House of Lords - European Union Committee

Directive on Alternative Investment Fund Managers - European Union Committee Contents

Letter from Maples and Calder

By way of introduction, Maples and Calder is an international law firm specialising in advising major international financial institutions in relation to the formation of alternative investment funds (including hedge funds and private equity funds) in the Cayman Islands, Ireland and British Virgin Islands. We estimate that we have established, over the years, more alternative investment funds than any other professional firm in the world. We have over 200 lawyers based in the Cayman Islands, Dublin, London, Hong Kong and Dubai, the majority of whom practice in the area of alternative investment funds. We are a member of the Alternative Investment Management Association ("AIMA") and the Managed Funds Association ("MFA").

We are aware that various committees of the European Union ("EU") Commission and the EU Parliament are currently reviewing the draft of an EU Directive dealing with the proposed regulation of Alternative Investment Fund Managers based in the EU. We are also aware that the current draft EU Directive includes various provisions that would impose limitations upon the marketing of non-EU domiciled alternative investment funds to investors based in EU member states and the ability of EU or non-EU based alternative investment funds to appoint investment managers and service providers based outside the EU (particularly in the United States of America ("US")).

Over the last 20 years or so, the Cayman Islands has become the preferred domicile for approximately 70% of the world's hedge funds. Currently there are in the region of 9500 hedge funds registered with the Cayman Islands Monetary Authority ("CIMA") under the Mutual Funds Law, There are also significant numbers of private equity and other closed ended alternative investment fund registered in the Cayman Islands. Consequently, many of our clients, who are investment managers based in the EU or the US or investors based in the EU and who manage or invest in Cayman Islands alternative investment funds, will be affected by the potential impact of the EU Directive as currently drafted. In particular we are aware that many institutional investors have expressed concerns that the EU Directive would severely limit their ability to invest in the vast majority of alternative investment funds which are either based outside the EU or employ service providers or investment managers based outside the EU.

As the leading Cayman Islands law firm, we are writing to you to offer to provide you with background information on the regulation of alternative investment funds based in the Cayman Islands which may assist you in your discussions and research so that the EU Directive might accurately reflect the role and regulation of alternative investment funds formed outside the EU. We would also respectfully submit that the alternative investment funds and service-providers based in the Cayman Islands are already subject to regulation and that institutional and sophisticated investors should not be unnecessarily prevented from investing in Cayman Islands alternative investment funds.

The vast majority of these Cayman Islands alternative investment funds are currently marketed under private placement rules to institutional and sophisticated investors (such as pension funds, insurance companies and charitable endowments) based around the world, including in the EU. The ability of the Cayman Islands to develop to this position as a market leader in alternative investment funds is based on the confidence that alternative investment fund managers, institutional investors and counterparties (such as financiers and prime brokers) have in the Cayman Islands legal and regulatory regime. Consequentially as a leading centre for the alternative investment funds industry, the Cayman Islands financial services industry is aware of its responsibility to regulate alternative investment funds appropriately. To this end, the Cayman Islands already regulates hedge funds under the Mutual Funds Law, investment managers under the Securities Investment Business Law and banks and trust companies (including custodians) under the Banks and Trust Companies Law. The Cayman Islands legal system is based on English law principles and the final court of appeal is the Privy Council in London. Whilst many hedge funds have suffered from the recent drop in market prices and values, it is worthy of note that the numbers of hedge funds which have actually been the subject of serious litigation or criminal frauds is a very tiny percentage of the overall number.

The role and importance to the international financial community of international financial centres such as the Cayman Islands is often misunderstood and misstated. It is our submission that the Cayman Islands currently provides the international alternative investment funds management industry and institutional investors with a stable, well-regulated and neutral jurisdiction through which to facilitate international and cross border business for the benefit of the global economy. In addition to the huge number of reviews that have been conducted by legal and professional advisers on behalf of the investors who invest in Cayman Islands alternative investment funds, the Cayman Islands financial services regime has also been subjected to significant reviews over the last few years by international bodies such as the International Organisation of Securities Commissions ("IOSCO") (which has admitted CIMA, the main regulator of financial services in the Cayman Islands, as a member of IOSCO), the International Monetary Fund, the Financial Action Task Force and the United Kingdom Government.

As you no doubt are aware, many reports on the recent global financial crisis (including the Turner Report commissioned by the UK's Financial Services Authority, the UK financial services regulator, and the Larosière Report commissioned by the President of the EU Commission) have acknowledged that alternative investment funds established in offshore financial centres were not the origin of such crisis, which arose from trading and lending activities of banks onshore in major financial centres such as London and New York. However, we are aware that the G20 nations have mandated a review and regulation of hedge funds in order to assist with the need to monitor trading activities of large financial institutions which may constitute a systemic risk to the global financial system. Consequently, the Cayman Islands financial services industry stands ready to engage in a constructive dialogue and discussions with regulatory authorities in other countries to assist with a review of the existing level of regulation and, where appropriate, develop improvements to its regulatory regime to assist with the global oversight of the world's financial system.

This is consistent with the approach taken to other international initiatives over the past few years where the Cayman Islands has responded positively and swiftly to requests for assistance from international bodies and foreign governments in connection with the fight against crime and money laundering by implementing strict anti-money laundering and client verification legislation. Furthermore in connection with the exchange of information on tax matters, the Cayman Islands has entered into a number of OECD Model tax information exchange agreements with the US and several EU member states and is currently in negotiations with a view to entering into further tax information exchange agreements with other EU member states. In 2004 the Cayman Islands adopted the EU Savings Directive under which Cayman Islands banks automatically share information about bank accounts of EU residents with EU member states.

In the Appendices to this letter we summarise why international business is conducted in the Cayman Islands (Appendix 1) and in particular why hedge funds are often domiciled in the Cayman Islands (Appendix 2). We will also explain the ways in which the Cayman Islands Government has introduced measures to combat money laundering and to facilitate the exchange of information to assist foreign governments and tax authorities (Appendix 3 and Appendix 4). Finally we outline the laws dealing with the regulation of financial services in the Cayman Islands (Appendix 5).

Cayman Islands alternative investment funds act as an effective channel for global international investment and provide much needed liquidity, investment opportunities and access to capital markets for businesses and investors in both the major developed economies and emerging market countries. For example, Cayman Islands investment funds are currently being formed to participate in the US administration's TALF and PPIP programs. We would hope that any new regulations on alternative investment funds are developed in a way which will not impede the formation of such alternative investment funds which can provide liquidity and capital to assist in the global economic recovery.

APPENDIX 1

INTERNATIONAL BUSINESS IN THE CAYMAN ISLANDS

1. REASONS FOR ESTABLISHING A BUSINESS IN THE CAYMAN ISLANDS

1.1 The financial services industry in the EU reflects the growth of globalisation and is international and cross border by nature. Once a financial institution has decided to establish an office in the EU, its next challenge is often how to create business structures or investment fund vehicles which can accommodate investors and business partners from all over the world within the complex parameters of existing tax and securities laws that apply to the investors, the management team and the business or investment activities, all of which could be located in multiple jurisdictions. In this regard even though the financial institution arranging the international transaction or the investment fund manager is based in the EU, the international business partners will not all be based in the EU. Consequently, the EU may not be the natural location for the incorporation of a company established to own or conduct the international business venture or to act as the investment fund. In many cases, the business parties or investors will be looking for a neutral jurisdiction, like the Cayman Islands, which does not give any one party "home field" advantage and does not disadvantage one or more of the parties. In fact, international investors will have their own reasonable legitimate business reasons (including legal, political, tax or regulatory) for preferring not to use an EU incorporated company for an international business venture.

1.2 The Cayman Islands is the domicile of choice for the establishment of companies for many different types of international businesses and has been particularly successful in attracting investment fund formation from US and EU based investment fund managers. In this regard, the Cayman Islands does not compete as a financial centre with the EU. Instead, the use of Cayman Islands vehicles established by EU based businesses simply help these EU businesses service an international client base or to carry out international cross border transactions. Whilst certain services can be provided to the Cayman Islands vehicles by Cayman Islands based service providers, in many cases EU based businesses provide these services to the Cayman Islands companies and thus generate fees and revenues for these services in the EU. In this way economic activity surrounding the Cayman Islands vehicle helps sustain or create jobs and taxable revenues in the EU.

