Economic substance requirements for fund management business

The ES Law requires certain entities incorporated or registered in the Cayman Islands and carrying on specified activities to have ‘adequate substance’ in the Cayman Islands. One of the specified activities that may be relevant to your business is “fund management business”.

The scope of this eAlert is limited to the application of the ES Law to fund management business.

Relevant Entities

The ES Law applies only to “relevant entities” meaning Cayman companies (other than domestic companies), Cayman limited liability companies, Cayman limited liability partnerships and foreign companies registered in Cayman, but excluding investment funds and entities that are tax resident outside of the Cayman Islands.

Fund Management Business

“Fund management business” is the business of managing securities belonging to another person in circumstances involving the exercise of discretion, carried on by a relevant entity licensed under the Cayman Islands Securities Investment Business Law (SIBL) for an investment fund.

Economic Substance Test

A relevant entity conducting fund management business is required to satisfy a 3-branch economic substance test in relation to such fund management business. It must:

1. conduct core income generating activity in the Cayman Islands which includes:

taking decisions on the holding and selling of investments;

calculating risk and reserves;

taking decisions on currency or interest fluctuations and hedging positions; or

preparing reports or returns, or both, to investors or the Cayman Islands Monetary Authority, or both,

2. be directed and managed in an appropriate manner in the Cayman Islands which will require, among other things:

the board of directors, as a whole, to have the appropriate knowledge and expertise to discharge its duties as a board of directors;

meetings of the board of directors to be held in the Cayman Islands at adequate frequencies given the level of decision-making required;

the minutes of all meetings of the board of directors and appropriate records of the relevant entity to be kept in the Cayman Islands,

3. having regard to the level of relevant income derived from the relevant activity carried out in the Cayman Islands –

(i) have adequate operating expenditure incurred in the Cayman Islands;

(ii) have adequate physical presence (including maintaining a place of business or plant, property and equipment) in the Cayman Islands; and

(iii) have an adequate number of full-time employees or other personnel with appropriate qualifications in the Cayman Islands.

The satisfaction of the economic substance requirements will be a question of fact. There will not be a one-size-fits-all approach and much will depend on the size and scope of the business (both in the Cayman Islands and in other locations) and its expected gross income in the Cayman Islands.

Possible Expansion of Scope

Currently, the definition of “fund management business” covers only entities that are licensed under SIBL. However, amendments have been proposed to apply economic substance requirements to relevant entities that fall within the definition of, and are registered as, excluded persons under SIBL (Excluded Persons).

Any Excluded Person providing discretionary investment management services to investment funds will wish to monitor these developments closely. For now, we alert you to the proposed changes so that you may prepare for the future and make provisions within your business plan to ensure compliance with the law if and when these proposals become law.

Next Steps

All relevant entities conducting fund management business will need to undertake an internal review to determine what measures, if any, they might need to take in order to achieve compliance. If you would like further guidance on how these requirements will impact your business, please reach out to your usual Appleby contact.