Special report: Offshore – The Cayman Islands

The Cayman Islands dominates the offshore world, but can it maintain its leading position?

The Cayman Islands is the quintessential offshore jurisdiction. Tax-neutral, with a government and financial regulator keen to keep up with the latest developments in the financial services sector, Cayman has ridden out the financial crisis and a considerably intensified focus on regulation with its business sector in good health.

That health has drawn increasing numbers of law firms to the island. Currently, 12 of the Offshore Top 30 have a Cayman office, with several smaller Cayman firms thriving. Cayman has also pulled in a small number of onshore firms to launch offices, with Irish funds specialist Dillon Eustace and US litigation boutique Kobre & Kim both present on the island.

There are now 34 firms and sole practitioners listed on the Cayman Islands Law Society directory, and in excess of 400 lawyers – with the 12 in the Offshore Top 30 employing around 370 lawyers between them.

But Cayman has also had to contend with attacks from groups campaigning against ‘tax havens’ and some corners of the mainstream media arguing that its company registration laws allow for deliberate tax avoidance at a time when it is increasingly important for tax revenues to be collected.

FUNDS

In the offshore world Cayman’s main claim to fame has always been investment funds. In the past decade the number of funds licensed, administered or registered in Cayman has increased dramatically. Much of that growth came in five short years before the recession hit, with an increase of 66 per cent in the number of Cayman funds between 2004 and 2008.

Since then fund registrations have dropped off a little as the hedge fund industry consolidates following the heavy hit it took with the financial crash. Cayman Islands Monetary Authority (Cima) figures for 2012, the most recent available, show there were just under 9,000 licensed, administered or registered fund structures in Cayman plus 1,891 ‘master funds’, which were required to be registered for the first time under new rules.

Despite the number of funds being lower than in the previous year, with subscriptions down and redemptions – where an investor withdraws its money from a fund – up, net income and the net asset value of all Cayman funds had risen.

The decline in the number of funds between 2008 and 2012 reflects a global trend, but lawyers report that in the past year things seem to be returning to normal, with funds practices beginning to get busier again.

“The investment funds and hedge fund industry is still here – and pretty much exclusively here,” says Campbells managing partner Ross McDonough. “There was a slowdown of that type of work before the financial crash but it seems to be picking up again right now.”

Carey Olsen Cayman managing partner Jarrod Farley says the crash meant a lot of “dead wood” in the funds sector was cleared out, enabling the market to mature.

“What you’re left with is a mature market where fund launches are balanced out by funds reaching the end of their lives,” he notes.

The Cayman funds industry has also been relatively unaffected by EU efforts to regulate its alternative funds industry. When the alternative investment fund managers directive (AIFMD) was mooted several years ago some predicted that managers would migrate their structures to the EU in response to investor demand for more transparency. In fact, this appears not to have happened to any great degree, with the major change being an increase in parallel structures allowing a choice between Cayman and the EU. This is largely because Cayman’s investor base is still predominantly outside Europe. The US, as a close geographical neighbour, has always been a strong source of money for Cayman funds. Meanwhile, Asian investors also like the Cayman structure.

“AIFMD, for many users of Cayman, is a bit of a sideshow,” says Ogier’s Cayman practice partner Nick Rogers. “It’s important and they’re all having to consider whether to embrace it or work around it, but for the majority of the Cayman-registered hedge funds AIFMD and access to investors isn’t the whole driver of the decisions they’re making.”

Investment managers using Cayman funds are overwhelmingly based in the US, with the greatest proportion of funds managed out of New York. Managers in the UK look after the next-largest proportion of funds, according to Cima data, but there is a sizeable amount of money managed from Connecticut, California, Massachusetts and Illinois as well as New York.

Between 2011 and 2012 there was a slight growth in the amount of net assets managed out of North America and a small drop in the amount managed out of Europe. Meanwhile, although the relative value of the assets managed from Asia and the Caribbean is far smaller, there was growth in both regions.

The three top jurisdictions for the administration of Cayman funds are Cayman itself, the US and Ireland.

Although there might have been a slowdown in fund registration work in recent years, funds litigation has helped keep Cayman funds practices alive.

“The past couple of years have been strong for commercial litigation work. I suspect the really big-ticket litigation is starting to wane a little and corporate activity is starting to pick up,” says Mourant Ozannes’ Cayman managing partner Neal Lomax.

“We’ve benefitted from quite a bit of fallout from Madoff and other schemes that became exposed when liquidity dried up,” McDonough adds.

Several cases have gone all the way through the Cayman courts system, with some even reaching the Privy Council to decide on key issues such as redemptions and suspensions as well as winding-up petitions and insolvencies.

PRIVATE EQUITY

Cayman structures are most often used for hedge funds, but the jurisdiction also has a strong private equity industry. This is harder to monitor but lawyers note that looking at company registration statistics gives a fairly good idea of the sector’s health. Traditionally, most private equity funds run out of Cayman have been set up as exempted limited partnerships (ELPs), but there is now a trend for private equity funds to use the exempted company structure instead.