Impact of the Cayman Islands Economic Substance Law

The Cayman Islands have been a popular jurisdiction for decades. However, the introduction of the International Tax Co-operation (Economic Substance) Law in December 2018 brought with it increased requirements for operational substance – reflecting a significant change to Cayman’s historically loose substance requirements.

“Traditionally, the Cayman Islands have been a popular domicile for fund managers, due to the nation’s favourable tax environment, relative ease and lower cost of set up versus other jurisdictions, and a proliferation of Cayman lawyers in Asia,” explains Alexander Traub, Regional Executive, Asia Pacific for Alter Domus, a fully integrated fund and corporate services provider dedicated to international clients.

Alex continued, “In addition to this, as a UK commonwealth jurisdiction, the Cayman Islands benefits from sharing a common law system that many are familiar with – as well as from its close geographical proximity to the US, making it a familiar and popular jurisdiction for US investors.”

In line with a global efforts to match revenue and gains with operational substance, Cayman’s new economic substance law aims to ensure that companies engaged in the banking, distribution and service centres, financing and leasing, fund management, headquarters, holding companies, insurance, intellectual property or shipping businesses have actual operations in the island nation.

According to Alter Domus’ Head of China, Ming Bi, “Due to Cayman’s new Economic Substance Law – coupled with its Securities Investment Business Law, which introduces changes around registration and exemption of securities investment – many private equity managers are making organizational changes to their funds to remain in compliance with both new regulations.”

“It’s important to understand this is an evolving requirement,” adds Jayesh Peswani, Director, Relationship Management (Asia-Pacific) for Alter Domus. “The changes reflect ongoing negotiations between Cayman and the OECD, where the OECD is pushing Cayman (as well as other offshore jurisdictions) to regulate the fact that entities domiciled there actually have operations there. Tighter regulations negate the ease of setting up and doing business in Cayman when compared with onshore jurisdictions. At present, both parties are trying to find a balance between these two factors.”

“Although specifics are scant at the moment, we anticipate that in 99% of cases, at least at present (because this is shifting, and fast), fund managers domiciled in Cayman would not have to make any significant changes to their current operations. For the 1% that are affected, they will have to demonstrate a certain level of operations in Cayman, such as holding on-shore board meetings or maintaining some level of portfolio management on-shore,” added Jayesh.

As the actual requirements of the new law remain a moving target, some organisations are choosing to take minimal action for the time being – preferring to wait until the law takes on a more final form before taking more decisive efforts. “Even so, we are seeing more requests for Cayman onshore directorship. In addition, Cayman directors are taking a more active role in their respective funds, as evidenced by increasing requests for information from on-shore directors,” commented Alex.

Ming added, “Aside from the majority of managers that are choosing to wait and see what happens, we’ve also seen some of our clients setting up non-Cayman investment managers to mitigate some of the risk, rather than asking Cayman directors to take on more roles.”

Jayesh expressed, “On the flip side, other clients are looking to re-domicile their managers to where they have their operations, with quite a few making such inquiries over the past few weeks. If the funds are focused on Asia, they are either looking at Hong Kong or Singapore, and Luxembourg is a natural choice for European funds. Clients moving from Cayman to Asia will probably end up re-domiciling where their advisors (and ultimately operations) are, whether that is Hong Kong or Singapore.”

Although Cayman’s economic substance law will definitely affect its future as a financial centre, the specifics remain fluid as negotiations continue. Taking a “best of breed” approach, Alter Domus is able to structure solutions leveraging a mix of domiciles – choosing the most advantageous locations for each client’s particular needs.

“With 2,200 employees operating in more than 40 offices and desks worldwide, Alter Domus has the global presence to remain domicile agnostic – allowing us to structure the best possible solution for each client based on their individual needs, operations and financial requirements,” concluded Alex. “Once clients have decided where to domicile and have substance, Alter Domus is ready to support not only funds and holding companies, but their management entities as well.”