Adapt to survive
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From initially being seen as a threat, the ever-flexible Cayman is tackling the new regulatory environment head-on, says Robert Duggan
The development of the financial services industry in the Cayman Islands is founded on innovation as well as regulatory integrity, and it is these curious bedfellows that have helped the jurisdiction pull through the financial crisis and give cause for optimism.
The promise of further financial regulation globally - in some cases as a knee-jerk reaction to the financial crisis and in others for good reasons - represents a sometimes significant challenge to Cayman.
When the first draft of the EU Alternative Investment Fund Managers Directive (AIFMD) was published in April 2009 the investment funds community in Europe was taken by surprise. Its aim was to reshape the funds landscape in Europe and, through the ’third country’ provisions, beyond.
As the most significant third-country domicile for investment funds Cayman stood to suffer significantly if the AIFMD was adopted in the form in which it was first published.
The prospect of funds domiciled in Cayman not being able to be offered to European investors - even to institutional and other sophisticated and high-net-worth ones - was disconcerting to both the financial services community in Cayman and the investor community in Europe.
Happily lobbying paid off and the directive was adopted late last year in a form that demonstrated a general improvement in understanding of the alternative investment fund industry on the part of European legislators.
In some quarters of the EU a myth was peddled that funds domiciled in Cayman have been upping sticks and leaving for the damper climes of Europe, but this is not the experience of the industry. That self-serving hype has followed close behind the AIFMD debate is no surprise, as Undertakings for Collective Investment in Transferable Securities (Ucits) jurisdictions have sought to gain market share.
A middle ground harbours the truth that onshore jurisdictions have benefited without particular cost to jurisdictions such as Cayman, as fund stables have been split to offer parallel Cayman and onshore products with substantially similar strategies.
Indeed, evidence suggests that the bifurcation of fund stables owes more to the demands of certain, mostly institutional investors in Europe for hedge fund products in a more familiar and structured wrapper than to a fundamental weakness of the traditional offshore fund model.
While the first draft of the directive suggested an end of the road for Cayman-domiciled funds in Europe, the final form removed this threat and left a number of opportunities for the ongoing offering of third-country funds in Europe.
Until the directive is implemented by EU member states, there is a buffer period during which third-country regulators can seek to address the requirements that the directive will impose on them should they wish to facilitate managers or funds domiciled in their jurisdictions trading inEurope.
A passport regime may be made available to third-country funds managed by EU managers from 2015. If certain criteria, including appropriate cooperation agreements between the regulator in the third country in which the fund is established and the regulator in the member state of the manager, and tax cooperation agreements between the third country and the member state in which the fund is to be marketed, are in place, the fund may be offered to professional investors.
National private placement regimes, such as they are, have been preserved. Managers and fund vehicles domiciled outside the EU will continue to have access to European investors, subject to the rules and regulations of those regimes, until at least 2018.
The layered effect of the AIFMD offers significant hope that funds domiciled in Cayman and managed by EU investment managers will be able to be marketed in Europe. The Cayman government and the Cayman Islands Monetary Authority will have to keep working on safeguarding regulator-to-regulator cooperation agreements and tax information exchange agreements. This is already underway, providing a significant degree of comfort.
As is the case with many well-run and well-regulated jurisdictions, Cayman does not fear all regulatory initiatives, but rather will stand to benefit from some.
The US Dodd-Frank Act will have significant ramifications for investment banks and investment advisers, but perhaps of particular interest to Cayman is the so-called ’Volcker Rule’ that will restrict, if not stop, proprietary trading by US banks.
Hedge fund managers are optimistic that they will benefit from the passage of the Volcker Rule, not only as it will release capital retained within and traded by banks that has a good chance of making its way into hedge funds, but also because it will prompt an influx of some talented traders.
Cayman stands to benefit from the Volcker Rule too, as it is foreseeable that new fund managers and underlying fund products will be created as the proprietary trading divisions of banks are dismantled and spun out. Indeed, the US funds industry is a significant user of Cayman - more so than Europe - so the benefits that might arise from Dodd-Frank represent a tremendous opportunity for Cayman and one that ought to counter any downside of the AIFMD.
Cayman has withstood challenges before and the islands are still well-placed to do so if they continue to innovate and regulate in a measured way. To think that they would do otherwise would be to deny the foundation upon which the jurisdiction’s financial services industry is based.
Robert Duggan is a partner at Mourant Ozannes