In a financial landscape as turbulent as the waves off Seven Mile Beach, the Cayman Islands has endured as the preferred jurisdiction for investment fund domicile. The industry blossomed for decades in the territory's flexible product-development and compliance climate. But today, the regulatory tides are starting to shift.
Recently, the Cayman Islands began implementing changes to its legal and regulatory regime — closing gaps and augmenting its existing framework. These measures support the territory’s commitment to achieve international best standards as set by the Financial Action Task Force (FATF). They’re intended to accomplish the following:
In this article, we’ll detail some of the changes going into effect and examine what they mean for funds and fund administrators.
In December 2017, Cayman authorities began adjusting existing regulatory structures. The Cayman Islands Monetary Authority (CIMA) issued new Guidance Notes pursuant to section 34 of the Monetary Authority Law (2016 revision). In addition, the Cayman Cabinet approved new Cayman Islands Anti-Money Laundering (AML) Regulations. These regulations apply to persons carrying on relevant financial business, as defined in the Proceeds of Crime Law (revised).
As a result, investment funds, both regulated and unregulated, are directly impacted by certain new obligations, which went into effect May 31, 2018. Overall, these developments expand the rules for identifying and verifying clients. AML regulations provide detailed requirements to the industry for conducting customer due diligence. They also specify when simplified versus enhanced due diligence measures are required.
Among the regulatory updates, one in particular stands out: changes to the Regulation 8 exemption. Until now, this heavily relied upon exemption freed investment funds and fund administrators, in certain circumstances, from having to conduct full due diligence and customer verification procedures on investors. This made it easier for them to accept subscriptions into investment vehicles and to make distribution and redemption payments.
The Regulation 8 exemption permitted the use of simplified due diligence measures when certain criteria were met. Subscriptions had to be funded from a bank account held in the name of the investor in a country Cayman recognized as having an equivalent AML regime. (These were referred to as Schedule 3 countries.) When these criteria applied, it was sufficient to obtain basic customer identification information and bank account details.
The exemption was also employed when redemption monies were paid to a bank account held in the investor’s name in a Schedule 3 country. Verifying the customer’s identification wasn’t expressly mandated for these transactions. (Although in practice, most fund administration houses carried out the checks anyway in keeping with their internal policies and procedures.) This enhanced the efficiency of client services and operational ease for the administrators.
Now, however, Regulation 8 has been replaced by Regulation 23, which adds additional layers of controls.
The newly implemented Regulation 23 still permits an avenue for administrators to use simplified due diligence measures – but only when investors make subscription fund payments in person or electronically. This is significant in that it creates more circumstances where verification is required and where verification cannot be waived. Subsequent payment to an investor (e.g., fund distributions or redemption proceeds) is one such circumstance.
To apply, Regulation 23 requires four precursors:
When these four elements exist, it remains generally permissible to accept electronic payment without verifying identity. Onward payment to the investor (or any third party), however, requires more than blind reliance that the funds will be returned to an account in the payee’s name located in a country approved to have similar AML measures as those of the Cayman Islands.
Regulatory developments increase compliance costs. Because of this, industry reaction to the regulatory shift described above is mixed. For some administrators operating across borders, these requirements may have already been standard. For others, they’ll represent a more significant change — forcing them to amend policies and procedures, as well as update operational and compliance processes related to authorizing payment of distributions and redemption proceeds.
An investor’s circumstances can change during the lifetime of an investment. Sometimes, this means the risk rating is higher at the time the onward payment is due than initially assessed. The investor might now be subject to sectoral or geographic international sanctions. Or they might be a designated person for purposes of the Terrorism Law (2017 Revision).
With that in mind, the verification process before onward payment provides what could be the final opportunity to assess the risk exposure an investor poses — to a fund, its operators and service providers. It may also be the final opportunity to ensure compliance with obligations — including disclosure obligations, where money laundering or terrorist financing is suspected or actually uncovered.
These and other changes to the AML Regulations formalize a “risk-based approach.” This approach is the new standard required of the financial services industry in carrying out its anti-money laundering duties and obligations. Financial services providers must take steps to comply. They need to identify, continually assess and understand the money laundering and terrorist financing risks as they relate to:
In keeping with the risk-based approach, static risk assessment is no longer acceptable on its own. Regulations now require ongoing periodic scrubs, including against sanctions lists and designated persons list. The risk assessment merely dictates their frequency.
These developments are only one small part of the changes resulting from the revised AML Regulations. When coupled with the increased penalties that will apply to breaches and CIMA’s new ability to issue administrative fines, the industry is keen to get its collective house in order. Violation of the AML Regulations can result in negative consequences ranging from fines to imprisonment.
While the Cayman Islands still offers many advantages, the regulatory tides are shifting, and fund administrators should take time to consider how they may be affected. For information on our offshore fund services, click here.