Changes to governance frameworks for funds registered in the Cayman Islands

Jonathan: Good morning, good afternoon, and good evening, everybody. Thank you for joining our webinar today to discuss the changes in the governance frameworks for funds that are registered in Cayman. My name’s Jonathan White. I’m the chief revenue officer for Waystone Governance and Compliance based out of New York City. I’m joined today by Lynden John and Vanessa Gilman, both of who are based in Cayman. Just to introduce the topic, in April this year, the Cayman Island Monetary Authority, CIMA, issued a rule focused on the governance frameworks related to regulated entities in Cayman, as well as a statement of guidance, which encompasses the governance framework for both mutual funds and private funds in Cayman also. 

Webinar agenda & introduction to speakers

The objective today is to really talk about these recent developments and the regulatory landscape and the changes in the regulatory landscape, provide some insight to the audience as to what these changes actually mean. And then, additionally, we want to talk about what the potential risks are for fund managers should they find themselves not completely addressing the statement of guidance and the rule itself. The goal really to equip you as the fund manager with the information you need to take away. And I’d like to start off by providing introductions to Vanessa and Lynden. So Vanessa brings over 20 years of experience in the offshore financial services. She’s an independent director in our fund governance team based outta Cayman. And what she brings to the table is that specialist in regulatory matters given her background. She offers extensive regulatory knowledge around hedge funds, private funds, fund of funds, SPVs across the board way of investment strategies and asset classes. 

She’s an accredited director. She’s a chartered alternative investment analyst and a member of the Chartered Institute of Securities and Investment. Lynden, Lynden John brings over 17 years of experience in the financial services sector. He’s an executive director based outta Cayman, focused on the product development related to our Cayman service offering. And he really specializes in the provision of governance and regulatory services for both mutual funds and private funds. Lynden has a extensive track record in providing tailored and commercially effective solutions across areas like tax planning, bankruptcy, remote transactions, economic substance, and distress situations, and even resolving regulatory matters and restructurings. So thank you both for joining us. Lynden, let’s start off with yourself. Can you just for the audience provide the key highlights of both the statement of guidance and the rule just to level set with an understanding of what they mean? 

Cayman updates and new statements of guidance

Lynden: Yeah. In short, there’s been several updates and new statements of guidance that have been issued by the regulator, and they apply to mutual funds and private equity funds alike. The updates cover a range of topics, for example, cybersecurity, conflict of interest, the operator’s governance, and there’s several quirky ones inside there as well. And while the rules and the statements of guidance are quite detailed, there’s two key areas that come out of the statements of guidance. One is the independence and the ability of operators to demonstrate the independence of judgment, and then the others around the internal controls and whether you are able to document them, implement them, and then obviously monitor and abide by them. And those are the key two areas. So the key takeaways today is really talk about how operators must or should exercise independent judgment and around the internal governance framework that can capture your control environment and how you monitor it and how do you document your adherence to the controls. 

Jonathan: Thanks, Lynden. Vanessa, just going over to you, would be helpful for you to provide the audience some context as to why this is happening. What is happening in Cayman, and what’s the background to this statement of guidance and rule? 

Statement of Guidance background 

Vanessa: Sure. Thank you. And it is actually very important to understand that wider context because, by understanding that, it will also help us to see why it is that these rules are very important to implement. So let’s just take a step back, even just a few years. So the jurisdiction as a whole has been seeing a good deal of pressure from the G20, also from the FATF and also from the European Union. And this pressure has been for overall transparency increasing, but then also just general improvements in the anti-money laundering regime that we have here also to combat proliferation financing and terrorist financing. So there’s been a number of initiatives that have come about to support this overall objective across the globe, not just in Cayman, but in Cayman as well. 

We’ve seen the introduction of the FATCA and CRS filings that now need to get made. There’s a beneficial ownership regime that’s also come into the mix. Also, private funds have fairly recently been captured under the banner of CIMA’s regulation, and there’ve been various enhancements to the AML regulations overall. So, now, with that general background and context, this momentum is sort of continuing. And most recently the jurisdiction of the Cayman Islands was placed on the FATF’s gray list. And the reason for that was that the jurisdiction needed to demonstrate over a period of time that it was in fact enforcing its very strong AML regime amongst other things. And so the Cayman Islands did set out to demonstrate that enforcement, and CIMA’s role in that included the onsite inspections of various service providers. Now, these service providers did in fact receive administrative fines in some cases if there were breaches, if there were deficiencies that CIMA noted. 