1.3 When reviewing the reasons why Cayman Islands vehicles are established by international businesses, it is important to note that the primary reason for forming Cayman Islands vehicles is to carry out legitimate international business activities. The fact that there are no direct corporate or income taxes levied in the Cayman Islands and that accordingly transactions can be structured on a "tax-neutral" basis, unfortunately often leads to a misconception that investors in offshore companies are only doing so to evade tax and not for legitimate business reasons which are tax compliant. A financial institution's or an investment fund manager's decision to establish an international joint venture company or an investment fund in the Cayman Islands will likely be based on a detailed review of all business factors, including where the investors or shareholders are based, where the business venture or investment activity will take place, the nature of all tax, regulatory, litigation and bankruptcy laws and political risk in all relevant countries which could impact the proposed business plan and transaction cash flows. This detailed review will be conducted with the advice of experienced legal counsel and advisors in all relevant jurisdictions to ensure that the use of a Cayman Islands vehicle for the proposed business venture will meet the business objectives of all the parties and will be in compliance with the laws and regulations (including tax and regulatory requirements) in those other relevant jurisdictions.

1.4 Certainly, the creation of an investment fund or joint venture company in the Cayman Islands will require the parties to understand the tax implications of the transactions involved. The Cayman Islands government does not levy corporation, income or capital gains tax and so the business parties do not suffer an additional layer of tax in the Cayman Islands. However, that does not mean that the business parties or investors are free from tax liabilities in their home jurisdictions. An EU investor in a Cayman Island company will be taxable in the EU on its dividends or capital gains on its investment in accordance with the EU tax laws. In addition the Cayman Islands fund may be subject to withholding taxes (eg the US withhold on certain dividend sourced income) in the country in which its investments are located. In addition, many EU and US tax laws already provide for significant and detailed anti-tax avoidance provisions designed to prevent the abusive use of offshore companies. The Cayman Islands government has repeatedly condemned tax evasion and has already introduced transparency and cooperation measures by signing several Tax Information Exchange Agreements (including with the US in 2001 under which it regularly shares tax information with the US authorities) and adopting the EU Savings Directive in 2004.[41] As noted in Appendix 4, the Cayman Islands have also recently introduced a unilateral tax information assistance regime for several OECD countries which has been cited by the OECD as "setting a good examplè[42]. Furthermore, as the recent US Government Accountability Office report states, the Cayman Islands has been publically acknowledged by US Federal agencies for its timely co-operation with information requests[43].

1.5 With regard to tax matters, as mentioned previously many services provided by EU based businesses to Cayman Islands companies or investment funds result in taxable revenues being earned and taxes being paid in the EU. However many EU member state's tax laws are also specifically drafted to enable EU based investment advisors to service foreign based investment funds without the risk that the foreign investment fund itself (or indirectly the foreign investors) will be deemed to be taxable in the EU member state. Without the ability for the EU based funds industry to manage foreign based funds in this way, it is accepted that the EU investment fund management industry would not have flourished in certain EU member states and the EU would not be able to attract as much foreign sourced investment capital. For the same reason, the US currently has similar rules that enable US based fund managers to manage foreign based investment funds on a similar basis[44].

1.6 In most cases, a Cayman Islands company is simply the channel through which global capital moves between jurisdictions. For example, Cayman Islands companies are established for many international business purposes, including helping Boeing or Airbus to sell aircraft with export credit backed support, US or EU multinationals to access global markets competitively, EU or US based banks supported by government agencies to make secured loans to Cayman Islands joint venture companies to finance power projects in developing countries and US or EU based hedge fund managers to attract international investors. Through investment funds and companies the Cayman Islands already acts as a crucial channel for inward investment into major economies including the EU and the US: according to US Treasury figures[45], Cayman Islands investment funds are one of the largest holders of US debt, sovereign and private. Cayman Islands investment funds are already being formed to play a role in the economic recovery by enabling international institutional investors to channel private capital into the leading economies, for example to buy "distressed" assets, which will bring much-needed liquidity to the markets from private capital sources[46]. So, rather than being "part of the problem", the Cayman Islands is a key player in the international financial community, providing solutions to the present economic difficulties.

1.7 Approximately 9,500 open-ended investment funds (including hedge funds) are domiciled in the Cayman Islands. Whilst many hedge funds have suffered from the recent drop in market prices and values, it is worthy of note that the actual numbers of hedge funds which have been the subject of serious litigation or criminal frauds is a very tiny percentage of the overall number.

2. EXAMPLES OF THE TYPES OF BUSINESS CONDUCTED IN THE CAYMAN ISLANDS

2.1 The Cayman Islands financial services industry has grown significantly over the last 30 years directly as a result of the corresponding growth in worldwide financial markets and in particular the alternative investment fund industry. The development of the global alternative investment fund industry is well-documented in many books and journals and this submission is only intended to provide a very brief overview of this topic. The Cayman Islands has been successful in attracting the following types of financial business:

(a) investment funds—principally hedge funds and private equity funds marketed to institutional investors. The Cayman Islands are widely recognised as the leading jurisdiction for hedge fund formation.

(b) capital markets transactions—such as securitisations, capital raising corporate finance subsidiaries and note issuing programmes;

(c) structured investment products—note repackagings, credit linked transactions such as credit derivatives and credit linked notes and structured and derivative products;

(d) insurance companies and related products, such as captive insurance companies, catastrophe bonds and other alternative risk transfer products;

(e) commercial aircraft and ship finance;

(f) joint venture companies and corporate subsidiaries for international businesses; and

(g) international commercial banking.

2.2 Many of these transactions are arranged and managed by well-known fund managers, investment banks and companies based around the world and in which sophisticated institutional and high net worth investors (including pension funds, insurance companies, university endowment funds and sovereign funds) invest in order to diversify their investment portfolios through a variety of "alternative investment strategies". Consequently, only a small percentage of Cayman Islands investment funds (probably less than 1%) are marketed to retail investors and substantially all capital markets debt issuance is through the global clearing systems such as DTC and Euroclear/Clearstream and is held by institutional investors. There is a growing trend for big institutional investors, such as pension funds, insurance companies, university endowment funds and sovereign funds, to allocate larger proportions of their investment portfolios to alternative investment funds, many of them established in the Cayman Islands. It is well-documented that almost all the major developed countries have ageing populations and in the medium term it is anticipated that both private and state-run pension plans will struggle to finance their pension fund obligations based on traditional investment strategies. Consequently hedge funds, private equity funds and other investment funds based in offshore financial centres with global investment strategies may play an increasingly important role in generating enhanced returns for pension funds investors.

2.3 The alternative investment fund business, capital markets and commerce generally are becoming increasingly global. Many large multinational companies have separate and diverse businesses in many different jurisdictions. Most major investment banks and many of the bigger investment fund managers now have global investor client bases and investment management teams in more than one of the main financial centres, including New York, London, Tokyo and Hong Kong. These investment banks, investment fund managers and multi-national companies must compete globally for capital, investors and customers to build their businesses. To provide some examples:

(a) a fund manager based in London or New York with expertise in investing in European or US equities might seek investors from outside the UK or US, including Europe, the Middle East or Japan, who are looking to invest in European or US equities. The same US or UK based fund manager may also have expertise through branches in other countries to offer investment funds which specialise in investing in investments in countries outside the UK or the US (eg emerging markets);

(b) a multinational corporation may wish to enter into a joint venture with investors from many different jurisdictions to build a power generation plant or other infrastructure project in a developing country;

(c) an entrepreneur in a developing country may wish to start a business with a view to eventually raising capital by way of a public share offering in the UK or the US;

(d) a commercial airline will need the ability to raise significant capital sums from international lending syndicates to finance its aircraft fleet;

(e) a financial institution based in one jurisdiction may wish to issue notes or bonds to investors in different jurisdictions through the international capital markets, allowing it to access new sources of capital whilst at the same time providing international investors with new investment opportunities with diversified risk profiles;

(f) a business may wish to insure against natural disaster risk by way of issuing bonds into the international capital markets; and

(g) an international bank may maintain a branch or subsidiary in the Cayman Islands to provide multi currency accounts for corporate customers in order to facilitate trade financing or to provide sweep facilities and an internal treasury function to the group.

