New CIMA Rules on De-Registration: What does It Mean for a Fund in Liquidation?

Background

Fund liquidations have become more and more commonplace in the alternative investment industry since the financial crisis began in 2007. Accordingly, many questions have arisen regarding financial reporting for funds, from the timing of the fund dissolution to the required presentation and disclosure of financial data. The Financial Accounting Standards Board (FASB) issued Accounting Standard Update 2013-07: Liquidation Basis of Accounting (“ASU 2013-07”), an accounting update that clarified timing of liquidation and the reporting requirements. However, for offshore funds, in particular Cayman Islands-regulated mutual funds, guidelines were not established for how to liquidate and deregister with the Cayman Islands Monetary Authority (the “Authority” or “CIMA”) It was not until last spring that CIMA issued rules which clarified many of the questions offshore funds had while liquidating and winding down operations. On March 30, 2015, the Rule on Cancellation of License or Certificate of Registration of Regulated Mutual Funds (the “Rule”) and Regulatory Procedure for Cancellation of Licenses was issued pursuant to Mutual Funds Law (MFL) (the “Regulatory Procedure”). The Rule became effective October 1, 2015.

A mutual fund is defined by the MFL as “any company, trust or partnership either incorporated or established in the Cayman Islands, or outside the Cayman Islands, which issues equity interest redeemable or repurchased at the option of the investor.” This would generally include hedge funds, private equity funds and all other funds incorporated or established in the Cayman Islands.

CIMA is responsible for regulating mutual funds operating in and from the Cayman Islands in accordance with Mutual Funds Law (2013 Revision). All mutual funds under the jurisdiction must comply with CIMA regulations unless they meet the following criteria as set out in section 4(4) of the MFL:

• The fund’s equity interests are not held by more than 15 investors, and a majority of the investors are capable of appointing or removing the operator of the fund (the directors, general partner or trustee, as applicable); or
• The fund is not incorporated or established in the Cayman Islands and is not offering its shares to any member of the public in the Cayman Islands.

In addition, closed-end funds, whose equity interests cannot be redeemed at the option of the investor, are currently not regulated by CIMA under the MFL.

The purpose of the Regulatory Procedure is to provide more clarity and certainty to regulated mutual funds on what the Authority expects when applying to cancel a license or certificate of registration. Further, the published Rule is designed to streamline the cancellation of a license or registration of regulated mutual funds, reduce the administrative burden of the Authority and to protect the interests of investors and creditors. The published Rule requires regulated mutual funds to apply to the Authority to cancel their licenses or registrations when they cease to conduct business, as further described below.

Regulated mutual funds that do not apply to CIMA when canceling their licenses or registrations can continue to be liable for fees and penalties.Furthermore, failure to request proper cancellation of a license or registration could threaten the ability of the managers to serve as fund operators in future.

Timing of Application for De-registration

The Rule sets out a prescribed timeframe within which a mutual fund must apply to CIMA to cancel a license or certificate of registration.

A mutual fund is required to make an application to CIMA for the cancellation of a license or certificate of registration when the mutual fund intends to or has ceased to carry on business as a mutual fund under the MFL on the earlier of: (i) 21 days from the date the mutual fund ceases to carry on business; or (ii) before December 31 of the year the mutual fund ceases to carry on business.

A mutual fund ceases to carry on business on the date stated in the resolution of the directors, shareholders or unit holders where it was resolved that the fund will stop trading or investing, liquidate its assets and wind down operations. A fund to which a liquidator has been appointed is deemed to have ceased to carry on business. This is consistent with FASB’s ASU No. 2013-07, which describes the date of liquidation to be when (a) a plan for liquidation has been approved and made effective by operators of the fund; or (b) a plan of liquidation is being imposed by outside forces such as involuntary bankruptcy.

CIMA’s Requirements for Cancellation of License or Registration of Funds

A Cayman fund should submit a minimum of the following regardless of the reason for cancellation:

• The original license or certificate of registration
• The prescribed fee
• A certified copy of the resolution of the operators, shareholders or unit holders, which indicates the date on which the fund will cease or has ceased to carry on business as a fund in or from the Cayman Islands

Other documents may be required to cancel a license or certificate of registration depending on the reason for the cancellation of the license or certificate of registration, such as ceasing to carry on business, voluntary liquidation, continuation as an exempted mutual fund, transfer to another jurisdiction, funds that never carried on business, funds dissolving by way of a merger and de-registrations of master funds.

Change to Audit Waiver

Under the MFL of the Cayman Islands, a regulated mutual fund is required to complete and file its Funds Annual Report (“FAR filing”), along with its audited financial statements signed by a local (Cayman) auditor within six months from its fiscal year end or within the extension period allowed by CIMA. Paragraph 7.1 of the Regulatory Procedure states that a regulated mutual fund must provide audited financial statements from the date of the last audited financial year end to the date of commencement of liquidation or the date of the final distribution to investors. This is commonly known as a “stub” period audit.

Prior to the implementation of the Regulatory Procedure, it had been CIMA’s practice to allow an audit waiver request from mutual funds for a stub period audit following the last audited financial year end even when the mutual fund had been active but wished to surrender its mutual fund license or certificate of registration. This practice ceased effective October 1, 2015. It is expected that stub period audit waivers will no longer be granted by the Authority. It is uncertain if CIMA will accept financial statements with remaining hold back amounts still to be distributed to investors as the final audit report.

Fees

To avoid incurring annual fees and penalties, a mutual fund should file such requests within the timeframe prescribed in the Rule. In any given year, if a process is started but not completed by or before its year-end, then at least 50% of the applicable annual registration and a penalty of one-twelfth of the annual fee due for each month the payment remains outstanding may be due to CIMA.

Conclusion

Timely application for deregistration of a regulated mutual fund is important. When there is a decision to liquidate a Cayman fund, directors of the fund should take these rules into consideration to avoid incurring annual fees and penalties. Also, as a result of the Regulatory Procedure, any mutual fund wishing to surrender its license or certificate of registration is required to arrange for an audit for its “stub” period following the last audited financial year-end. If there are questions or concerns regarding the application for these regulations, consult your offshore legal counsel or a Marcum professional.