Regulating master funds

In May the Cayman Islands Government announced that in the future certain master funds will be subject to a fee of $1,500 and regulation by the Cayman Islands Monetary Authority. What this regulation will look like is still up in the air, say Gene DaCosta and Olivaire Watler from Conyers Dill and Pearman.

As yet, the Cayman Islands Monetary Authority has not released a timetable for implementation of the new regulations nor has any legislation been drafted. The proposal is under consultation in Cayman’s legal and financial services circles, but most industry experts do not expect the procedure for registering these funds to be overly onerous or to increase reporting requirements, law firm Conyers Dill and Pearman wrote in a note.

When Premier McKeeva Bush announced in his budget address in May 2011 that certain master funds will in the future be regulated by CIMA and required to pay a fee, not everybody in the financial services industry was surprised, but significant stakeholders were, said Olivaire Watler, associate with Conyers in Cayman. The Law Society or the Cayman Islands Bar Association for instance were not consulted.

Unclear

Conyers, Dill and Pearman Partner Gene DaCosta believes that as a result the form and extent of any master fund regulation is still unclear.

“There has been very little discussion in the industry with all the players and key stakeholders, which then results in different parties taking different views on the need for registration of master funds and indeed what the regulation should encompass.”

Conyers believes that the proposal will apply to master funds, which have one or more existing feeder funds already registered with CIMA but do not constitute mutual funds or are otherwise exempted from registration.

The motivation to regulate these funds comes in part from growing pressure pushing for international regulation and recommendations by the OECD that the regulatory status of these master funds should be improved.

Under the master/feeder fund structure, investors acquire interests directly in the feeder fund, which then invests into the master fund. Assets are usually acquired, held and traded at the master fund level, explained DaCosta.

Regulation of the feeder fund is already a requirement by law, but it is also crucial that the master fund be audited because that is where the assets are usually held, he said.

While a local audit sign-off for the master fund is not a requirement at the moment, the master may already be audited by the international offices of accounting firms off island, he added. “That is the current practice, auditors recommend that already.”

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The impact of regulation

From talks with clients, DaCosta noted, that the concern is not so much about the $1,500 fee. “They did not seem at all concerned that there is a fee or the amount.

They were more interested in how it was going to be implemented in principle and in practice, if it was only a fee generating mechanism and the rationale behind it.”

However, at the same time the $1,500 fee cannot be seen in isolation, added Watler.

“There may be other service provider fees and additional audit fees for local sign off, as well as attorney fees if they are involved in the process of registration itself. All of those go into the equation of the cost of establishment for fund structures here,” he added.

But, while cost will always be taken into account, Watler agreed that the fee in itself is unlkely to be a deterrent for fund registrations in the future.

Meeting the objectives?

In fact stricter regulation of master funds in itself may actually be beneficial. The market has consistently shown that business gravitates to where the best infrastructure, service providers and regulation can be found. The efficient registration and regulatory regime and high quality service providers in Cayman are such an example, Conyers noted.

“Based on the proposed fee, it must be a very basic form of regulation, in the form of registration of these funds,” said Watler, who noted that much of the detailed information concerning these master funds, such as the investment policies and the nature of the instruments in which the fund will be investing, perhaps even the directors of the fund, will already be with CIMA, because it will be contained within the offering document of the feeder fund.

In order for it to be effective at the minimum it must mean that there would have to be a local audit sign-off, said Watler. “I think if it falls short of that then we are looking at window dressing.”

The key question will be whether the proposed regulation can address international concerns that were raised by the OECD in its peer review of Cayman. The supplementary version of the Phase 1 peer review states that “in some cases, there are currently no penalties for non-compliance with obligations to maintain ownership and identity information in the case of companies and partnerships.

This is of particular concern in respect of unregulated mutual funds which may manage a significant total asset value.”

This large number of unregulated funds highlighted in the report would extend far beyond master funds, said Watler, who believes that if the proposed regulation aims at this criticism it may well fall short of meeting that objective.

“The section 4(4) [of the Mutual Funds Law] exemption pertains to any fund, which has less than 15 investors the majority of whom are capable of appointing and removing the directors of the fund. There are many other funds that fall into that category. So I don’t see that the current proposal to regulate master funds would necessarily address those criticisms, not in total at least,” he said.

If the objective is to raise revenue – Premier Bush said the fee income would be used to alleviate the burden for Cayman residents caused by growing electricity bills – it may fall short of that, too. Some master funds are already regulated and pay a higher fee of $3,500 because they voluntarily opted to be regulated. Under the proposed new legislation, these funds may well opt to be treated under the new regulation and pay the lesser fee of $1,500, said Watler. So in effect some revenue may be lost.

In any case it will take some more time for the new regulatory regime to be finalised and implemented. “There is still a lot of speculation. There are a number of different ways of looking at this issue and people are now attempting to bring that to government’s attention for their further consideration.” DaCosta concluded.

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