From Ogier

INTRODUCTION

This note summarises the attractions of the Cayman Islands for prime brokers wishing to establish a prime brokerage business outside their home jurisdiction, and it highlights the key Cayman issues that need to be addressed when setting up such a business in the Cayman Islands.

The information set out in this note is a summary of the position under Cayman Islands law as at the date shown on the cover; it is not to be taken as specific legal advice applicable to particular issues or circumstances.  Anyone wishing to establish a prime brokerage business should contact one of the Ogier partners listed on the last page.

THE CAYMAN ISLANDS AS A JURISDICTION

The Cayman Islands are so well entrenched as the leading domicile for offshore investment funds that it is easy to lose sight of the reasons for this success.  The Appendix to this note provides a more comprehensive explanation of what makes the Cayman Islands the leader in this field, and a leading offshore financial centre, but some of the key attractions are as follows

Regulation.

Cayman’s regulatory system is effective and transparent and is globally recognised as meeting or exceeding relevant international standards.  Investors, fund managers, financial institutions and international regulatory authorities take comfort from funds and managers being regulated in the Cayman Islands, and the comfort so derived assists with launching, growing and operating such funds.

Taxation

The Cayman Islands have no direct taxation or broad-based indirect taxation on individuals or structures; it raises revenue through a raft of indirect taxes, fees and charges, such as user-pays fees and charges, stamp duties, work permit fees etc.  There is no income tax, corporation tax, capital gains tax, estate duty, inheritance tax, gift tax, withholding tax or land tax.  Nor are there any broad-based indirect taxes, such as a value-added tax or sales tax.  Cayman funds therefore provide a neutral base in which to combine investors from a number of jurisdictions.  For managers operating in the Cayman Islands, the absence of such direct taxation or broad-based indirect taxation tax facilitates the attraction and retention of talent and increases revenues available to grow the business.

Economic stability

As a British Overseas Territory, the Cayman Islands offer the security and stability associated with the British Flag.  The UK remains responsible for the Islands’ external affairs and their legal system.

Professional expertise

The Cayman Islands have a deep pool of talent and experience, with substantial banks, administrators, law firms, corporate-management firms, audit firms and IT companies supporting the financial services industry.  The great majority of professionals working for such organisations have worked in some of the world’s largest financial centres and as such bring with them superior knowledge, experience, and familiarity with complex issues within their respective fields.

Infrastructure

The quality of the Cayman Islands’ fundamental facilities and systems of transportation, communication and other local services provide a secure and reliable platform for international business and commerce.

Investment policy

The Cayman Islands operate a very pro-inward investment policy.  The Department of Commerce and Investment has been mandated to facilitate the establishment of businesses in the financial services industry.  The Department assists in liaising with different Government departments to minimise red-tape and to expedite the process.

Formation of vehicle

Once the decision is made to establish a prime brokerage business in the Cayman Islands, it is necessary to select the appropriate type of vehicle and to ensure that it is appropriately licensed to conduct its activities.  For these purposes, this note assumes that:

(a) the activities to be provided by the new business will be limited to prime brokerage services, which may include any or all of broker/dealer services, arranger services, securities management services and advisor services.  For example, the vehicle will not be conducting banking business, trust business or insurance business, nor will it be providing administrative or custodial services, or acting as an investment manager;

(b) the new business will lease its premises, rather than purchase real estate, in the Cayman Islands;

(c) a motivating factor in establishing the business in the Cayman Islands is to conduct substantive activity there, such that the business can be said to be conducting its operation in the Cayman Islands.

It is beyond the scope of this note to explain all the different types of business vehicles available in the Cayman Islands.  Unless there are compelling reasons based on the particular features of an individual case, our expectation (based on the above assumptions) is that the appropriate vehicle for the new business will be an ordinary non-resident company, with the liability of its members being limited by shares.

Formation of an ordinary non-resident company is a simple process which can be completed within a week.

For the purpose of the rest of this note, the prime broker vehicle is referred to as the Company.

REGULATORY REQUIREMENTS

Securities Investment Business Law

The Securities Investment Business Law (Revised) (the SIB Law) applies to any Cayman Islands entity engaged in “securities investment business”.  Under the SIB Law, a person is not permitted to carry on securities investment business unless that person holds a licence granted under the SIB Law or is exempted from that requirement by virtue of being an “excluded person” (see below).