2.4 The global financial system needs, and will continue to need, legal entities which are formed (whether in the Cayman Islands or elsewhere) to facilitate such international transactions. In many cases, investment managers, investment banks and multinational companies will, on advice of their onshore legal counsel, use companies based in the Cayman Islands and other international financial centres to build their investment fund structures, capital markets transactions or other business ventures. The international business community thus benefits by being able to form such legal entities swiftly and efficiently in a stable jurisdiction and on a tax-neutral basis. This can be of particular benefit to developing countries in Africa and other regions, where facilitating inward private investment is critical to their economic development.

2.5 In relation to banking, the Cayman Islands is one of the leading international financial centres that provides legitimate commercial advantages to onshore banks. All banks carrying on business in or from the Cayman Islands are licensed and regulated by the Cayman Islands Monetary Authority ("CIMA"). Branches and subsidiaries of international banking groups are regulated by CIMA on a consolidated basis with the onshore regulator in accordance with Basel Core Principles. Private banks are required to establish a full physical presence (ie staff and resources) with CIMA as the primary regulator. As a general policy, CIMA will not issue licences to a private bank unless they are a subsidiary or an affiliate of a major international banking group. For those entities where CIMA is the primary regulator, risk management policies and procedures will be implemented in accordance with Cayman Islands law. Entities which are principally regulated by the home supervisor will be required to adhere to home jurisdiction requirements. Both home and host supervisor will have access to relevant information retained by Cayman Islands branches or subsidiaries. The model of consolidated supervision and the risk procedures and ratios adopted by CIMA have been reviewed and approved by the IMF[47].

3. THE REASONS WHY THE CAYMAN ISLANDS ATTRACTS HIGH QUALITY INTERNATIONAL BUSINESS

3.1 Some of the reasons why the international business community use companies based in the Cayman Islands include the following:

(a) Political Stability. The Cayman Islands are politically and economically stable. Unemployment is low and the standard of living one of the highest in the Caribbean. The favourable economic situation of the Cayman Islands is key factor in its political stability. This stability is also reflected in Moody's country ceiling rating of "Aaa".

(c) Quality of Service Providers. The quality of the service-providers (attorneys, auditors, mutual fund administrators, trust companies, company managers, etc.) in the Cayman Islands is very high. The majority of the Islands' professionals are recruited from the top law and accountancy firms and financial institutions in London and other major financial centres. In response to client demand, the Cayman Islands have therefore developed an expertise and level of service in the financial services industry which meets the standards set by major onshore financial centres.

(d) Investor requirements. By using a Cayman Islands company to make an investment into foreign jurisdictions, investors are able to better realise their investment by either selling their shares or in an initial public offering (IPO) of shares in the Cayman Islands company. The Cayman Islands legal infrastructure, with which most international investors are familiar, makes it easier to effect such sale or IPO. If the investment were directly into a company in the foreign jurisdiction, the investors would need to understand what rules applied to such investment and a flotation could be more complex and expensive in ensuring that the listing and relevant securities registration rules and local rules are complied with on the IPO; the "catchment" area for investors would also be narrower. As many Cayman Islands entities have been listed on major stock exchanges such as London, New York and Hong Kong, investors can have confidence that a flotation should, from a legal standpoint, be possible in due course.

(f) Exchange Control and Cash Flow Neutrality. A Cayman Islands company is not subject to Cayman Islands foreign exchange controls and there are no significant restrictions on the payment of interest or dividends, the repayment of capital or the ability to repurchase shares or redeem or repurchase debt. This is important because some cross-border transactions would be rendered uneconomic if cash flows are interrupted by foreign exchange controls or such payment restrictions.

(g) Tax Neutrality. Cayman Islands companies provide a tax-neutral platform so that investors from multiple jurisdictions are not subject effectively to double taxation by virtue of the investment fund or offshore company adding extra layers of foreign taxation at different levels of the structure in addition to the investors' home country tax. This neutrality is important because it provides a level playing field for all investors; in other words it avoids creating a vehicle in a jurisdiction that may provide more benefits to some investors than others. The fact that there are no direct corporate or income taxes levied in the Cayman Islands and that accordingly transactions can be structured on a "tax-neutral" basis, unfortunately often leads to a misconception that investors in offshore companies are free from all forms of taxation. This is not the case at all. Investors based in onshore jurisdictions are likely to be taxed on dividend and other income received from the offshore company and on any capital gains realised on the sale or redemption of shares in the offshore company. Many onshore jurisdictions have also introduced anti-avoidance tax rules that tax income and gains which are rolled up in the offshore vehicle as if they had been distributed. Additionally, the offshore company may itself be subject to withholding taxes imposed in respect of income or gains on its investments by tax authorities in the onshore jurisdictions in which the offshore company's businesses or investments are located and such withholding taxes are frequently not creditable against taxes paid by the investor in the offshore vehicle in respect of the same income or gains. Furthermore, a Cayman Islands company may have a branch or a place of business in an onshore jurisdiction or be centrally managed and controlled in an onshore jurisdiction and be subject to the taxing regime in that onshore jurisdiction.

(h) Legal Neutrality. This is often important. A Cayman Islands company provides a level playing field for all investors; in other words it does not provide more benefits to some investors than others based on, for example, their nationality. This favours the pooling of international investment.

(i) Jurisdictional Litigation Risk, Tax and Regulatory Mitigation. International investors and businesses are often concerned that a direct investment in investments based in jurisdictions outside their home territory might expose them to jurisdictional litigation risk or make them subject to additional complex tax or regulatory requirements in multiple jurisdictions. Investments through offshore companies can therefore be a valuable risk management tool for international businesses. To highlight some examples:

(1) Some non-US investors prefer to invest in US investments through an offshore fund and not directly in the US because of the perceived increased litigation risk of being deemed to be present in the US by virtue of their passive investment activities. International investors are well aware of the highly litigious business environment in the US and the often vexatious litigation commenced by US class action lawyers. Many investors are concerned about the risk of being subject to a jury trial in the US and the unpredictable damages claims which might ensue. This concern was highlighted by a McKinsey report prepared for the Mayor of the City of New York in 2007[50] as a reason why the New York financial service industry was losing business to other major international financial centres, such as London. On a similar theme we have seen more offshore companies being formed by non-US businesses and listing on the AIM stock exchange in London rather than the NASDAQ as a result of the increased regulatory risk and costs involved with compliance with recent US regulations, such as the Sarbanes-Oxley Act.

(2) In some cases US investors in fund limited partnerships prefer to see the partnership hold non-US investments through offshore holding companies to reduce the risk that their limited liability status might be jeopardised by an investment by the fund in other jurisdictions.

(3) In order to encourage passive inward foreign investment into some jurisdictions, we understand that the onshore tax codes in some countries may seek to create certain safe harbours for foreign investors or foreign investment funds whose activities are restricted to passive investing with an onshore based fund manager in the onshore jurisdiction. These foreign investors or foreign investment funds may be deemed not to be engaged in a trade or business in the onshore jurisdiction for tax purposes solely by virtue of their passive investment activities and therefore are not generally subject to tax in that jurisdiction generally on their other worldwide business revenues, save perhaps for a withholding tax on certain dividend payments on some investments. However, foreign investors or foreign investment funds may still prefer to invest in investments managed by an onshore fund manager through an offshore fund to reduce the risk that the foreign investors could unnecessarily be held to be engaged in a trade or business within the onshore jurisdiction and inadvertently become subject to onshore tax on their foreign-based assets because their investments are managed by an onshore-based fund manager. In this way the use of offshore investment funds helps onshore fund managers compete globally for international investors.