And, in fact, some of the service providers actually took CIMA to court to defend themselves against these administrative fines. And that was a very interesting outcome. As part of the court’s ruling, the court actually confirmed that statements of guidance are just that, they’re guidance and they’re subjective. So if CIMA wants to demonstrate and have the power to enforce and take meaningful enforcement action, the best way to do that is to promulgate rules because it’s with a breach of a rule that CIMA is actually empowered to levy an administrative fine. So that’s what we’re seeing. That’s the general context internationally and also affecting Cayman. And so there’s various rules and SOGs that have come about, including on corporate governance, and, in fact, many were gazetted in April 2023 this year and will come into effect, at least the rules component will come into effect on the 14th of October. So that essentially gives industry about six months to digest these rules and to implement them, which we are encouraging all of our client funds and prospective clients to do so because the intention is, of course, for CIMA to enforce them. 

Jonathan: So thank you very much, Vanessa. So, really, in summary, this is something that fund managers really need to pay attention to, particularly in light of the potential for enforcement as this rule becomes in effect in October. Switching over to you, Lynden, you talked about independence and internal controls in your introduction to the statement of guidance and rule. Could you elaborate on that, please? 

Independence and internal controls 

Lynden: Absolutely. So independence is an issue in topic prior to the statement of guidance being updated in the new rules. Funds really drove whether your board is independent from its investor side or tax requirement. The new rules state that the operators do need to demonstrate how they exercise independent judgment. And this brings around the issue, in fact, how do you actually demonstrate that? And the simplest way of looking at it is putting an independent director on the board or having independent governance committee. Several of our clients have asked us, you know, what does it mean to demonstrate independent judgment. And when you take a simplest example of a fund, for example, where the board is made up of employees of the manager, it’s quite difficult to demonstrate that there’s independent judgment because of the conflict of interest. 

That should be an employee of the manager who receives performance and management fees from the entity that they’re providing oversight to may cause a conflict when it comes to the governance and ensuring that the controls in place are working efficiently. And that is what the operator or CIMA is trying to get the operators to be able to articulate. So the golden and rule of thumb is if it’s easy to articulate, saying, well, you have an independent director, therefore independent judgment’s made, you should be fine, you should be in compliance. But if it’s quite difficult to articulate why those board members or your committee members are independent from the other service providers, and you can articulate that independent judgment, you may have an area there that you need to focus on and consider your options. And that brings you to the control environment, which is the second part of this, the main updates. 

Traditionally, if you think about control, they’re documented in policy procedures. And with a hedge fund or a private equity fund, the majority of rules are written into the operating membrane or the funds constitutional documents, and the regulations for the statement of guidance around internal controls are recognized, and they actually state that, and CIMA appreciates that a fund does not have any employees and that most, if not all, of its business operations are outsourced and service providers, and therefore, by default, the operators can take reliance on their service providers, on their internal controls. But it’s not just as, “Oh, I delegated it, and therefore I can take reliance,” you have to demonstrate how you’ve assessed that, and that’s the statement guidance on outsourcing. So what we’ve articulated a little bit earlier is the simplest way to do that is through a very well-defined board meeting process where the operators come together on a frequent and a regular basis that’s suitable to the nature of the fund. 

You would have reports and questionnaires completed by the various service providers are responsible for the various aspects of the fund. It would address the statement of guidance questions, you’d make sure that they’ve been completed. As a board, you would you’d read it, assess it, and document it through the minutes process. And in doing that, by default, you are following a monitoring of controls, you’re testing the controls, and wherever there’s a deficiency or an area or gap, the board would then take their correct actions to resolve that. And that is really what we mean by independence and the focus on controls. 