For the purpose of the SIB Law, “securities investment business” is broken down into four categories: (1) dealing in securities, (2) arranging deals in securities, (3) managing securities and (4) advising on securities.  Generally, activities falling within these categories will be “regulated” activities, unless they can be shown to fall within certain specified “excluded activities” (these are not regarded as securities investment business for the purpose of the SIB Law).  The services generally provided to funds by prime brokers, as they relate to “securities”, are each likely to fall within the definition of “securities investment business” under the SIB Law.  For the purpose of the SIB Law, “securities” is broadly defined to mean, in effect, any of the following: equity interests in a company, in a limited partnership or in a unit trust; debt instruments; warrants; options; futures; and contracts for differences.

Exemption

The SIB Law describes categories of persons who are classed as “excluded persons”.  To recap, excluded persons do not require a SIB Law licence to conduct securities investment business.  It is therefore possible for a prime broker to organise its business activities to ensure it is not subject to the SIB Law’s licensing requirements.

The most commonly applicable exemption available to the proprietor of a securities investment business, such as a prime broker, is for such a business to be carried on exclusively for one or more of the following classes of persons:

(a) sophisticated persons (broadly, a “sophisticated person” is a listed or regulated entity, or an experienced investor that invests more than US$100,000 per transaction);

(b) high net worth persons (broadly, a “high net worth person” is an individual with a net worth of at least US $1,000,000 or an individual with total assets of at least US $5,000,000); or

(c) entities all of whose investors are either sophisticated persons or high net worth persons.

While a prime broker that is an exempted person is not required to obtain a SIB licence, it is still required to register with the Cayman Islands Monetary Authority (CIMA), pay an annual fee of US $6,098 and make an annual declaration to CIMA as to the ongoing applicability of the relevant exemption.

If none of the exemptions under the SIB Law applies, or if it is important for the new business to be seen to be regulated, then it is necessary for the Company to apply for a licence under the SIB Law.

APPLYING FOR A SIB LICENCE

Procedure

The Company may apply for a restricted licence, or an unrestricted licence, under the SIB Law.  The application process for each type of licence is broadly the same, but the fee payable for a restricted licence is lower.  The maximum number of clients to whom an entity holding a restricted securities investment business licence may provide services is 20.

Licence applications under the SIB Law normally take approximately six to eight weeks following the date of submission of a duly completed application.  Applications from businesses located in heavily-regulated jurisdictions, such as the USA, the UK and Canada, may be processed more quickly if the application is accompanied by evidence of proper insurance coverage, a detailed and clear business plan and up-to-date audited financial statements.

The application procedure for a SIB licence involves:

(a) completion of an application, submission of it to CIMA together with supporting documents and payment of the applicable application fee;

(b) review of the application by CIMA followed by any comments it may have;

(c) resolution of any issues to CIMA’s satisfaction; and

(d) subject to approval by the Head of the Investment and Securities Division of CIMA, consideration of the application by  CIMA’s Management Committee for final approval.

Documentation

In practice, the key to prompt and favourable consideration of an application is the preparation and collation of full information before it is submitted.  We can advise on the required information and supporting documentation at the appropriate time.

Commercial items that are required (in addition to the formal items) include the following:

(a) particulars of the key personnel’s securities experience and securities qualifications;

(b) a detailed business plan;

(c) an organisational-structure chart of the applicant showing delegation, responsible staff and reporting authorities;

(d) a group-structure chart;

(e) an outline of the group’s major sources of income;

(f) details of any sub-contracting agreements;

(g) list of companies with whom the applicant has or intends to have agency agreements; and

(h) information as to the applicant’s systems and controls.

Points to note

Insurance

The Company will be required to obtain the following insurance cover:

(a) professional-indemnity insurance;

(b) professional-liability cover for its senior officers and corporate secretaries; and

(c) business-interruption cover.

The amount of such insurance coverage must be appropriate to the size, complexity and nature of the licensee’s securities investment business.

Delegation

Neither the SIB Law nor CIMA requires a SIB licensee to maintain a direct physical presence in the Cayman Islands, so all functions could be delegated.