APPENDIX 2

CAYMAN ISLANDS HEDGE FUNDS

1. INTRODUCTION

1.1 The hedge fund industry is an international industry. Hedge fund investment managers based in the EU compete against hedge fund managers based in other locations such as Manhattan, Hong Kong, Singapore and Geneva. Typically, hedge fund investors are not retail investors but institutional investors such as sovereign wealth funds, pension plans, insurance companies, university endowments and family offices of high net worth investors. The minimum investment required to invest in a hedge fund is usually above US$100,000 and often above US$1,000,000. In most cases, a European individual retail investor can only indirectly be exposed to an investment in hedge funds or other alternative investment funds through a fund of funds established as a UCITS fund in places like Ireland or Luxembourg.

1.2 Once an investment advisor has decided to establish an office in the EU, the next business challenge is how and where to establish the investment fund company it will manage which will enable it to attract investors from around the world.

1.3 Let us assume that an investment advisor based in the EU wants to start a new global long/short hedge fund which will focus on investing in debt or equity securities issued by companies based in the EU, the US and emerging market countries. The investment advisor will often start a hedge fund with a small number of seed investors. In this example, we will assume that the investment advisor is in discussions with a number of international investors including a Middle Eastern sovereign wealth fund, US pension funds, UK pension funds, a Cayman Islands fund of funds and Japanese financial institutions.

1.4 The first question is where the investment advisor will establish the hedge fund vehicle into which the investors will invest and which will undertake the investment activities. The investment advisor must consider the location of the investors, the countries in which it will invest, the effect of any tax or exchange controls on cash flows through the hedge fund, the confidence, familiarity and preference of the investors and trading counterparties in the selected jurisdiction, the regulatory position and the quality of the local service providers.

1.5 The Cayman Islands has become the preferred domicile for approximately 70% of the world's hedge funds. In our example, the investment advisor has decided to establish the new hedge fund (a "Master Fund") in the Cayman Islands with various feeder funds (the "Feeder Funds"), including a Delaware feeder fund, as represented by the diagram in Example 1 below.

1.6 This example is indicative only of general principles and a fully worked example would require specialist advice from counsel in all relevant jurisdictions.

2. WHY THE CAYMAN ISLANDS?

2.1 The international investors will want to invest in a tax neutral investment fund. None of the non-EU investors will usually want to invest in a hedge fund based in the EU or the US, since otherwise the hedge fund might unnecessarily be subject to EU or US corporation tax. Foreign investors will not want to be subject to EU or US tax on a global strategy fund where the only touch point with the EU or the US may be the location of the investment advisor. The Cayman Islands hedge fund may be specifically exempted from EU corporation tax if the hedge fund's central management and control is outside the EU. US tax exempt investors (such as pension funds and college endowments) will often prefer to invest in a Cayman Islands company to qualify for relief against unrelated business taxable income as permitted under the US tax code.

2.2 There are no additional taxes or exchange controls imposed on the hedge fund in the Cayman Islands.

2.3 The hedge fund is regulated by the Cayman Islands Monetary Authority and investors are comfortable with the Cayman Islands regulatory regime, which is based on a requirement for adequate disclosure. In addition, investors recognise that the investment advisor will be regulated by an EU based regulator, such as the UK Financial Services Authority. The prime broker and custodian are also likely to regulated in the EU. If a fund administrator in the Cayman Islands is selected, that administrator will be regulated by the Cayman Islands Monetary Authority. If an overseas administrator is selected, that administrator will usually be regulated in that overseas jurisdiction.

2.4 Currently, the shares in a Cayman Islands investment fund can be sold to EU and UK investors under the permitted sophisticated investor private placement rules in the relevant securities laws. Each jurisdiction in which the company offers its shares will also typically have its own offering restrictions.

2.5 International investors are familiar with Cayman Islands hedge funds and comfortable with the legal system and their rights as shareholders in the Cayman Islands. The Cayman Islands Companies Law expressly provides for the easy redemption of shares.

2.6 All major prime brokers and counterparties are comfortable with conducting business (including extending credit and margin) to Cayman Islands companies.

2.7 The hedge fund, although domiciled in the Cayman Islands, will still be required to comply with the laws on market manipulation, insider dealing, late trading and short selling in the jurisdictions in which it trades.

2.8 For more detail and information on hedge funds please see: Hedge Funds: Law and Regulation (Cullen/Parry) Sweet & Maxwell; Hedge Funds (Gabbert) Lexis/Nexis; International Financial Services London—Hedge Funds Report April 2009 and; Alternative Investment Management Association—www.aima.com

3. ANTI MONEY LAUNDERING DUE DILIGENCE

3.1 The company formation agent who incorporates the hedge fund is required under the Money Laundering Regulations (described in more detail in Appendix 3) to "identify the client". This means in this instance identifying (a) the initiator of the transaction, normally the investment manager or sponsor that approached the company formation agent and (b) the directors and shareholder(s) of the hedge fund in accordance with the requirements of the Money Laundering Regulations and the related guidance notes.

3.2 As most hedge funds in the Cayman Islands are regulated under the Mutual Funds Law (2009 Revision), the hedge fund itself is required to conduct "KYC checks" on the investors into the hedge fund. This is often delegated to the administrator of the hedge fund if the administrator is located in the Cayman Islands or a jurisdiction which is deemed to have laws and regulations equivalent to the Money Laundering Regulations.

4. CASH FLOWS AND TAX

4.1 The investors will subscribe for shares in the relevant Feeder Fund and each Feeder Fund will in turn subscribe for shares in the Master Fund. It is common for a hedge fund to have a Delaware based feeder fund for US taxable investors, a Cayman Islands unit trust for Japanese investors and a Cayman Islands corporate feeder for other non-US investors and US-tax exempt investors. The Feeder Funds will make the necessary tax and regulatory filings in the US, Japan and other relevant jurisdictions on advice form counsel in those jurisdictions.

4.2 The Cayman Islands Master Fund will invest the share subscription proceeds in the global investments. It will not be subject to additional tax in the Cayman Islands but it may be subject to withholding taxes in other jurisdictions on amounts it receives on its investments.

4.3 The Cayman Islands Master Fund will be advised by the EU based investment advisor and will pay advisory fees for these services. These will be taxable receipts in the EU and helps create jobs for an EU based business.

4.4 The Cayman Islands Master Fund may trade through an EU based prime broker and use an EU based custodian and will pay fees and commissions for these services. These will be taxable receipts in the EU and help create jobs for these EU based businesses.

4.5 The investors will not be subject to capital gains or income tax in the Cayman Islands. Investors will however be subject to income and capital gains taxes on receipt of dividends or proceeds of share redemptions in their home jurisdiction. The investors may also be subject to anti-tax avoidance rules in their home jurisdictions to prevent abuse.

4.6 The countries in which the hedge fund invests benefit from increased liquidity created by the hedge fund's investment activities.

4.7 Please note that we only practise Cayman Islands law and do not purport to hold ourselves out to be experts in tax or securities laws of any other jurisdiction. Tax and securities law is by its nature, very complex and the above analysis is a general overview only. Each fund will have different circumstances and will require detailed advice from counsel qualified in the relevant jurisdictions.

APPENDIX 3

CAYMAN ISLANDS ANTI-MONEY LAUNDERING REGIME

1. So-called "all crimes" anti-money laundering legislation was introduced in the Cayman Islands in 1996. Prior to this, in common with many other countries such as the UK, the Cayman Islands had money laundering provisions which criminalised dealings with the proceeds of drug trafficking. The Proceeds of Criminal Conduct Law ("PCCL"), was passed in 1996 and has been regularly amended and revised to meet international standards. The Cayman Islands was the first Caribbean jurisdiction to introduce such legislation and the PCCL has been used as a legislative model for other regional jurisdictions. The PCCL essentially provides for the criminalisation of all forms of money laundering, a mandatory reporting obligation, a tipping off offence, the empowerment of the police and courts to search, freeze and confiscate the proceeds of crime and the ability of the courts and relevant authorities to assist in the enforcement of foreign confiscation judgments. The PCCL was recently repealed and replaced by the Proceeds of Crime Law, 2008, which extended the powers and provisions of the PCCL, to include sections similar to the UK Proceeds of Crime Act 2002 and Serious Organised Crime and Police Act 2005.

