Our thinking Quick reads Substance in the Cayman Islands: Testing times for fund management businesses
Hedge funds and CTAs
October 2019
7 min read

Substance in the Cayman Islands: Testing times for fund management businesses

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The introduction of The International Tax Co-operation (Economic Substance) Law, 2018 (“ES Law”) in the Cayman Islands and the associated regulatory guidance has received a lot of attention lately. Rightly so in many respects, as it further demonstrates the commitment of the Cayman Islands to adopting international best practice standards. The ES Law represents the Cayman Islands’ implementation of the OECD Base Erosion and Profit Shifting (“BEPS“) standards, regarding geographically mobile activities and the EU’s ongoing effort to encourage good tax governance in third country jurisdictions previously identified as having harmful tax practices (BEPS Action 5).

While good governance is certainly to be encouraged in all forms, in some cases, what the ES Law seeks to achieve has long since been accepted as best practice in most international financial centres.

Take fund management business in the Cayman Islands, for example:

Fund management business is one of the nine categories of geographically mobile “relevant activities” identified by the OECD, which, if carried out by a “relevant entity” in the Cayman Islands, is subject to an economic substance test set out in the ES Law.

The principal legislation governing fund management business in the Cayman Islands is the Securities Investment Business Law (“SIBL”). SIBL was first enacted in the Cayman Islands in 2002 for the purpose of regulating Cayman Islands entities who carry on “securities investment business” (defined as, amongst other things, dealing, arranging deals in, managing or advising on securities).

Relevant entities carrying on securities investment business needed to be either licensed or otherwise registered as an “excluded person” (typically and most often because the securities investment business was carried on exclusively for one or more of: a sophisticated investor, a high net worth person or a vehicle comprised of one or more of these categories of people). SIBL was most recently revised in June 2019 to reflect the replacement of the historically lighter touch “excluded persons” regime (removing the previous safe-harbour for fund management entities) with the requirement to become a “registered person” by 15 January 2020.

These requirements should prove relatively uncontroversial for relevant entities carrying on fund management who are already licensed, given the licensing requirements imposed by the Cayman Islands Monetary Authority (“CIMA”) under SIBL largely track the economic substance requirements for fund management companies under the ES Law.

Upon registration as a registered person, CIMA will apply a ‘fit and proper persons’ test to the directors and senior officers of the applicant, in similar terms as already apply to licensed entities under SIBL.

The ES Law defines fund management business specifically as the business of managing securities as set out in paragraph 3 of Schedule 2 of SIBL carried on by a relevant entity licensed or otherwise authorised to conduct business under SIBL for an investment fund. This narrows the scope of the relevant activity significantly. Importantly, it excludes non-discretionary advice or the arranging of deals from the scope of the definition of fund management, for example.

Relevant entities that are either licensed or registered under SIBL and who are carrying on fund management will therefore become subject to the ES Law, meaning that they must satisfy the so-called economic substance test in respect of the fund management activities they carry on in the Cayman Islands.

In respect of fund management business, this entails:

1. Conducting Cayman Islands core income generating activities (“CIGA”) in relation to that relevant activity;

These are activities that are of central importance to a relevant entity carrying on fund management business in terms of generating income and that are being carried out in the Cayman Islands, namely:

  • taking decisions on holding and selling of investments;
  • calculating risk and reserves;
  • taking decisions on currency or interest fluctuations and hedging positions; and
  • preparing reports or returns, or both, to investors or CIMA, or both.

2. The relevant entity being directed and managed in an appropriate manner in the Cayman Islands in relation to that relevant activity;

To comply with this:

  • the board of directors, as a whole, must have the appropriate knowledge and expertise in line with its role;
  • board meetings must be held in the Cayman Islands at adequate frequencies, given the level of decision making required;
  • a quorum of directors must be present in the Cayman Islands during board meetings;
  • the minutes of the board meetings must record the making of strategic decisions of the relevant entity at the meeting; and
  • the minutes of all board meetings, along with appropriate records of the relevant entity, must be maintained in the Cayman Islands.

3. Having regard to the level of relevant income derived from the relevant activity carried out in the Cayman Islands, the relevant entity has:

  • an adequate amount of operating expense incurred from within the Cayman Islands;
  • an adequate physical presence in the Cayman Islands (e.g. office space; maintaining plant and equipment); and
  • an adequate number of full-time employees or other personnel with appropriate qualifications in the Cayman Islands.

It is expected that what is “appropriate” or “adequate” in any particular case will be highly fact specific and much will ultimately depend on a qualitative assessment of the relevant entity’s business plan, specific activities, size, resources and/or financial projections. For this reason, a checklist-based approach is strongly discouraged and unlikely to be useful.

While it may be tempting to see the ES Law as yet another regulatory hurdle to jump, a closer look suggests it may also present some new opportunities. Admittedly, there will be challenges. Established fund managers who have traditionally incorporated a SIBL excluded person management company as part of their management structure will now have to pay particular (and closer) attention to the use of that entity. If it is to continue to have a role in their structure, it may need to satisfy the new substance requirements. However, as both the implementation of the BEPS framework and Tax Information Authority (“TIA”) Guidance continues to evolve and develop, it can be expected to provide new structuring opportunities for fund managers in key financial jurisdictions, whether that be by way of compliance with economic substance requirements, exemptions therefrom or outsourcing.

Reporting Obligations

From 2020, all relevant entities must notify the Cayman Islands TIA of inter alia, whether or not a relevant activity is being undertaken and their financial year end date. Relevant entities undertaking relevant activities, who are required to comply with the economic substance requirements, must prepare and submit to the TIA an annual report containing prescribed information for the purpose of the TIA’s determination as to whether the economic substance requirement has been satisfied in relation to that relevant activity.

The first report must be submitted within twelve months of the last day of the end of the entity’s financial year commencing on or after 1 January 2019. It is expected that relevant entities will be able to make such reports through a dedicated online reporting portal.


It is possible to outsource certain functions and still satisfy the economic substance requirements. This option can only be satisfied if that activity is carried out by another person in the Cayman Islands and the relevant entity has adequate procedures in place to monitor and control the outsourced activity.

The resources of the service provider in the Cayman Islands will also count towards the people and premises limb of the substance requirements set out above. Further, employees of the service provider can count towards the total of relevant entity employees for the purposes of the substance requirements.

Time spent by outsourced service provider employees must be verified to ensure that only the portion of full-time equivalent employee time directly used in the service of the relevant entity is counted. Responsibility for accuracy of these details remains with the relevant entity.

As always, the adequacy of any such arrangements are also highly fact specific and a careful analysis of any proposed outsourcing arrangement should be undertaken on a case by case basis, with specific regard, as mentioned above, to the circumstances of the relevant entity.

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