Records to be kept at the registered office

However, the Company will be required to maintain at its registered office electronic copies of all procedural manuals, contractual agreements, insurance information, due diligence information, client correspondence, and client transaction information to be available for inspection by CIMA at any time upon reasonable notice.  It is possible that CIMA will consider alternatives to this; for example, it may entertain an agreement to pay CIMA’s expenses to travel to the non-Cayman location where such records are kept.  Such documents should be retained for a period of at least five years, and they should be kept up-to-date at all times as far as is reasonably practical.

Letter of good standing

If the Company has never engaged in securities investment business prior to making the application for a SIB licence, CIMA will require the applicant’s ultimate holding company to furnish a letter of good standing issued by the overseas regulator operating in the jurisdiction where the parent is domiciled or maintains its headquarters.

Minimum financial requirements

The applicant will be required to meet minimum financial requirements.  The financial-resources calculation specified in the applicable regulations requires the following from each applicant: for securities’ managers, there is a minimum-base requirement of US$122,000; and, for all other licensees, there is a minimum-base requirement of US$18,500; in addition to other financial requirements based on counterparty risk and position risk.

Further information

For further information on licensing under the SIB Law, and for details of the ongoing obligations of a licensee, please refer to Ogier’s client briefing Regulation of Securities Investment Business in the Cayman Islands.

CORPORATE GOVERNANCE AND RESTRICTIONS ON LICENSEES

Ordinary non-resident companies have certain features and corporate governance obligations under Cayman law.  Where a company is a licensee under the SIB Law, certain additional obligations and restrictions apply, some of which are noted below.

Shares

The Company must have at least one shareholder, who may be an individual or a non-natural person; there is no requirement for a shareholder to be resident of the Cayman Islands.  The identity of the shareholder(s) of an ordinary non-resident company is publicly-available information in the Cayman Islands.

In respect of a company limited by shares (which is the most common form of company), the liability of each shareholder is limited to the amount unpaid on its shares.  Therefore, once the shares issued by the Company have been fully paid for by the shareholders, those shareholders are not liable for the Company’s debts and obligations (except in rare circumstances that do not apply to a well-run business).

There are no thin-capitalisation restrictions in the Cayman Islands.  And it is common for a company to issue only a small number of shares (e.g. 100 or 1,000); and the shares can be denominated and paid for in any currency.

However, a company licensed under the SIB Law may not do any of the following without CIMA’s consent:

(a) issue new shares;

(b) permit the transfer or disposal of any of its issued shares;

(c) reduce or change the nature of its issued share capital; or

(d) enter into an agreement to sell or merge the whole or any part of the company to or with a third party.

Directors and officers

The Company must have at least one director.  That director or, if more than one, none of the directors, is required to be resident in the Cayman Islands, nor does any director require formal qualifications.  Furthermore, no director is required to also be a shareholder.  And it is permissible for a director to be corporate director.

In addition, the Company needs to have a secretary (who may be a director).

The identity of the directors and officers of an ordinary non-resident company is not publicly-available information in the Cayman Islands.

If the Company is to obtain a full licence under the SIB Law:

(a) it needs to have a minimum of two directors, each of whom must be determined by CIMA to be fit and proper person; and

(b) its senior officers may not be changed without CIMA’s prior approval.

Accounts and record keeping

The Company must maintain proper books of account that give a true and fair view of the state of its affairs.

If the Company is to obtain a full licence under the SIB Law, then it must have its accounts audited annually, and it must file audited financial statements with CIMA.  Such accounts are not publicly available.  A licensee is not permitted to change its auditor without CIMA’s prior written approval.

In addition, the Company must keep minutes of all resolutions and proceedings of its directors and shareholders.

Registered office

The Company must have a registered office in the Cayman Islands, and it must make certain annual filings with the Registrar of Companies.  The Ogier group is able to provide this service.

Anti-money laundering

The Cayman Islands have stringent regulations against anti-money laundering and terrorist financing that apply to all businesses.  An applicant for a SIB licence must, therefore, be able to satisfy CIMA that it is able to meet the requirements of such regulations.  If such functions are delegated, CIMA needs to be satisfied as to the procedures and ability of such delegate(s) to carry out the required due-diligence work.

