Setting up a Crypto or Digital Asset Hedge Fund
The following is a guide and not a substitute for specific advice. This guide is not intended to be legal or tax advice.
WHY CAYMAN IS A LEADING FUND JURISDICTION
The Cayman Islands is the leading international domicile for global investment funds, both open-ended and closed-ended investment funds.
The Cayman Islands investment fund is the global collective investment vehicle preferred by investors in North America, UK, China, Japan, the Middle East, Latin America, and many other countries. It is used by international investors to aggregate investment into countries around the world to facilitate efficient global co-investment and asset management. In fact, 70 percent of non-US domiciled investment funds managed by US SEC registered advisors are domiciled in the Cayman Islands.
The Cayman Islands is home to many of the world’s top professionals in the areas of law, accountancy, corporate services and investments expertise. Many of the world’s leading firms in these areas have chosen to set up in the Cayman Islands.
The Cayman Islands Government and the private sector have maintained a partnership which has resulted in a climate that is responsive to local and international market needs and provides flexibility while maintaining the financial centre’s integrity.
The Cayman Islands has maintained a very stable economic and political climate throughout its history.
The jurisdiction has no direct personal, corporate or property taxes.
The Cayman Islands is recognised internationally for its efforts to adhere to international regulatory standards and plays a leadership role in the offshore arena on international regulatory issues. The jurisdiction is well known to have in place a regulatory regime which surpasses many of the world’s top international financial centres in the area of anti-money laundering.
The fund terms will dictate the required legal structure and the law to which the fund will be subject to. In order to formulate the proposed terms of your fund, please contact us for our fund formation questionnaire which sets out the terms that need to be identified. These questions will include questions such as location of investors, frequency of subscriptions and redemptions, fees charged by the manager, minimum investment amount per investor, number of share classes, investment strategy etc.
CONSIDERATIONS FOR FUND MANAGERS PRIOR TO SET UP
The following will need to be taken into account prior to launching a fund and fund managers should be aware of the various requirements prior to launching a fund.
Fund managers should clearly set out the terms of the fund that they wish to have set up. This should be set out in a questionnaire and will cover all of the key fund terms that will be stipulated in the offering prospectus.
1. Select and form legal vehicle – company, partnership, trust or LLC
2. Choose structure – stand-alone fund, master-feeder, segregated portfolio company (umbrella fund)
3. Service Providers:
(i) Investment Manager
(ii) Legal Counsel
(iii) Administrator or registrar and transfer agent and NAV calculation agent
(iv) Independent Directors – CIMA Registered
(vi) Bank Account
(vii) Prime Broker(s) / Custodian
(viii) AML Compliance Officers (also to prepare AML Manual & Risk Based Assessment)
(ix) FATCA/CRS Reporting
(x) Registered Office
(xi) Board Support/Company Secretary
4. Finalise Fund Documentation
5. Register fund with Cayman Islands Monetary Authority (CIMA)
CRYPTO FUND STRUCTURE
Typical structures involving Cayman vehicles are:
i) a stand-alone fund, whereby all investor monies are pooled in a single vehicle which makes direct investments
ii) a side-by-side arrangement, whereby a Cayman stand-alone fund operates in parallel to an onshore stand-alone vehicle with an identical investment strategy (but a different investor base) and the two vehicles execute the same trades, and
iii) a master-feeder structure. The typical master-feeder structure involves US tax-exempt investors and non-US investors investing in a Cayman exempted company feeder fund, US taxable investors investing in a Delaware limited partnership feeder fund, and the two feeder funds investing together into a single master fund (typically a Cayman exempted company or a Cayman exempted limited partnership), with the master fund holding the underlying portfolio investments.
CAYMAN ISLANDS REGULATORY FRAMEWORK
The Mutual Funds Law (Revised) (MF Law) and the Private Funds Law (PF Law) are the principal Cayman Islands legislations applicable to investment funds. The MF Law refers to “mutual funds”, being “a company, unit trust, partnership or LLC that issues equity interests, the purpose or effect of which is the pooling of investor funds with the aim of spreading investment risks and enabling investors in the mutual fund to receive profits or gains from the acquisition, holding, management or disposal of investments…”.
“Equity interest” is further defined to include a share, trust unit, partnership interest or LLC interest which is “redeemable or repurchasable at the option of the investor”. Therefore, the MF Law applies only to open-ended funds, since interests in closed-ended funds are not redeemable at the option of the investor.
Master funds are treated as registrable mutual funds if:
a) they are incorporated in Cayman and hold investments and conduct trading activities for the principal purpose of implementing the overall investment strategy of one or more feeder funds registered with CIMA; or
b) they otherwise fall within the definition of a mutual fund, for example a Cayman master fund in a mini-master structure where the only feeder fund is a Delaware LP but the master fund also takes in investors directly.
