This update highlights important changes to the regulatory and compliance regime for the Cayman Islands investment funds industry in 2018.
The changes that have been made to the Cayman Islands anti-money laundering (AML) regime are to bring Cayman in line with international best practice and are a welcome update to the financial services landscape in Cayman. The main change for those who use the jurisdiction for investment funds is the requirement to appoint natural persons as money laundering reporting officer (MLRO), deputy money laundering reporting officer (DMLRO) and AML compliance officer (AMLCO). Although performance of these functions can still be delegated to an administrator or another service provider, this change means that most funds will now need to appoint natural persons to these roles and then review their fund administration agreements to ensure that the delegation of the function is dealt with and update their documentation and procedures regarding anti-money laundering compliance generally. We would welcome the opportunity to discuss any of these issues with you in greater detail. Please get in touch with your usual Harneys contact or one of the authors of this alert, with any questions.
Unregulated Funds: Now explicitly subject to AML Regulations
As noted in previous briefings, unregulated funds (eg hedge funds exempt from registration with the Cayman Islands Monetary Authority (CIMA) or private equity funds) will need to comply with the Cayman Islands Proceeds of Crime Law (the PCL) and the Anti-Money Laundering Regulations (the AML Regulations) with effect from 31 May 2018.
In practice, unregulated funds will achieve AML compliance in much the same way that funds regulated by the Mutual Funds Law have done to date, namely by delegating these functions to a service provider, such as a regulated administrator or investment manager.
The most straightforward option available would be to delegate to an administrator or investment manager that is regulated for AML purposes in a recognised jurisdiction (eg Cayman Islands, Ireland or Bermuda), with equivalent standards to the AML Regulations. In such cases, compliance by the delegate with its jurisdiction’s regulations would be sufficient to ensure that the Cayman-based fund is compliant with its obligations, provided the fund has appointed natural persons as MLRO, DMLRO and AMLCO before it delegates these functions, as described below.
One important point to note is that US and Hong Kong based fund administrators are generally not regulated in the United States or Hong Kong and are only subject to general anti-money laundering legislation in those jurisdictions. As such, delegation to US or Hong Kong based administrators would be subject to confirmation that they will provide services in accordance with the PCL and the AML Regulations or the directors or general partner (for example) of the fund would need to confirm that the standards they adopt are equivalent to the Cayman AML regime. As is the case for regulated funds, natural persons would still need to be appointed by the fund as the AMLCO, MLRO and DMLRO in these circumstances.
Unregulated funds should take this into consideration as a matter of urgency this quarter.
All Funds: Role of Money Laundering Reporting Officer, Deputy Money Laundering Reporting Officer and AML Compliance Officer
The AML Regulations, Guidance Notes issued in December 2017 and a notice issued by CIMA in April 2018 now require all funds that are subject to the AML Regulations to designate natural persons as their MLRO, DMLRO and AMLCO. Once natural persons have been appointed, performance of these functions can then be delegated to a third party, such as the fund’s administrator.
This recent development means funds need to look at their administration or delegation agreements and liaise with the current service providers, to ensure that they appoint individuals to these roles and make appropriate amendments to their service agreements. Funds can continue to delegate the function of reporting suspicious activities to their administrator in accordance with their own regulatory obligations, once they have appointed these individuals. New funds registering with CIMA from 1 June 2018 will need to confirm who has been appointed to these roles as part of the registration process. Existing registered funds have until 30 September 2018 to confirm who has been appointed, via a filing on CIMA’s REEFS portal.
For those funds that now need to appoint an MLRO, DMLRO and AMLCO, these are management level roles and the responsibilities of an MLRO/DMLRO are substantial and include assessing reports of suspicious activity in relation to money laundering or terrorist financing and determining whether to report such suspicious activity to the Cayman Islands Financial Reporting Authority. Where the fund does not have its own employees (which will be the case for most funds), the Guidance Notes detail the criteria that should be applied in selecting an appropriate person to fill each role and guidance on the delegation/outsourcing decision making process. CIMA is currently updating the Guidance Notes to reflect its April notice and the requirement to appoint a natural person to these roles.