2. The Terrorism Law was introduced in 2003 and provides for terrorism and terrorist financing offences. The Terrorism Law includes a mandatory reporting obligation and tipping off offence. Since October 2001, the Cayman Islands have also applied the Terrorism (United Nations Measures) (Overseas Territories) Order, which provides for similar offences.

3. The Money Laundering Regulations (the "Regulations") were introduced in 2000 and essentially codified the basic procedural requirements which the financial service industry had been applying voluntarily for some time. The Regulations require that financial service providers conducting relevant financial business maintain the following procedures when entering a business relationship or carrying out a one-off transaction:

(a) client identification and verification;

(b) record keeping;

(d) suspicious activity reporting and appointment of a Money Laundering Reporting Officer;

(e) appointment of a Compliance Officer; and

(f) training and awareness.

4. Client identification and verification procedures will normally include obtaining information on the controllers and principal beneficial owners of client entities. In 2001, the Regulations were amended so that the requirement to maintain client identification and verification procedures would apply to all relationships established prior to the introduction of the Regulations (ie perform due diligence on all relationships pre-2000). Financial service providers were given until September 2003 to obtain such information. To date, the Cayman Islands are the only jurisdiction to have completed the retrospective due diligence exercise across all industries.

5. The Regulations apply to all licensed banks, trust companies, corporate service providers and company managers, insurance companies, and insurance brokers, agents and managers, mutual fund administrators and regulated mutual funds, as well as those entities registered and licensed to conduct securities investment business, amongst others.

6. In contrast, the US has yet to apply the USA Patriot Act Rules to entities beyond certain banks, broker-dealers, and commodity pool operators, and the key company incorporation states of Delaware, Nevada and Wyoming do not enforce similar standards. Wyoming supposedly domiciles over 400,000 companies and Delaware domiciles over 500,000 corporations. The Cayman Islands domiciles just over 60,000. The UK (and other EU member states) has only recently extended its Money Laundering Regulations to trust companies following the implementation of the third EU Money Laundering Directive in 2007.

7. Unlike other jurisdictions (including certain states in the US and members of the European Union, including the UK), the Cayman Islands do not permit companies to issue bearer shares, unless they are deposited with a recognised custodian.

8. The Guidance Notes on the Prevention and Detection of Money Laundering in the Cayman Islands (the "Guidance Notes") were first issued in 2001 and provide practical guidance as to the application of the Regulations. The Guidance Notes superseded the Anti-Money Laundering Code of Practice which had been in use from 2000. The Guidance Notes are not law but apply to the same entities subject to the Regulations and are to be considered when determining a financial service provider's compliance with the Regulations. They therefore carry evidentiary weight and must be followed by financial service providers. The Guidance Notes, which run to more than 150 pages, set out detailed guidance, of both general and sector-specific application, for financial service providers who must verify client identity, maintain adequate records, maintain suspicious activity reporting procedures, provide anti-money laundering training and so forth.

9. The Cayman Islands have been a member of the Caribbean Financial Action Task Force ("CFATF") since its inception in 1992. The CFATF is a 30-nation member organisation, recognised by the FATF as an associate member, which is commissioned to undertake peer evaluations on behalf of the FATF and fellow agencies. The United States is a CFATF supporting nation, along with the UK, Canada, France, Mexico, Spain and The Netherlands.

10. The Cayman Islands anti-money laundering and combating of terrorist financing regime recently underwent an assessment by the CFATF in June 2007. The CFATF evaluation team included a representative from US Treasury FinCEN and the Canadian RCMP. The assessment report was issued in December and indicated that the Cayman Islands were compliant or largely compliant with 38 out of the 49 FATF AML and CFT Recommendations. The Recommendations represent the international standards for AML/CFT.

11. The results of this assessment follow the excellent rating provided by the IMF on evaluating the Cayman Islands using the same AML/CFT methodology in 2003. The IMF reported that the Cayman Islands had an intense awareness of anti money-laundering and combating of financing of terrorism in the business community.

12. Based on the FATF evaluations undertaken to date since 2004 on over 85 FATF member and non-member (onshore and offshore) jurisdictions, the Cayman Islands currently rank sixth equal for overall compliant and largely compliant Recommendations. This means that the Cayman Islands achieved better results than most other countries including the United Kingdom, Switzerland, Spain, Italy and Ireland.

APPENDIX 4

CAYMAN ISLANDS INTERNATIONAL COOPERATION AND INFORMATION EXCHANGE

1. The Cayman Islands has invoked numerous statutory measures to cooperate with and assist foreign governments, authorities and courts with the provision of information held in the Cayman Islands. Such laws override any statutory or common law duties of confidentiality.

2. Mutual legal assistance for criminal matters has been covered under the Criminal Justice (International Cooperation) Law from 1997 and, with particular regard to US criminal matters, under the Narcotics Drugs (Evidence (United States of America) Law from 1984 and the Mutual Legal Assistance (United States of America) Law ("MLAT") from 1986. It is understood that the MLAT mechanism with the US has been rarely used since 1986 (ie approximately 230 requests). Extradition between the Cayman Islands and US is provided for by the United States of America Extradition Order 1976 and Amendment Order of 1986.

3. The Misuse of Drugs Law and Proceeds of Crime Law, 2008 also contain provisions for the sharing of information with authorities in relevant circumstances. As of 2008, of 23 requests made to the Cayman Financial Reporting Authority by US authorities since 2003 in relation to money laundering and predicate offences, 22 have been granted.

4. The Cayman Islands are also a party to the Hague Convention 1970 on the taking of evidence abroad and can share information with other Hague Convention signatories.

5. As a regulatory matter, CIMA is empowered under the Monetary Authority Law (2008 Revision) to entertain requests for information from any recognised overseas regulatory authority exercising equivalent functions. As such, CIMA do not consider requests from fiscal authorities in relation to tax matters (see below under 6). If certain criteria are met, CIMA will direct a local financial service provider or connected person to disclose information they hold which is responsive to the overseas regulatory authority's request. Separately, CIMA has entered into Undertakings and Memoranda of Understanding with the multiple regulatory authorities and agencies, including the SEC and the FSA.

6. In relation to disclosure for tax matters, the Cayman Islands made an advance commitment to the OECD in terms of adhering to their principles on exchange of tax information and transparency. In 2001, the Cayman Islands signed a Tax Information Exchange Agreement with the United States. This provided for the provision of information in relation to criminal tax matters from the 2004 tax year and civil matters from the 2006 tax year and does not require a dual criminality test (ie that the matter constitutes a criminal offence in both the US and the Cayman Islands). Since then, the Cayman Islands have introduced the Tax Information Authority Law, 2005, which established the Tax Information Authority as the competent authority in the Cayman Islands for dealing with foreign tax information requests and tax reporting and schedules the Tax Information Exchange Agreement with the United States. The US Tax Information Exchange Agreement conforms to the model developed by the OECD Global Forum on Taxation, and is a form of an agreement which both the G-8 and G-20 countries have endorsed as reflecting "high standards of transparency and exchange of information for tax purposes".

7. In 2005, the Cayman Islands implemented with the Member States of the European Union exchange of information measures consistent with the EU Savings Directive and has introduced the Reporting of Savings Income Information (European Union) Law, 2007 (and related Regulations). The Tax Information Authority is empowered to deal with disclosures under both laws and is the local liaison with the relevant foreign competent authority. A total of 11,616 reports were made for the period 1 January 2005 through 31 December 2007[51].

8. The Cayman Islands decided not to introduce the transitional withholding tax option, favoured by Switzerland, Belgium, Luxembourg and Austria, as it was perceived not to be supportive of higher standards of transparency and could promulgate tax evasion. The Law and Regulations imposed obligations on "paying agents" within the Cayman Islands (which may include banks and fund administrators) who make or hold payments of "savings incomè for individuals who are tax residents of EU Member States. The obligations require that "paying agents" provide information via the Tax Information Authority to the respective EU tax authorities on the amount of payments of "savings incomè together with details of the recipient EU tax resident individuals.