Jonathan: So what you’re saying in summary is, you know, the simplest way to provide that demonstrable independence and objectivity is through independence board members or independent governance committee members to be able to focus and really think about their internal controls and then really hold those regular board meetings that are in line with and have an agenda based on the expectations of both the guidance and the rule from CIMA. Just pivoting now over to Vanessa and thinking about, well, like, how should a manager consider research and understand whether they are doing these things today, and then how should they address them if they’re not? 

How should a manager consider the research? 

Vanessa: And that’s a very interesting question. Many managers will take this approach where it’s sort of let’s wait and see, let’s wait and see what others do, let’s wait and see if CIMA’s actually gonna enforce this. So we are encouraging clients and prospective clients to take a more proactive stance. Why? Well, let’s consider the reason these rules and SOG have come about in the first place, and that is because we’re in a climate of increased enforcement where Cayman needs to be removed from a gray list and definitely not put on a blacklist, which would be detrimental to financial services and the funds industry in particular as well. And so things have changed, and some funds this year have already seen a difference. 

So if audited financial statements haven’t been filed, maybe foreign filing fees haven’t been submitted for a number of years. Some funds in this circumstance have received warning letters from CIMA explaining that they could be subjected to an administrative fine. And so that’s the climate that we’re working in at this stage. And so what we want to see is that our clients are taking a proactive stance at implementing these rules. And that’s because CIMA could in fact bring an enforcement action against either the fund, against its service providers, or to the board as a whole and to individual directors as well. And this is something that as directors, any individual director, this could have a lasting impact, lasting and adverse. So one example would be the completion of due diligence requests and questionnaires. Now, in that case, if there were a CIMA administrative fine levied, in fact, that’s considered an enforcement action and would now have to be disclosed as a part of a due diligence questionnaire or request. And so for many directors, that would be something to avoid. It does have a lasting impact. 

Jonathan: Thank you, Vanessa. That’s a clear and consistent message and certainly in line with what we’ve been seeing over the past couple of years related to seamless enforcement objectives, but I guess the key question is how would the regulator actually know. 

How would CIMA know if a fund complies?

Vanessa: And that’s a very interesting question. How would CIMA know if a fund complies? And, of course, it’s possible that CIMA could enhance the current reporting requirements for funds. They certainly have the power to do so under the Mutual Funds Act and the Private Funds Act. They could very well introduce new reporting requirements. They can also inquire on the general affairs and in any manner that they see fit in order to carry out their functions as a regulator. So they have that power. But let’s consider too they already have a lot of information at their disposal, including through the fund annual return form, which is submitted as a part of the audited financial statement submission process to CIMA on an annual basis. So there’s some very key questions on there, for example, how many board meetings are being held? 

Okay, we can get a sense of is a fund actually following the guidance to have at least one meeting a year. And also there are questions about who is serving on the board. So CIMA can get a sense of, are these parties maybe parties of the investment manager or are they independent parties? And there’s specific questions in terms of is the investment manager independent? And, of course, the idea there is that if a funds board is comprised mainly of employees of the asset manager, it’s gonna be impossible really to answer that question in a way that would show and demonstrate effective adherence to the new rule and SOG. So those are just a few ways that CIMA could actually gather information just from the far itself. But let’s also remember that CIMA is going to continue to conduct onsite inspections of service providers. 

And as part of that process, they are going to be sampling records of the clients of those service providers. So let’s say that the registered office of a fund was subjected to an inspection. It could be that funds records are included in a sample that the authority requests. So that’s a way for the fund to actually be more visible and the authority to get even more insight than perhaps it would normally have to things like minutes and what’s discussed at meetings, et cetera. So there’s a number of ways that CIMA could already access information. It’s empowered to do so, and there could be more to come. 

Jonathan: Yeah, no, thank you for that. That’s very helpful. Switching up, right? Waystone has spent the past couple of months having extensive conversations with clients and managers around the globe around this topic and providing insight. Just wondering if you want to come up with some of the common questions that come up around the topic. One of them common questions that I certainly hear often is, does the rule actually state that independent directors are required? Can you comment on that, Vanessa? 

Does the rule state that independent directors are required?  