The Money Laundering Regulations (Revised) (the AML Regulations) require that relevant financial services providers have in place anti-money laundering policies, procedures and practices that enable them to comply with Cayman’s anti-money laundering regime.  Among other things, the AML Regulations require the relevant financial services provider to maintain and to monitor record keeping in respect of: client identification, accounts files, and business correspondence regarding its clients’ transactions.

It is also necessary for the new business to appoint a money laundering reporting officer and a money laundering compliance officer (who may be the same individual) and to prepare and to maintain an “anti-money laundering policies and procedures” manual for its staff.

IMMIGRATION AND EMPLOYMENT

Work permits for expatriate employees

Non-Caymanians require a work permit, and it is the employer’s responsibility to apply for work permits for its employees.  Permits are typically granted for one to three years.  But, if the employer has a “staff business plan” (it is mandatory for a business with 15 or more work-permit holders to submit such a plan), it is typical for three- to five-year work permits to be issued for workers covered by such a plan.

The Cayman Islands have a skilled and educated workforce, but, as a small jurisdiction, there is a limited pool of qualified candidates for the more senior or technical roles.  There are in place new directives regarding the issuance of work permits to the financial-services sector in order to facilitate inward investment into the Cayman Islands.  In practice, for a prime brokerage business, this means that junior administrative staff are often recruited from the local population in the Cayman Islands, while work permits are generally granted for roles requiring greater expertise.

The Cayman Islands have had a long-standing policy objective to grow and to train the Caymanian population to fill the positions occupied by expatriate workers.  The work-permit process, therefore, includes a requirement to advertise locally for positions to be filled before expatriate workers can be employed.  Caymanians and those legally resident in the Cayman Islands must be employed in priority to equally qualified expatriate applicants.

Work-permit fees vary depending on the type of application and the position applied for.  The highest annual work permit fee, which would apply to (say) the CEO’s position for prime broker, is currently US$ 33,750.

Terms of employment

The Labour Law (Revised) imposes a minimum set of standards with which all employment contracts must comply, as well as imposing certain other conditions on employers and employees.  These minimum standards and conditions include customary provisions relating to remuneration, vacation, maternity leave, termination, severance pay, health and safety, and non-discrimination.

In general terms, though, employees in the Cayman Islands enjoy fewer protections and benefits than employees in jurisdictions such as Europe.

Health insurance

Under the Health Insurance Law (Revised), every employer in the Cayman Islands is obliged to obtain for every employee a standard health-insurance contract from an approved insurer.  The employer is responsible to pay the premium on every employee policy but is able to deduct up to 50% of the premium paid from the employee’s remuneration.

Pension contributions

Every employer must provide a pension plan or make contributions to a pension plan on behalf of each employee.  An employer must contribute a minimum of 5% of an employee’s earnings up to maximum annual pensionable earnings of US $73,171 i.e. a maximum of US $3,659 per annum. Employees are required to make matching contributions.

Business premises

Office space in Grand Cayman is generally of a high standard, and there is a range of options that are likely to be suitable for any new business.  Ogier has strong relationships with a number of real estate brokers and is in a position to make introductions at the appropriate time.

Stamp duty is payable on any lease as follows:

(a) for a term over 10 years – 20% of average annual rent

(b) for a term over 5 years – 10% of average annual rent

c) for a term under 5 years – 5% of average annual rent

In calculating the term, option periods are taken into account.

Quality of life

Cayman residents enjoy a tropical climate in a beautiful setting.  The Cayman Islands are a friendly and sophisticated island state with strong cultural ties to the UK and the USA that offers a very high standard of living.  There are three islands, with most commercial activity taking place on Grand Cayman.  The population of Grand Cayman is approximately 55,000.  New residents are enticed by the combination of a sophisticated business and social scene with an outdoor lifestyle that enables year-round participation in land- and water-based leisure activities.

There are numerous schools offering a choice of UK and US curriculums.  Health standards are very high with two hospitals (and a third under construction) and a large number of medical and dental facilities.  The housing market is stable and varied with no restrictions on ownership.  For an informative overview of life in the Cayman Islands visit the New Resident.

