Changes to private funds legislation in the Cayman Islands and a growing investor demand for environmental, social and governance (ESG) investing are throwing up new issues for limited partners looking to commit capital in Cayman structures. This Q&A discusses the trends and common pitfalls.
Are more limited partners wishing to instruct Cayman counsel before committing capital and, if so, why?
It is surprising that investors making a significant investment have not always taken their own Cayman counsel prior to committing capital. They have sometimes relied on fund counsel (despite clear disclosures in offering documents that the fund counsel does not represent the investors individually).
It may also be that there is increased regulatory oversight of Cayman funds resulting from the 2020 Private Funds Act coupled with the more prescriptive rules issued in Summer 2020 by the Cayman Islands Monetary Authority (CIMA) as to the contents of offering documents, segregation of assets and calculation of net asset values, so institutional investors are now looking for more comfort that the fund will be in regulatory compliance. This trend is reinforced by the potential for substantial administrative fines to be imposed upon the fund by CIMA for breaches of prescribed provisions of certain Cayman laws and regulations, including the Private Funds Act and the Anti-money Laundering Regulations.
In particular, European investors are seeking Cayman counsel on the investor side.
What sort of issues arise and how should an advisory service assist limited partners?
Every transaction is different. Some clients require a 'deep dive' review and diligence on the commercial and legal documentation provided by the fund while others prefer a higher level 'red flag' legal review. In both cases, it helps to ensure that the limited partner is making its investment with its eyes wide open. In a deeper dive, counsel should look at anything off market in the limited partnership agreement (LPA) that may be too sponsor friendly or where it may be possible to improve the investor's position. Limited partners that have traditionally invested in US or European structures may be less familiar with the inner mechanics of fund LPAs and other fund documentation or less familiar with Cayman-specific issues, so may need to be guided through these.
The issues identified vary from deal to deal, but, for instance, may include:
- whether a fund has a firm end date or whether there is a never ending option for the general partner to extend the term;
- extremely off-market interest rates for defaulting partners; and
- checking a number of core regulatory filings and registrations.
Other examples of provisions resulting in successful limited partner negotiating may, for instance, include those regarding:
- expenses;
- indemnification and exculpation;
- distribution clawback rights;
- carried interest clawback protections;
- distributions in kind;
- term extensions; and
- the impact of a defaulting limited partner on non-defaulting limited partners.
Are there any common pitfalls which limited partners can easily avoid when investing into a Cayman fund?
Investors tend to be focused on a myriad of issues depending on their own investing mandate, background, sector and geographical interests. Having said that, limited partners should ensure that:
- they dissect the regulatory compliance of the fund;
- there is a qualifying general partner of any Cayman partnership; and
- their limited liability is not jeopardised by the fund documentation drafting.
Other common pitfalls concern:
- confidentiality and information inspection rights;
- investor voting rights and limitations;
- LPA amendment provisions;
- general partner removal;
- waterfall provisions; and
- advisory committee powers.
Are there any other notable trends?
It would be remiss not to note the uptick in focus on ESG issues. In this regard, there has been a growing number of investors seeking the general partner's acknowledgment of and agreement to the investor's binding ESG policies and for them to take such policies into account when making investment recommendations or decisions. There has been a marked increase in desire by limited partners to ensure exactly how the fund's investment process, systems and staff support the identification of ESG factors that may be material to any investment.