Vanessa: So to be clear, the rule is not saying that there must be an independent director or an independent governance committee member. What the rule is emphasizing is that the governing body of a fund must be able to demonstrate and it must be exercising independence and objectivity in decision-making. So that’s what’s emphasized. And, presumably, if a board of a fund is comprised strictly of employees of the asset manager, it would sort of limit that argument that they are actually exercising that sort of independent and objective decision-making. And so that’s why we were encouraging our clients and prospective clients to really consider that point and add that independent component. 

Jonathan: The other question that comes up, right, because this rule now encompasses private funds, so that impacts private equity managers, it impacts hedge fund managers that have traditionally had board of directors on their team and LTDs. And now from a private-public perspective, we talk about committee, governance committee. Could you just talk a little bit about the difference between board members and boards and as it relates to also governance committees? 

Difference between board members and boards 

Vanessa: Yes. And that’s an important element to discuss. So when would you use either or? So I guess, first of all, it depends how a fund is structured. So let’s say a fund is established as a company. So in that case, there would be a board of directors that would be serving as the governing body of that fund. So adding an independent director would mean actually that independent director serving on the board of directors of that fund. Now, a lot of funds, including a lot of our private equity and private fund funds are in fact established as limited partnerships. And in that case, there’s a general partner that would be considered the governing body or the operator to that fund. Now, where would an independent component come into play if there were a general partner? 

So there could be an independent director appointed directly to the general partners, say if the general partner itself was a company or an independent manager, if it was an LLC, so that could be one way to go. But the general partner could also establish a governance committee that would essentially carry out very similar independent decision-making and allow the general partner to fulfill the rule and the statement of guidance in that way. Now, when would you use direct appointment? When would you use a governance committee? Again, it kind of depends on the way that fund structure is set up. So, for example, let’s say the GP is serving a group of funds, some of which are maybe onshore in the home jurisdiction of that sponsoring entity, or there could be some offshore feeders as well, and maybe the offshore feeders are subject to Cayman. So you have a mix there. Some funds are in the picture that are not actually regulated in Cayman. 

So, in that case, it might be a bit cumbersome and maybe not cost-efficient to have an actual independent member appointed to the general partner itself. In that case, that’s where a governing committee might be more useful and more of a practical solution. In other cases though, the GP is just serving maybe a master feeder structure, and both the master and the feeder are regulated here in the Cayman Islands. And, in that case, the simplest solution likely would be to appoint an independent party to serve directly on the general partner. But in either case, the key thing to take away, as Lynden was mentioning earlier, is that the governing body needs to host and also have their meeting agendas be very tailored to the Cayman Islands regulatory requirements. And so, of course, a governance committee can accomplish the same thing. It can be set up with properly noted agendas and meeting minutes as well to demonstrate that compliance of regulatory requirements here in Cayman. 

Jonathan: Thank you, Vanessa. That’s very helpful. One more question for you though. Can anybody be an independent director? Are there any regulatory requirements around the role? Are there any specific expectations as managers consider who they might go to to fulfill these obligations? 

Can anyone become an independent director? 

Vanessa: Sure. And I’m glad you asked that. One area that the rule on corporate governance and also the SOG both speak to is the expectation that there’s a diversity of skills, background, experience, and expertise. So what we would encourage our clients and prospective clients to do when you’re screening for independent candidates to join the board, do consider that diversity, consider whether there is familiarity with Cayman funds specifically and the Cayman regulatory regime and requirements here. You want your independent candidates and your governing body as a whole to be able to identify any specific gaps and then to be able to support the board overall with carrying out its responsibilities to ensure that fund is in compliance. 

Jonathan: Thank you. Thank you for that, Vanessa. And, Lynden, over to you now and switching back to board meetings, you talked about professional board meetings being an elegant way, a simple way of addressing the requirements from the statement of guidance and the rule, especially when establishing an agenda that is relevant to addressing the requirements of the rule and statement of guidance. Can you give a little bit information about what that agenda should look like? 