APPENDIX: FINANCIAL SERVICES – THE CAYMAN ADVANTAGE

Cayman Islands’ standing as an international financial centre

The Cayman Islands are recognised as a top-tier international financial centre, with leadership and expertise in a number of areas.  It offers a diverse pool of professional service providers (lawyers, administrators, auditors, managers and fiduciaries) in an environment of economic and political stability.

As the world’s leading domicile for offshore hedge funds, the top international banking centre, the second largest captive insurance centre and a world leader in structured finance, the jurisdiction stands as the only offshore international financial centre to possess such breadth and depth in financial services.  Cayman’s financial-services success is built upon core principles of proportional and appropriate regulation, adherence to recognised relevant international standards, international cooperation, and a robust and proactive legal system.

Financial services account for a substantial portion of Cayman’s gross domestic product and the success of this sector contributes substantially to Cayman’s “Aa3 stable” sovereign credit rating (reaffirmed by Moody’s in February 2013).

Cayman Islands’ approach to regulation

The Cayman Islands Monetary Authority (CIMA) is the financial-services regulator, responsible for prudential and anti-money-laundering regulation of licensees and registrants.  CIMA is a full member of the International Organization of Securities Commissions (IOSCO), the Offshore Group of Banking Supervisors (OGBS), the Offshore Group of Insurance Supervisors (OGIS) and the Offshore Group of Collective Investment Scheme Supervisors, as well as a member of the OECD’s Level Playing Field sub-committee.

CIMA adopts and applies the Basel core principles (for banking), IAIS principles (for insurance), IOSCO principles (for securities and investment) and OECD principles (for corporate governance).

Combating anti-money laundering (AML) and terrorist financing (CTF)

The Cayman Islands have been a member of the 30-nation Caribbean Financial Action Task Force (CFATF) since its inception in 1992.  Members of Cooperating and Supporting Nations of the CFATF include the United States, Canada, the United Kingdom, France, Mexico, Spain and the Netherlands.

The CFATF is an Associate Member of the inter-governmental AML/CFT body, the Financial Action Task Force (FATF) and conducts regular peer assessments of its members based on FATF’s and CFATF’s recommendations.

The Cayman Islands were reviewed by the CFATF in late 2007.  The resulting report recognised that the compliance culture in Cayman was well established and highly commendable.

The General Accountability Office report in July 2008 on behalf of the U.S. Government determined that the Cayman Islands are one of the U.S. Department of Justice’s “best partners” as a result of its excellent record of cooperation.

AML/CFT procedures are mandatory for all licensees, registrants and entities conducting relevant financial business.  Unlike other jurisdictions, this also applies to corporate service providers and trust companies

Transparency for revenue authorities

The Cayman Islands have an established history of transparency in tax matters.

Even though they are not part of the EU, the Cayman Islands have voluntarily participated in the implementation of the EU Savings Directive since its commencement on 1 July 2005.  The Directive established a multi-national information exchange with the sole purpose of curbing tax evasion and tax avoidance by EU residents.  It focuses on the savings income paid to individuals (and certain residual entities) resident in the EU by a paying agent resident in a country other than the one in which the individual is resident for tax purposes.  To assist in the implementation of the Directive, the Cayman Islands have in place a proactive reporting mechanism in respect of all EU states (of which there are now 28 following the last country to join: Croatia on 1 July 2013).

The Cayman Islands also feature on the OECD’s “white list” of jurisdictions that have substantially implemented the internationally-accepted exchange-of-tax-information standards.  As at April 2013, they had entered into 31 tax information exchange agreements  with a substantial number of the world’s leading economies (for example, with EU member states, the UK, the USA etc).

In fact, in its Phase 2 Report of April 2013, the OECD’s Global Forum on Transparency and Exchange of Information for Tax Purposes concluded that the Cayman Islands had properly implemented its standards for transparency and tax information.  Among the many positive comments in the report, the OECD stated that the Tax Information Authority’s exchange process is “very well organized with many internal processes in place for handling EOI requests as well as the unit being well resourced in personnel, IT and technical expertise.  As a result, high quality responses are provided to partner jurisdictions and in 87% of cases the time in which a final response was provided has been less than 90 days”.