9. The Tax information Authority Law was amended in 2008 to provide for a parallel mechanism for cooperation in tax matters that can be used in addition to bilateral agreements. The mechanism would allow the Cayman Islands to enter unilateral arrangements for the sharing of tax information with certain jurisdiction and was designed specifically to reflect OECD technical standards for transparency and provision of information. This legislation has been recognised by the OECD as innovative and acknowledged as offering the possibility of speeding up the process of allowing for the exchange of tax information internationally.

10. As at 31 July 2009, the Cayman Islands has entered a total of 11 bilateral agreements and has 12 unilateral arrangements in place for tax information exchange with up to 17 of the 30 OECD member states, including the US, UK, Germany and Ireland.

11. The OECD issued a progress report on 2 April 2009 with respect to 82 financial centres around the world towards implementation of an internationally agreed standard on exchange of information for tax purposes. Cayman was placed on the OECD's "grey" list of jurisdictions that have committed to the internationally agreed tax standard, but not yet substantially implemented it. The 11 jurisdictions with which Cayman has entered into a bilateral tax information exchange agreement were recognised but Cayman was not credited for the additional 12 jurisdictions to which it has extended the unilateral exchange mechanism described above. However a footnote to the list acknowledged the additional 12 jurisdictions and stated that this legislation is being reviewed by the OECD. It is hoped that this will lead to Cayman being removed from the "grey" list at the earliest opportunity and added to the "white list". The countries with which Cayman has bilateral tax information exchange agreements are: United States, Denmark, Finland, Greenland, Iceland, Norway, The Faroe Islands, The United Kingdom, Sweden, Ireland, The Netherlands.

12. The Cayman Islands Government and CIMA have had ongoing dialogue with foreign national and international agencies such as the SEC and International Organization of Securities Commissions ("IOSCO") to ensure that the Cayman Islands is viewed as cooperative and responsive in relation to requests for information on regulatory and criminal matters. This assistance was recently publicly recognised by the US Department of Justice in relation to an agreement reached with the Cayman Islands regarding a particular MLAT request and consequent prosecution in the US.

APPENDIX 5

REGULATION OF FINANCIAL SERVICES IN THE CAYMAN ISLANDS

1. CAYMAN ISLANDS REGULATOR

1.1 The Cayman Islands Monetary Authority ("CIMA") is the financial services regulator, responsible for prudential and anti-money laundering regulation of hedge funds, investment managers, fund administrators and custodians as licensees and registrants under the Mutual Funds Law, the Securities Investment Business Law and the Banks and Trust Companies Law.

1.2 CIMA is a full member of the International Organisation Securities Commission ("IOSCO"), the Offshore Group of Banking Supervisors ("OGBS"), the Offshore Group of Insurance Supervisors ("OGIS") and the Offshore Group of Collective Investment Scheme Supervisors, as well as a member of the OECD's Level Playing Field sub-committee.

1.3 CIMA adopts and applies the Basle Core principles (for banking), IAIS principles (for insurance), IOSCO principles (for securities and investment) and OECD principles for corporate governance.

1.4 In a review conducted in 2003, the International Monetary Fund ("IMF") recognised that an "extensive program of legislative, rule and guideline development has introduced an increasingly effective system of regulation, both formalising earlier practices, and introducing enhanced procedures." (source: CIMA website).

1.5 As a regulatory matter, CIMA is empowered under the Monetary Authority Law (2008 Revision) to entertain requests for information from any recognised overseas regulatory authority exercising equivalent functions. Separately, CIMA has entered into Undertakings and Memoranda of Understanding with the multiple foreign regulatory authorities and agencies, including the US Securities Exchange Commission and the UK's Financial Services Association.

2. INVESTMENT FUNDS

2.1 As part of the overall good governance of the financial industry, the Mutual Funds Law regulating mutual funds and mutual fund administrators, came into force in July 1993 and was most recently amended in August 2008. Responsibility for the regulation of mutual funds and mutual fund administrators rests with CIMA. Hedge funds and mutual fund administrators are required to be registered or licensed before commencing business.

2.2 The aim of the Mutual Funds Law is to protect investors and the Cayman Islands against undesirable promoters and managers of mutual funds by ensuring that only those with the appropriate experience and standing are permitted to establish and manage mutual funds in the Cayman Islands.

2.3 Whilst the content of investment objectives, rates of return or other commercial matters (such as the appointment of local custodians or managers) are not expressly subject to proscriptive rules, the position of the Cayman Islands law is that, provided proper disclosure is made and persons of appropriate experience and reputation are responsible for the mutual fund, investors should be free to make their own determination as to whether to invest.

2.4 There are three available forms of regulation of mutual funds under the Mutual Funds Law:

(a) The Licensed Mutual Fund

The first route is to apply to CIMA for a licence for the mutual fund that may be issued in the discretion of CIMA. It is necessary to file with CIMA an offering document together with the prescribed statutory form (Form MF3). If CIMA considers that each promoter is of sound reputation, the administration of the mutual fund will be undertaken by persons who have sufficient expertise and who are fit and proper to be directors (or, as the case may be, managers or officers in their respective positions), and that the business of the fund will be carried out in a proper way, then the licence will be granted. This route will be appropriate for mutual funds which are promoted by well-known and reputable institutions and which do not propose to appoint any Cayman Islands mutual fund administrator.

(b) The Administered Mutual Fund

The second route is for the mutual fund to designate its principal office in the Cayman Islands at the office of a licensed mutual fund administrator. In this case, an offering document together with the prescribed statutory form must be filed with CIMA. The administrator and the fund must also complete and file a prescribed statutory form. There is no requirement for the mutual fund itself to obtain a licence. Instead, the mutual fund administrator is required to be satisfied that each promoter is of sound reputation, the administration of the mutual fund will be undertaken by persons who have sufficient expertise to administer the mutual fund and are of sound reputation and that the business of the mutual fund and the offer of equity interests will be carried out in a proper way. The administrator must report to CIMA if it has reason to believe that a fund for which it provides the principal office is acting in breach of the Law or may be insolvent or is otherwise acting in a manner prejudicial to its creditors or investors (see the section below headed CIMA's Powers').

(c) The Section 4(3) Mutual Fund

There exists a further category of regulated mutual fund pursuant to section 4(3) of the Law and which is of application either:

(i) where the minimum investment per investor is at least US$100,000; or

(ii) where the equity interests are listed on a recognised stock exchange.

For a section 4(3) fund, there is no requirement for licensing or the provision of a principal office by a mutual fund administrator in the Cayman Islands; rather the section 4(3) mutual fund simply registers with CIMA by filing an offering document together with the prescribed statutory form (Form MF1).

2.5 Every regulated mutual fund must issue an offering document (unless exempted by CIMA), which must describe the equity interests in all material respects and contain such other information as is necessary to enable a prospective investor to make an informed decision (whether or not to invest). In addition, the pre-existing statutory obligations with regard to misrepresentation and the general common law duties with regard to proper disclosure of all material matters continue in effect. There is an obligation to file an amended offering document in the event of material changes where there is a continuing offering. CIMA has issued guidelines regarding the form and content of offering documents for certain types of licensed hedge funds.

2.6 Every regulated fund must file, with its initial application, a written consent from each of the administrator and the auditor to its appointment.

2.7 All regulated mutual funds must (unless specifically exempted) appoint auditors (approved by CIMA) and file audited accounts within six months of the financial year-end.

2.8 CIMA has implemented its electronic reporting system for all funds registered with CIMA in the Cayman Islands. CIMA has released on its website the electronic Fund Annual Return ("FAR") form and has opened the internet portal through which funds' local auditors must submit the required returns. Related guidance notes have also been released. The FAR form and portal can be accessed at www.cimoney.com.ky/ereporting. The FAR form must be submitted annually through the fund's auditor, although the operators of the fund remain responsible for the accuracy of the contents of the FAR form. All directors and investment managers of registered hedge funds should therefore put in place procedures to ensure compliance with these new requirements.

