This article reviews the need-to-know features of the legal and regulatory frameworks governing virtual currencies in the Cayman Islands, with particular regard to applicable securities and banking laws.
Introduction to the legal and regulatory framework
Owing to its neutral tax treatment, political stability and respected legal regime, the Cayman Islands is the global jurisdiction of choice for the formation of investment funds, which are increasingly investing in virtual assets and taking advantage of the investment opportunities in this space. The Cayman Islands has been, and remains, the leading domicile for virtual asset investment funds globally[1]. A number of virtual asset exchanges have been launched by Cayman Islands entities.
The Cayman Islands Special Economic Zone provides a simplified route to establishing a physical presence and employing staff in the Cayman Islands.
In mid-2020, the Cayman Islands government introduced a new framework for regulating virtual asset businesses, known as virtual asset service providers (VASPs). The framework implements Financial Action Task Force recommendations on international standards on combating money laundering and the financing of terrorism and proliferation applicable to VASPs (including virtual asset issuances, exchanges, transfer and custodian services, and financial services related to a virtual asset issuance); defines virtual assets and which virtual assets constitute securities; enables funds to use virtual assets as representations of equity interests; recognises virtual asset trading exchanges; and introduces a regulatory sandbox licence. No case law has yet considered issues arising in the virtual assets space.
Structuring of virtual currency businesses
There is no direct taxation imposed on Cayman Islands entities and structuring will largely be driven by onshore tax considerations, Cayman Islands regulatory requirements and business needs.
Exempted companies
The most common type of entity used by VASPs to form investment funds investing in virtual assets, virtual asset issuances (commonly known as initial coin offerings and security token offerings) and virtual asset exchanges in the Cayman Islands is the exempted company. Exempted companies conduct business based on a declaration by the incorporating subscriber that the operations of the company are to be carried on mainly outside the Cayman Islands.
An exempted company must have a minimum of one shareholder and one director. The appointment of officers is optional. There is no requirement for Cayman-resident directors or officers.
Exempted limited partnerships
Exempted limited partnerships are more commonly used to form closed-ended funds investing in virtual assets, which may be investing in illiquid virtual asset issuances rather than more commonly traded virtual assets. The Exempted Limited Partnership Act (the ELP Act) governs the formation of exempted limited partnerships.
The ELP Act also contains provisions relevant to the affairs of an exempted limited partnership, being the primary legislation governing partnerships generally. An exempted limited partnership is a partnership consisting of at least one general partner (who has responsibility for the business affairs of the partnership) and any number of limited partners that is registered as such under the ELP Act.
An exempted limited partnership is not a separate legal entity. It is instead a set of contractual obligations affecting the partners, between themselves, where a general partner is vested with certain powers and obligations in relation to a business and the assets of the business.
Exempted limited partnerships are often treated differently to companies for onshore tax purposes, typically being treated as fiscally transparent. The general partner holds the partnership’s assets in statutory trust for the partners and is tasked with managing the business and affairs of the exempted limited partnership. If the assets of the partnership are inadequate to satisfy the claims of creditors, the general partner is liable for the debts and obligations left unpaid.
Foundation companies
A foundation company shares many of the features of an exempted company. A foundation company is a body corporate with limited liability and separate legal personality from its members and directors and other officers. It can sue and be sued and hold property in its own name. The key feature of a foundation company that often makes it an attractive vehicle for issuing virtual assets is that it is not required to have members following incorporation. This is a particularly useful structure for those projects that will ultimately be decentralised and governed by the community. During 2021 and 2022, foundation companies were especially popular as a vehicle through which decentralised autonomous organisations could contract with the world and hold assets. Careful structuring, legal and regulatory analysis, is required for any projects considering such an approach.
A foundation company must, however, unlike an exempted company, appoint a qualified person as a secretary, namely a person who is licensed or permitted by the Companies Management Act (revised) to provide company management services in the Cayman Islands, and that secretary must maintain a full and proper record of its activities and enquiries made for giving notice, and ensure that the company complies with Cayman Islands anti-money laundering, countering the financing of terrorism and anti-proliferation financing obligations when accepting transfers of virtual assets without consideration.
Trusts
If ownership and autonomy are concerns, which may be relevant particularly for issuing virtual assets, they can be addressed to a certain degree by having a Cayman Islands charitable trust or STAR trust (introduced by the Special Trusts (Alternative Regime) Act) hold all the shares in issue of the exempted company. A Cayman Islands STAR trust is a non-charitable purpose trust that can hold assets for a specific purpose. The trustee must be a licensed trustee in the Cayman Islands.
Summary of Cayman laws to be considered in the virtual currency space
The following Cayman Islands statutory and regulatory regimes must be considered when structuring a virtual currency business in the Cayman Islands:
- The Virtual Assets (Service Providers) Act
- The Securities Investment Business Act
- The Mutual Funds Act
- The Private Funds Act
- The Money Services Act
- The Bank and Trust Companies Act
- The Proceeds of Crime Act, the Proliferation Financing (Prohibition) Act, the Anti-Money Laundering Regulations (the AML Regulations) and existing guidance notes, and the Terrorism Act
- The Stock Exchange Companies Act
- The US Foreign Account Tax Compliance Act and the Organisation for Economic Co-operation and Development’s Common Reporting Standard
- The beneficial ownership regime
- The International Tax Co-operation (Economic Substance) Act
Download the article to continue reading and learn more about the below points as they relate to virtual currencies in the Cayman Islands:
- VASP regulation
- Securities and investment laws
- Banking and money transmission
- Anti-money laundering
- Regulation of exchanges
- Regulation of virtual asset custodians
- Regulation of issuers and sponsors
- Tax
- Other issues
This article formed part of The Law Reviews – The Virtual Currency Regulation Review Fifth Edition, published September 2022.
[1] According to PWC’s 4th Annual Global Crypto Hedge Fund Report 2022, 49 per cent of virtual asset investment funds are domiciled in the Cayman Islands.