Revised regulations regarding accepting subscription payments from bank accounts located in regulated jurisdictions
Until the new regime was adopted, for AML purposes, funds and their administrators had not been obliged to obtain full KYC documentation from investors whose accounts are held in their name at a bank regulated in an equivalent AML jurisdiction, on the basis that the appropriate due diligence had been undertaken by the bank.
As part of the overarching risk based approach that is now key to the AML regime, the AML Regulations require that, before the fund receives subscription monies from an investor’s account held at a regulated bank, the fund (or its delegate) will need to (a) conduct an assessment of the level of risk relating to the investor (eg low, medium or high) and have identified the risk as low and (b) have identified the customer and its beneficial owner and assessed whether or not full KYC documentation or further information is required. CIMA has confirmed that the Guidance Notes are also being amended to clarify these provisions.
In reality, very few fund administrators relied on the previous exemption and obtained full KYC from all investors regardless. Where that may not have been the case, the practical consequence of this will be that some investors in Cayman Islands funds will be required to provide full KYC in more situations than previously.
Substantial administrative fines for breaches of the AML Regulations
Amendments to the Monetary Authority Law and associated regulations came into force on 15 December 2017, giving CIMA increased powers to impose administrative fines for breaches of certain regulatory laws. These fines can initially be imposed for breaches of the AML Regulations, with a maximum fine of up to CI$1 million (US$1,219,500).
CIMA must classify breaches as minor, serious or very serious, and will apply these criteria when it exercises its discretion to impose fines. The minimum fine for a breach considered to be “minor” is CI$5,000 (US$6,098).
Once further regulations under the Monetary Authority Law are adopted, we fully expect CIMA to use these new powers to take increased action for breaches of all regulatory laws, including the Mutual Funds Law and the Securities Investment Business Law (eg failure to make filings within time limits without applying for exemptions or extensions).
New Tax Offence in the Cayman Islands Related to Anti-Money Laundering
Changes to the Cayman Islands Penal Code (the law which contains most criminal offences in the Cayman Islands) mean that a new criminal tax offence has been introduced into Cayman Islands Law. At first sight this may seem odd in a jurisdiction with no direct taxation, but a direct consequence of the new offence is to require reporting of suspicion of overseas tax evasion as part of the AML framework in the Cayman Islands.
It is now a criminal offence when a person, with intent to defraud the Cayman Islands government: (a) wilfully makes, delivers or causes false or fraudulent information to be made to a person employed in the public service relating to the collection of money for the purposes of general revenue; (b) wilfully omits information required to be provided to a person employed in the public service relating to the collection of money for the purposes of general revenue; or (c) wilfully obstructs, hinders, intimidates or resists a person employed in the public service in the collection of money for the purposes of general revenue.
Without any specific punishment provided, the offence will be punishable with imprisonment for four years and with a fine. Not an insignificant deterrent.
As noted, the main offence of tax evasion is likely to be of limited applicability given the lack of direct taxation in the Cayman Islands.
The real impact of the new offence is as part of the Cayman Islands AML framework because overseas tax evasion is now ‘criminal conduct’ and the proceeds of such conduct would be the proceeds of crime. The Proceeds of Crime Law requires ‘dual criminality’ for offences that are not committed in the Cayman Islands in that the conduct must not only be an offence in the place where it is committed (if not the Cayman Islands) but must also be an offence in the Cayman Islands in order for it to be criminal conduct.
Failure to make the required disclosure, when a person knows or suspects or has reasonable grounds for knowing or suspecting that another person is engaged in criminal conduct (eg tax evasion overseas), in the absence of any defence, is punishable with prison time or a fine or both.
 Section 247A of the Penal Code