2.9 The fund must also inform CIMA if it has changed its registered office or its principal office or (in the case of a unit trust) if there has been a change in the trust company acting as its trustee.

2.10 The fund must also comply with any special conditions which CIMA has imposed in respect of its licensing as a mutual fund.

2.11 CIMA has wide-ranging enforcement powers under the Mutual Funds Law. If CIMA is satisfied, in respect of a regulated mutual fund, that: (a) the fund is unable or likely to become unable to meet its obligations as they fall due; (b) the fund is carrying on (or attempting to carry on) business or winding up in a manner that is likely to be prejudicial to investors or creditors; (c) the fund (if a licensed mutual fund) is carrying on business in breach of a condition of its licence; (d) the direction and management of the fund has not been conducted in a fit or proper manner; or (e) a person holding a position as a director, manager or officer of the fund is not a fit and proper person to hold the respective position, then CIMA has wide powers, eg to notify investors if circumstances permit, to appoint persons to assume control of the affairs of a regulated mutual fund, to require additional audited accounts to be provided, to reorganise the affairs of or dissolve a mutual fund or generally to take such other action as is considered necessary to protect the interests of investors or creditors including the cancellation of a fund's licence or registration. The exercise of all such powers is subject to appeal.

2.12 An auditor is under a statutory obligation, when auditing the accounts of a regulated mutual fund or a mutual fund administrator, to notify CIMA if it obtains information or suspects that the fund or the administrator: (a) is or is likely to become unable to meet its obligations as they fall due; (b) is carrying on or attempting to carry on business or is winding up its business voluntarily in a manner that is prejudicial to its investors or creditors (or, in the case of a mutual fund administrator, in a manner which is prejudicial to investors in any fund administered by it or to its creditors or the creditors of such a fund); (c) is carrying on or attempting to carry on business without keeping any or sufficient accounting records to allow its accounts to be properly audited; (d) is carrying on or attempting to carry on business in a fraudulent or criminal manner; or (e) is carrying on or attempting to carry on business otherwise than in compliance with the Law, certain other Cayman Islands laws and regulations (including as to anti-money laundering) or a condition of its licence (if a licensed mutual fund).

2.13 Any mutual fund administrator or auditor who (in good faith) advises CIMA that it has grounds for exercising its authority (as set out above) has the benefit of statutory protection from liability.

3. INVESTMENT MANAGERS, INVESTMENT ADVISORS, BROKERS AND DEALERS

3.1 The Securities Investment Business Law (2004 Revision) (the "SIB Law") sets out a framework for CIMA to regulate securities investment business in the Cayman Islands. Any person conducting securities investment business must be licensed by CIMA, unless that person is exempt from holding a licence.

3.2 A person who carries on securities investment business and who is exempt from obtaining a licence may still be subject to registration under the SIB Law (which means that they are required to make an annual filing with CIMA). The SIB Law also creates certain offences.

3.3 Securities investment business is defined as being engaged in the course of business in any one or more of the activities set out in Schedule 2 of the SIB Law. The activities set out in Schedule 2 include:

(a) dealing in securities as an agent;

(b) dealing in securities as principal, but only where the person dealing holds himself out as dealing in securities at prices determined generally and continuously, or holds himself out as engaging in the business of underwriting securities or regularly solicits members of the public to induce them to buy or sell or subscribe for securities and the dealing results from that solicitation;

(c) making arrangements in relation to securities with a view to another person dealing in securities or a person who participates in the arrangements dealing in securities;

(d) managing securities belonging to another person on a discretionary basis; and

(e) advising in relation to securities but only if the advice is given to someone in their capacity as investor or potential investor and the advice is on the merits of that person buying, selling, subscribing for or underwriting a particular security or exercising any right conferred by a security to buy, sell, subscribe for or underwrite a security.

3.4 An applicant for a licence must satisfy CIMA that: (a) it will be able to comply with the SIB Law (and any regulations made under the SIBL Law); (b) it will be able to comply with the Money Laundering Regulations (2009 Revision); (c) it will not be against the public interest, including, but not limited to the need to protect investors, for the application to be approved; (d) the applicant has personnel with the necessary skills, knowledge and experience and the facilities, books and records that CIMA considers appropriate; and (e) the applicant's senior officers and managers are fit and proper persons.

3.5 Once CIMA has licensed the investment manager, a licensee's obligations include the following:

(a) the licensee shall separately account for the funds and property of each client and for the licensee's own funds and property;

(b) to notify CIMA of any change in its principal office or of the name of any body corporate or individuals acting as its agents in the Cayman Islands;

(c) not to appoint a director or similar senior officer, or a general partner, as the case may be, unless CIMA's written approval to the appointment has been obtained or CIMA has exempted the administrator from this obligation;

(d) to have at least 2 directors;

(e) subject to certain exceptions, no shares may be issued or transferred unless CIMA has either given its approval to the issue or transfer or waived the obligation to obtain that approval; and

(f) to have its accounts audited annually by an auditor approved by CIMA and to send its audited accounts to CIMA within six months of the end of the relevant financial year together with a certificate of compliance with the provisions of the SIB Law and any regulations made under the SIB Law or the Monetary Authority Law (2004 Revision), signed by the licensee or if a company, a director of the licensee.

3.6 The investment manager is also required to comply with any special conditions attaching to its licence. CIMA may also make regulations in respect of licensees which:

(a) specify standards for the form and content of any advertising or promotion of securities or of securities investment business;

(b) require a licensee to make full and proper disclosure to clients of the capacity in which he is acting in relation to a particular securities investment business transaction and whether the transaction is being effected for his own account or that of any person other than the client;

(c) specify standards for dealings with clients and clients' assets, including the holding upon trust of clients' assets by the licensee;

(d) establish financial requirements and specify standards for financial conduct and record keeping and reporting;

(e) specify disclosure requirements in respect of the amount, value or arrangements for the payment or provision, of commissions or other inducements;

(f) specify arrangements for the settlement of disputes; and

(g) specify the nature and extent of any insurance arrangements required of the licensee.

3.7 A licensee shall not, without the prior written approval of the Authority, open outside the Cayman Islands a subsidiary, branch, agency or representative office or change its name.

3.8 CIMA has wide-ranging enforcement powers under the SIB Law. If CIMA knows or has reasonable grounds to believe that a licensee (a) is or appears likely to become unable to meet its obligations as they fall due; (b) is carrying on business fraudulently or otherwise in a manner detrimental to the public interest, to the interest of its clients or to the interest of its creditors; (c) has contravened any provision of this Law, or of any regulations made hereunder, or of the Money Laundering Regulations (2009 Revision); (d) has failed to comply with a condition of its licence; (e) has not conducted the direction and management of its business in a fit and proper manner, or has senior officers, managers or persons who have acquired ownership or control who are not fit and proper persons; or (f) has failed to comply with any lawful direction from the CIMA, then in such cases CIMA may (i) revoke the licence; (ii) impose conditions or further conditions upon the licence or amend or revoke any such conditions; (iii) apply to the court for any order which is necessary to protect the interests of clients or creditors of the licensee, including an injunction or restitution or disgorgement order; (iv) publish in the Gazette and in any official publications of CIMA, a breach by any person of the SIBL Law, of any regulations made thereunder or of any lawful direction issued by CIMA; (v) at the expense of the licensee, require the licensee to obtain an auditor's report on the licensee's anti-money laundering systems and procedures for compliance with the Money Laundering Regulations (2009 Revision); (vi) require the substitution of any director or officer of the licensee whenever appointed, or the divestment of ownership or control acquired under section 8 of the SIB Law; (vi) at the expense of the licensee, appoint a person to advise the licensee on the proper conduct of its affairs and to report to CIMA thereon; (viii) at the expense of the licensee, appoint a person who shall be known as the CIMA's appointed controller, to assume control of the licensee's affairs who shall, subject to necessary modifications, have all the powers of a person appointed as a receiver or manager of a business appointed under section 18 of the Bankruptcy Law (as revised); (ix) in the case of a reasonable belief that the licensee has materially contravened the Money Laundering Regulations (2009 Revision), report the same to the Attorney-General; or (x) require such action to be taken by the licensee as CIMA reasonably believes necessary for the purposes of dealing with the circumstances referred to in the aforementioned paragraphs.