Board meeting agenda recommendations

Lynden: Sure. And it’s important to remember that a board meeting is a tool, and if you set up correctly, it can achieve various outcomes. Many managers currently run their own meetings and have their own minutes and some service providers, particularly outside of the Cayman Islands host meetings, but they typically focus on the performance of the operation of the fund in context of its asset class. What we are talking about here is having very smart and tailored board meetings, which are designed not only to go through the operations and the performance of the fund, which is one of the operator’s fiduciary obligations, but also designed them so that they capture the test of controls. An example being conflict of interest, where you’d ask all the operators who are attending the meeting to declare if there’s any new conflicts. 

And that would tie into your conflict of interest policy, which allow the board to demonstrate their ability to identify them, document them, and then deal with them as they occur. And those get captured in the minute-taking process. Other areas and areas to focus on would be, say the self-review. Up until now, some board minutes exclude them, or some directors do include them, but there’s no prescriptive questionnaire of what you should or shouldn’t ask. The statement of guidance does not clarify what’s required. And so when you set your agenda, it’s good to have it as an agenda item, but also supported by a questionnaire, which captures those answers. And the point of having it really well run in a smart board meeting agenda that addresses each of these statement of guidance is that you’ve captured it in a questionnaire process, which goes to the back of those minutes and supporting documentation. 

And that is the internal audit control that says, we’ve asked these questions of the right people, we received an adequate response, we reviewed it, we’ve addressed it, in our minutes, we’ve captured any discrepancies or any additional actions that are to be taken. And when it’s summarized and it’s put into a very unique package, that is what will articulate and demonstrate that the operators have been providing oversight and managing the control environment. And that is why it’s quite important to ensure that you do have board meetings, that they are hosted by regulatory specialists that understand not just how to run a board meeting but how to capture a statement of guidance into your board meetings as documented, and then obviously put into the resident office for preservation, so that if the regulator were to inquire or to try to test or assess the efficiency of your controls, you have already documented in a very efficient process. What are the key things to consider when looking at your control environment is your governance operations to include that as a process and how you capture that internal control. 

Jonathan: Thank you. Thank you. And, obviously, this is a topic we can talk about for significantly longer. And I think you hit the nail on the head, right? It’s every scenario is somewhat different, it needs to be considered in isolation. And if anybody in the audience has any further questions or would like to speak to one of our professional directors, anybody at Waystone, Lynden, Vanessa, myself, anybody on the team here, please don’t hesitate to reach out. We’ll certainly be sharing contact details after this call. As a parting shot, Vanessa, do you have any, you know, additional comments that you’d like to throw in? 

Final thoughts 

Vanessa: Thank you. And, first of all, let me just start by saying that today’s discussion has been very interesting, however, we’re really just drawing out just a few key messages about the rules and the statement of guidance on corporate governance and the various areas that those touch on. So something very important to keep in mind is the rule becomes effective on the 14th of October this year. That’s the date that CIMA will be able to begin levying administrative fines, potentially taking enforcement action. And the intent overall is for CIMA to continue on its mission to demonstrate that strong enforcement, because this is integral to the Cayman Islands. And just a couple of more technical takeaways, key question being, how would the funds governing body demonstrate independent and objective decision-making? If that’s a question for you that you feel that your fund could answer better, then maybe you’re considering appointing an independent director either directly on the funds board or to the GP or establishing a committee. 

Those are all very viable solutions and we’d be happy to talk to you about those. And as Lynden mentioned earlier, there could be a few modest gaps in a funds documents, those can be remedied. And then last but not least, funds are relying on service providers to carry out their business operations. And of course, governing bodies are relying on the internal controls of those service providers. And the most efficient way to effectively monitor ongoing controls and compliance, including keyman regulatory compliance is through the adhering to meeting agendas and board meetings that are tailored specifically to Cayman requirements. So those are the big takeaways for today. And for any of the fund managers listening today that this seems a bit new, we welcome you to give us a call, Waystone has been offering fund governance solutions for over 20 years, and we’d be happy to assist your team. 

Jonathan: Thank you very much, Vanessa. Thank you very much, Lynden. Very informative. Great job in conveying the details, the state of the guidance and rule. Appreciate everybody’s attendance today and look forward to following up with you.