More recently, the Cayman Islands have stepped up efforts to counter tax evasion through increased transparency.

On 29 November 2013, the Cayman Islands’ Government signed a Model 1 intergovernmental agreement (IGA), as well as an amended Tax Information Exchange Agreement, with the US in relation to the US Foreign Account Tax Compliance Act (FATCA) and has also signed a FATCA-style agreement with the UK.  The goal of FATCA is to improve income tax compliance by U.S. taxpayers by giving the Internal Revenue Service (IRS) access to more information about the income and assets in their accounts held in foreign financial institutions (FFIs).  FATCA, and its accompanying regulations, seek to achieve this goal by imposing a 30% withholding tax on certain “withholdable payments” (payments of certain US-source income, including dividends and interest) to FFIs if the necessary information is not provided.  IGAs provide for information exchange under FATCA.

On 25 April 2013, the Cayman Islands’ Government committed to joining the G5 pilot programme of five European countries to automatically exchange tax information.  The data that Cayman will pass on to the UK, Germany, France, Italy and Spain is expected to go much further than the already existing reporting of interest income on bank deposits by EU citizens with accounts in the Cayman Islands.

On 19 June 2013, and in furtherance of full implementation of the revised Financial Action Task Force (FATF) standards, the Cayman Islands’ Government released an action plan for disclosure of beneficial ownership to improve transparency of the ownership and control of companies.

On 22 June 2013, the Cayman Islands became party to the Multilateral Convention on Mutual Administrative Assistance in Tax Matters; on that day, the UK, at the Islands’ request, signed the convention on their behalf.  The convention is a multilateral agreement developed by the OECD and the Council of Europe to combat tax evasion and aggressive tax avoidance.  It provides for all possible forms of administrative cooperation between states in the assessment and collection of taxes.  It is a framework which will need to be followed by bilateral agreements with the different countries.

International regulatory cooperation

CIMA has a statutory obligation and wide associated powers to cooperate with international counterparts.  It is a party to the IOSCO Multilateral Memorandum of Understanding Concerning Consultation, Cooperation and the Exchange of Information.  Accordingly, international regulators should not be concerned by a regulated investment fund or a licensed investment manager being domiciled in the Cayman Islands, as agreed gateways now exist for all IOSCO members to obtain appropriate information.

More specifically:

CIMA has entered into specific information-sharing bilateral memoranda of understanding with other major regulators, including the US Securities and Exchange Commission and UK’s former Financial Services Authority (the Financial Services Authority has been superseded by two separate regulatory authorities: The Financial Conduct Authority and the Prudential Regulation Authority, an arm of the Bank of England); and

At the time of writing it had signed MOUs with each of 26 European financial authorities (these MOUs provide for regulatory cooperation and are in a form approved by the central European regulator, European Securities and Markets Authority (ESMA)) and it was continuing negotiations to enter into such MOUs with the remaining ESMA members.

Entry into such agreements meets one of the conditions, under the EU’s Alternative Investment Fund Managers Directive (AIFMD), for alternative investment fund managers (AIFMs) to continue to actively market alternative investment funds (AIFs) to professional investors in the European Economic Area where either or both the AIFMs and the AIFs are domiciled in the Cayman Islands.

Recognised stock exchange

The Cayman Islands Stock Exchange (CSX) was granted approved organisation status by the London Stock Exchange in July 1999, the first offshore stock exchange to achieve this. Also, the UK Inland Revenue has designated the CSX as a “Recognised Stock Exchange” under Section 841 of the Income and Corporation Taxes Act 1988 which provides some key tax efficiency advantages. The CSX has approximately 2,000 fund listings and 1,000 debt listings to date. Listing on the CSX provides enhanced profile and access to institutional capital.

About Ogier

The Ogier Group provides international legal services and trust, company and fund administration services.  We employ over 850 people and provide advice on BVI, Cayman, Guernsey, Jersey and Luxembourg law and fiduciary services through our network of offices that cover all time zones and key financial markets.

Our highly qualified professionals deliver outstanding client service in each location. The Group’s legal and fiduciary offering is a successful combination and we regularly win awards for the quality of our client service, our work and our people.

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