3.9 Furthermore if an auditor of a licensee in the course of carrying out an audit or producing a report under the SIB Law becomes aware of or has reasonable grounds to believe that the licensee (a) is or is likely to become unable to meet its obligations as they fall due; (b) is carrying on business in breach of the SIB Law or any regulations made hereunder; (c) is carrying on or attempting to carry on business in a manner that is prejudicial to its clients or is winding up its business voluntarily in a manner that is prejudicial to its clients or creditors; or (d) is carrying on or attempting to carry on business without maintaining any or sufficient accounting records or record keeping systems to enable the auditor to carry out an audit or produce a report under the SIB Law, the auditor shall immediately give CIMA and the licensee written notice of his knowledge or belief giving reasons therefor, and an auditor who contravenes this provision is liable to removal by CIMA from its list of approved auditors.

3.10 CIMA may apply to the court for a licensee, former licensee or company that is or has been in contravention of section 5(1) to be wound up by the Court, notwithstanding any winding up of the company voluntarily.

4. MUTUAL FUND ADMINISTRATORS

4.1 Prior to the introduction of the Mutual Funds Law in 1993, service providers to mutual funds were normally licensed under either the Banks and Trust Companies Law or the Companies Management Law.

4.2 The Mutual Funds Law introduced two types of new licence, the mutual fund administrator's licence and the restricted mutual fund administrator's licence, one of which is required if the licensee proposes to undertake mutual fund administration. This is defined as the management, including control of all or substantially all of the assets of a mutual fund, or the administration of a mutual fund, the provision of a principal office to that fund or the provision of a trustee or, a director of that fund (depending on whether it is a company or a unit trust). Excluded from mutual fund administration are, inter alia, the activities of the general partner of a partnership mutual fund and the provision of a registered office at which statutory and legal records are kept or company secretarial work is undertaken.

4.3 CIMA will only grant a license to a fund administrator if the licensee meets the statutory test that it (a) has available sufficient expertise to administer regulated mutual funds, (b) is of sound reputation and (c) will administer regulated mutual funds in a proper manner. A mutual fund administrator requires a net worth of US$480,000; a restricted mutual fund administrator has no net worth requirement. The mutual fund administrator must itself have a principal office in the Cayman Islands with two individuals or a body corporate as its agent resident or incorporated in the Cayman Islands and may act for unlimited number of mutual funds.

4.4 A restricted mutual fund administrator may act in relation to such number of related licensed mutual funds as may be approved by CIMA (CIMA's current policy is to permit a maximum of 10 funds) but is required only to have a registered office in the Cayman Islands. This category permits the promoter who incorporates a fund manager in the Cayman Islands to manage a related family of funds. Subject to CIMA's approval, unrelated funds may be managed. The main difference, apart from net worth requirements and fees, is that, under current policy, a restricted mutual fund administrator will not be permitted to provide a principal office to the mutual fund so that every mutual fund for which a restricted mutual fund administrator provides mutual fund administration must, if not a section 4(3) mutual fund or exempted from registration under section 4(4) of the Law, be separately

4.5 Once CIMA has licensed the mutual fund administrator, its obligations are as follows:

(a) to notify CIMA of any change in its principal office or of the name of any body corporate or individuals acting as its agents in the Cayman Islands;

(b) not to appoint a director or similar senior officer, or a general partner, as the case may be, unless CIMA's written approval to the appointment has been obtained or CIMA has exempted the administrator from this obligation;

(d) no shares may be issued or transferred unless CIMA has either given its approval to the issue or transfer or waived the obligation to obtain that approval; and

(e) to have its accounts audited annually by an approved auditor approved by CIMA and to send its audited accounts to CIMA within six months of the end of the relevant financial year.

4.6 The administrator is also required to comply with any special conditions attaching to its licence.

4.7 CIMA has the enforcement powers described in paragraph 2.12 above with regard to a licensed mutual fund administrator which does not discharge properly its private sector regulation or otherwise acts in breach of the Law, including revocation of the mutual fund administrator's licence where it is placed in winding up (liquidation). Auditors have similar duties to report any issues to CIMA in the manner described in paragraph 2.13 above.

5. BANKING AND CUSTODY

5.1 The Cayman Islands is recognised as one of the top 10 international financial centres in the world, with over 40 of the top 50 banks holding banking licences. As at June 2009, there were 270 licensed banks, with approximately two thirds being international bank branches. Banks and trust companies (including those that conduct custody business) which conduct business in the Cayman Islands must be licensed under the Banks and Trust Companies Law (2009 Revision) (the "BTC Law"). Branches and subsidiaries are regulated by CIMA on the basis of consolidated supervision in connection with the onshore home regulator.

5.2 Private banks number less than 20 and are required to establish a physical presence in the Cayman Islands, with a greater minimum net worth and capital adequacy ratio, (source: CIMA website).

5.3 For all banking licensees CIMA typically adopts more stringent capital adequacy requirements than proposed under the Basle Core principles.

5.4 Reasons to establish a banking presence in the Cayman Islands include the provision of multi currency accounts (without exchange restrictions) with access to international markets, depositary sweep facilities and internal treasury functions, on a tax neutral basis, all of which are performed with full transparency to and subject to the regulation of the onshore banking regulator.

5.5 Applications for licences under the BTC Law are made to, and reviewed in detail by, the CIMA. The Cayman Islands have for many years insisted that no disreputable or unsound banking or trust company business be conducted in or from the Islands. It is now also the policy that bank licences will only be granted where the applicants can demonstrate an established track record in the banking or finance industry and that the branch or new entity is or will be a member of a group with acceptable home-based supervisory regulation on a consolidated basis.

5.6 Trust licences will only be issued where those involved in the direction or management of the relevant entity have the necessary experience in trust and fiduciary business.

5.7 It should be noted that CIMA will not generally consider any application for a bank licence unless the applicant is part of an established banking group or has an established bank within its group of companies, has an established track record of at least five years and a capital base of at least US$50 million.

5.8 CIMA has the enforcement powers described in paragraph 2.12 above with regard to a licensed bank or trust company which does not discharge properly its private sector regulation or otherwise acts in breach of the Law, including revocation of the licence where it is placed in winding up (liquidation). Auditors have similar duties to report any issues to CIMA in the manner described in paragraph 2.13 above.

7 August 2009

41 For more details on the various existing tax information assistance mechanisms in the Cayman Islands see http://www.tia.gov.ky/html/agreement.htm Back

42 Jeffrey Owens, Director of the OECD's Centre for Tax Policy and Administration, see http://www.oecd.org/document/9/0,3343,en_2649_33767_42482889_1_1_1_37427.00.html Back

43 United States Government Accountability Office, Report to the Chairman and Ranking Member, Committee on Finance, US Senate, "Cayman Islands: Business and Tax Advantages Attract US Persons and Enforcement Challenges Exists" GAO-08-778, p 5 Back

44 Daniel Shapiro, "Statement of Daniel S. Shapiro on behalf of The Managed Funds Association before the Committee on Finance United States Senatè, 26 September 2007, http://finance.senate.gov/hearings/testimony/2007test/092607testds.pdf Back

45 http://fms.treas.gov/bulletin/index.html Back

46 http://www.newyorkfed.org/markets/talf_faq.html Back

47 International Monetary Fund, "Cayman Islands: Assessment of the Supervision and Regulation of the Financial Sector-Vol II-Detailed Assessment of Observance of Standards and Codes", http://www.imf.org/external/pubs/ft/scr/2005/cr0592.pdf Back

48 www.dealogic.com Back

49 See www.opic.gov, www.ifc.org and www.ecgd.gov.uk for a list of projects or transactions in which Cayman Islands entities feature Back

50 http://crapo.senate.gov/documents/mckinsey_report.pdf Back

51 www.tia.gov.ky/html/news.htm Back