There are four (4) categories of registrable mutual funds:
(a) Section 4(3) of the MF Law: the most common form of mutual fund. The principal requirement is that the minimum initial investment purchasable by a prospective investor is US$100,000;
(b) Section 4(4) of the MF Law: this is a mutual fund with fifteen or fewer investors, a majority of whom are capable of appointing or removing the operators of the mutual fund. A s4(4) fund is not subject to the minimum initial investment requirement of a s4(3) fund nor is an offering document required to be filed with CIMA;
(c) An administered fund: this requires a licensed mutual fund administrator in Cayman to agree to provide the fund’s principal office and to apply to CIMA on the fund’s behalf. The primary advantage is that the US$100,000 minimum initial investment requirement also does not apply to administered funds. However, the additional role and responsibilities of the administrator may increase administration fees and limit choice; and
(d) A licensed fund: this is designed to be suitable for retail funds and as such involves a more prescriptive and iterative process with the regulator.
CORPORATE GOVERNANCE – INDEPENDENT DIRECTORS
Most funds will appoint independent directors to the board. Investors and regulators expect to see independent directors on the board from a corporate governance perspective and to avoid any potential conflicts of interest.
With increasing regulatory requirements of funds, it is important that directors are knowledgable on Cayman laws and regulations, changes in such regulations, experience form acting on other boards and that they are resident in the Cayman Islands. It is also typically important to have directors’ resident in Cayman to meet tax advice and ensure that the fund remains tax neutral.
Directors have significant personal risk and directors’ duties are set out in both common law and statute, with guidance also provided by the regulator. It is important that directors have significant experience in the industry.
Cayman funds registered under the Mutual Funds Law, are required to appoint a minimum of two (2) directors who must be registered under the Director Registration & Licensing Law (“DRLL”).
An exempted company is entitled to apply under section 6 of The Tax Concessions Law (Revised) for an undertaking that no law enacted in the Cayman Islands after the date of the undertaking imposing any tax to be levied on profits, income, gains or appreciations shall apply to the company or its operations, and that no tax to be levied on profits, income, gains or appreciations or which is in the nature of estate duty or inheritance tax shall be payable on or in respect of the shares, debentures or other obligations of the company or by way of withholding in whole or in part on any dividend payment or other distribution of income or capital by the company to its members or to a payment of principal or interest or other sums due under a debenture or other obligation of the company.
The undertaking may be for a period not exceeding 30 years from the date of approval of the application but, in practice, the undertaking is normally given for 20 years.
Similar provisions apply in respect of exempted limited partnerships and LLCs, in each case for a 50 year period.
Once the vehicle itself has been formed, the principal documents necessary or advisable to establish it to carry on business as an investment fund are as follows:
a) Offering Document (variously referred to as the "offering memorandum", "private placement memorandum" or "confidential explanatory memorandum").
b) Subscription Agreement - this is the contract between the investment fund and the investor, which, alongside the offering document and memorandum and articles of association, establishes the terms on which the investor will purchase shares.
c) Memorandum and Articles of Association - known as "constitutional documents", "articles of incorporation" or "bylaws" in some jurisdictions, the memorandum and articles of association, in conjunction with the terms of the offering document and certain common law principles, govern the contractual relationship between the investment fund and its shareholders.
d) Investment Management Agreement - this is the contract between the investment fund and the investment manager.
e) Administration Agreement - this is the contract between the investment fund and the administrator.
f) Prime brokerage/Custodian Agreement - this is the contract between the investment fund and the prime broker.
g) Director Services Agreement – this is the contract between the investment fund and each of the Directors.
h) Directors’ resolutions - commonly referred to as launch resolutions, these are the initial directors' resolutions which approve the terms of the offering of the investment fund’s shares, entry by the investment fund into the appropriate service agreements and the application to register the investment fund with CIMA. The directors must declare any interests (conflicts) in the business to be considered by the meeting or written resolutions where applicable.
i) AML Compliance Services Agreement - this is the contract between the investment fund and the appointed AML compliance officers (the MLRO, Deputy MLRO and the AML Compliance Officer).
We have been at the forefront of fund formation, legal and operational structuring of crypto, digital asset and blockchain investment funds. We have been instrumental in the development of solutions for fund managers seeking to launch a crypto hedge fund and can provide a complete solution form legal formation and structuring advice to the appointment of service providers form our key relationships, plus ongoing support.
For further information, please feel free to contact us: email@example.com