme that is captured by the definition of a private fund under the Act.

How should investment compartments of a private fund be treated?

Investment compartments, such as a segregated portfolio company, should be considered using the same criteria and characteristics as private funds. If an investment compartment is a separate legal entity and meets the definition of a private fund, it should be registered separately with CIMA as a private fund.

Are alternative investment vehicles (AIVs) required to register with CIMA?

Where a private fund chooses to report its financial statements on a consolidated or combined basis with a Cayman-domiciled AIV, the AIV will be included in the registration of the Cayman-domiciled private fund by including AIV details in the registration form of the fund and is not required to register separately with CIMA. However, the AIV is required to submit a separate annual return to CIMA. Where the main fund is a non-Cayman domiciled entity, the AIV is required to register with CIMA provided the private fund criteria are met.

Are single investor funds exempt from registration as private funds?

Yes, private funds with a single investor are exempt from registration under the Act provided that the private fund constitution specifies that the private fund has and is intended to only ever have a single investor.

Will CIMA extend the four eyes principle to private funds?

Yes, a minimum of two directors is required for private funds that are registered as companies, and a minimum of two natural persons should be named in respect of a general partner or corporate director of a private fund.

What are the audit requirements for a private fund?

A private fund that meets the criteria for registration under the Act is required to have its accounts audited on an annual basis by a local Cayman auditor approved by CIMA. The private fund is also required to file the audited financial statements and a Fund Annual Return (FAR) with CIMA within six months of its financial year-end. This is applicable for the 2020 financial year and for each financial year-end that follows.

What are the requirements for maintaining identification codes for securities held or traded?

A private fund that regularly trades securities or holds them on a consistent basis is required to maintain a record of the identification codes of the securities it trades and holds.

The identification code maintained should be the International Securities Identification Number, if available. If the International Securities Identification Number is not available, an alternative identification code that conforms to widely adopted international standards or a regional identification code or the legal identifier of the issuer is acceptable.

The private fund is required to make the record of identification codes available to CIMA upon request.

What are the valuation requirements of the Private Funds Act?

Private fund valuation procedures should be performed in accordance with the private fund’s valuation policy. A private fund is required to perform valuations at a frequency that is appropriate to the assets of the private fund and, in any case, on at least an annual basis. CIMA will issue regulations and requirements of valuation policies and procedures.

What are the requirements for the safekeeping of assets?

A private fund is required to appoint a custodian to:
(1) hold the private fund’s custodial fund assets in segregated accounts and (2) verify that the private fund holds title to any other fund assets and maintain a record of those other fund assets.

A private fund is not required to appoint a custodian if it is neither practical nor proportionate to do so and has notified CIMA thereof. Where a custodian is not appointed, a private fund is required to appoint an administrator or independent third party to perform the title verification. Alternatively, the manager or operator of the private fund can perform the title verification, provided the title verification function is independent from the portfolio management function or potential conflicts of interest are properly identified, managed, monitored and disclosed to investors.

Where the title verification is not performed by an independent third party, CIMA may require the private fund to have its title verified by an appropriately professionally qualified independent third party.

What are the requirements for the cash monitoring process?

A private fund is required to have appropriate cash monitoring policies and procedures in place for its investment strategy and types of investments held. CIMA is expected to issue rules and regulations related to establishing a cash monitoring policy. A private fund can choose to conduct the cash monitoring process internally, provided the function is independent from the portfolio management function or potential conflicts of interest are properly identified, managed, monitored and disclosed to investors, or it may outsource this process to an external third party.

The Private Funds Act introduces, among other changes, new provisions for the valuation of a private fund’s assets that increase the rigor around independence in the valuation process.

Under the Act, a private fund shall have appropriate and consistent procedures for the purposes of proper valuations of its assets, which shall establish that valuations are conducted in accordance with the requirements of the Act. For private funds that prepare valuations internally, they will likely need to enhance their internal processes and associated documentation. We also anticipate that CIMA will establish a set of rules in relation to the calculation of net asset values pursuant to the Act.

The Act requires a private fund’s valuations to be carried out at least annually and to be performed by:

• An independent third party professionally qualified to conduct valuations in a non-high-risk jurisdiction

Or

• The manager or operator of the private fund, or a person who has a control relationship with the manager of the private fund, provided that the valuation function is independent from the portfolio management function or potential conflicts of interest are properly identified, managed, monitored and disclosed to investors.

Where the valuation of the assets of a private fund is not performed by an independent third party, CIMA may require the private fund to have its valuations verified by an auditor or independent third party.

All entities that are registered as private funds under the Act and regulated by CIMA are required to have an audit opinion on their annual financial statements issued by a local audit firm approved by CIMA. With nearly 30 years of alternative assets experience, we provide a more efficient audit as we have an in-depth understanding of strategies, methodologies and investment philosophies. Our extensive experience with the operational, accounting and valuations issues impacting private funds enables us to assemble an experienced team to provide you with industry-focused perspective and insights.

EY Tax professionals provide detailed and focused tax assistance tailored to the unique needs of the alternative investment fund industry. They have extensive experience with the varied and specific facets of private equity and private funds taxation, including fund and organizational structuring, tax minimization planning, on-call advice and tax compliance.

Do you have funds that are winding down, but the existence of illiquid assets such as distressed/private equity or litigation/class action claims is preventing closure? Are there contingent liabilities such as uncertain tax positions that need to be resolved? Are you considering restructuring operations, such as moving away from third-party investors to a single-family office? Have changing regulations or increased compliance costs impacted longer-term business plans?

The EY Strategy and Transactions team is well-positioned to assist you with the wind-down of funds that have reached the end of their operational life while preserving investor value and freeing management time.

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