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As investors in the world’s third-largest economy continue to make significant investments in global assets, Nick Harrold examines the main features of the Cayman Islands mutual fund – the preferred investment vehicle for many Japanese investors.
Why is the Cayman Islands Unit Trust Popular with Japanese Investors?
Japanese investors want to invest through a mutual fund structure for a variety of reasons, including investor familiarity (Japanese mutual funds, which are commonly used by Japanese investors to make investments, are also structured in mutual fund). The Cayman Islands Mutual Fund may also offer additional flexibility to implement more complex investment strategies, due to the ability to denominate classes of units in currencies other than JPY and to pay distributions on the main, unrestricted, among other factors.
Importantly, a Cayman Islands mutual fund is also a tax-efficient way for many Japanese investors to access global investments. It is generally considered to be a foreign investment trust for the purposes of the Investment Trusts and Investment Companies Act of Japan (Act No. 198 of 1951) and if more than 50% of the assets of the trust are considered to be “securities” or “securities-related derivatives” within the meaning of the Financial Instruments and Trade Law of Japan (Law No. 25 of 1948), the trust is able to obtain corporate tax status investment in securities.
What are the origins and legal structure of the mutual fund?
The mutual fund has its foundations in the law of trusts. The law of trusts first developed in the 12th century, during the Crusades. When a landowner left England to fight in the Crusades, he transferred ownership of his land (the trust property) to an acquaintance (the trustee). The trustee will hold legal title and manage the land, paying and receiving feudal royalties, with the understanding that the property would be returned to the original owner (the beneficiary) upon their return.
The mutual fund has at its heart these same fundamentals of trust. In order to establish a valid mutual fund, the “three certainties” must be present: a trustee, holding property in trust (fund assets) in trust for the beneficiaries (unitholders).
How is a mutual fund constituted?
A unit trust is generally established by the execution of a trust deed that documents the terms under which the trustee will hold the assets of the trust in trust. When establishing a mutual fund, it is possible to use either a trust deed to which only the trustee is a party (a one-party declaration of trust) or a trust deed to which the trustee and the manager are parties (an act). In the case of public offerings in Japan, it is a well-established practice to have the manager responsible for the issue of the units in the constitution of the mutual fund, which is a de facto requirement for the use of a bipartite trust deed. However, for private placements in Japan, a one-party declaration of trust or a two-party trust deed can be used.
The question of whether a mutual fund has been validly constituted – and continues to exist – is not solely a question of whether a deed of trust has been signed. Instead, it depends on whether the three certainties are present at the relevant time. A common misconception in the market is that a registration certificate issued by the Registrar of Trusts confirms the existence of a trust, although in practice it only proves that the parties have registered what is supposed to be a trust, as an exempt trust, with The Clerk.
It follows that at the end of the life of a mutual fund, a mutual fund may be terminated either by the redemption of all outstanding units or by the trustee making a final distribution to holders of shares. shares, which would mean that two of the three certainties are no longer present: no trust property (fund assets) and no beneficiary (unitholders). This contrasts with the termination of other Cayman Islands fund vehicles where a formal deregistration or voluntary dissolution procedure is often required in order to terminate the affected vehicles.
Trust companies (other than private trust companies) must be licensed under the Cayman Islands Banks and Trust Companies Act (2020 Revision). License applications are submitted and reviewed in detail by the Cayman Islands Monetary Authority (“CIMA”). Trust licenses will only be issued to persons involved in the direction or management of the relevant trust company who have the necessary experience in trust and fiduciary business.
What is meant by a mutual fund that does not have a separate legal personality?
Under Cayman Islands law, a trust is not a legal person and does not exist as a separate legal entity. Rather, the trust unit is the name given to the collection of assets that are held in trust by the trustee. In the same way that a bank account, another collection of assets, is incapable of making investments, entering into agreements or suing or being sued in its own name (each a “Transaction”), a trust no more. Instead, it is the trustee (or his delegate) who must conclude all Transactions “on behalf” of the SICAV.
It is important to note that when a trustee (or the investment manager in the name and on behalf of the trustee) enters into a transaction, the trustee is bound as principal with full liability to the counterparty for all claims arising out of the transaction. of the transaction. The law neither recognizes nor distinguishes the entry into a Transaction by a fiduciary as a “trustee”, that is to say that it is not a question of a distinct contractual capacity so that the debt of the consideration is automatically limited to the net assets of the trust. This notwithstanding the fact that most Trustees will seek to execute transactions, “solely in our capacity as Trustee”. In practice, these words only mean that the trustee (or the investment manager as his delegate) intends to enter into a Transaction on behalf of the SICAV and its unitholders.
What are the main consequences of the absence of separate legal personality?
As a mutual fund does not have a separate legal personality, any counterparty to a transaction cannot legally bring an action against the trustee, as the legal owner of the assets of the mutual fund and the party who concluded the transaction as that main.
In the normal course of events, the Trustee will have a right of indemnity and recourse over the assets of the mutual fund in order to secure against the claims of the counterparty. However, there may be times when the counterparty’s claim exceeds the available net assets of the trust. In such circumstances, in the absence of further structuring, the Trustee will be required to pay the full amount of the Counterparty’s claim, which means that it will be required to pay any shortfall to the Counterparty on its own assets. This situation is of course not acceptable for a trustee, as it would mean that the trustee underwrites the trust liabilities equally from its own assets. In the worst case, if the trustee does not have sufficient patrimonial assets, this could mean that he is forced into insolvent liquidation, which would have an impact on all of his activities.
In order to deal with this potential exposure to personal liability, a wise trustee will seek to include contractual language of “limited recourse” in the terms of all transactions it enters into. Such language seeks to contractually limit the recourse of the relevant counterparty to the net assets of the mutual fund, thus protecting the trustee from any additional liability in respect of its proprietary assets. Although often subject to negotiation, a properly drafted limited remedy seeks to do no more and no less than putting a counterparty to a Transaction in exactly the same position as it would be if it entered into a Transaction with a corporate fund, that is that is, the counterparty uses the assets available in the fund and once these assets are exhausted, its claim is extinguished – to the extent that claims exceeding the available assets will result in the liquidation of the company.
What is an umbrella trust?
An umbrella trust is the name given to a set of sub-funds, generally set up under a common trust deed. Each sub-fund is established by signing a trust deed complementary to the main trust deed which incorporates the terms of the main trust deed by reference. While it is possible to establish the Master Trust itself as a full trust, there are often good reasons not to do so. The key point of such a structure is that each compartment of the umbrella is established as a separate and distinct trust. Unitholders of one compartment have no recourse to the assets of another compartment.
Is there a risk of cross-contamination between compartments of a multiple compartment structure, including if the assets of a compartment are insufficient to settle all creditors’ claims?
No, as long as the main trust deed is correctly drafted and the trustee manages the sub-funds in accordance with the terms of the trust deed.
The reason why there is effective segregation between the compartments is that: (i) as indicated above, it is only possible for a counterparty to a Transaction to bring an action against the trustee, as the legal owner of the assets (it is impossible for a counterparty to bring an action against a compartment since the compartment is not a legal person); and (ii) under a typical trust deed, the trustee only has a right of recourse and indemnification over the assets of the relevant sub-fund to indemnify itself against liabilities incurred when acting as trustee in the fund. with regard to this compartment. The trustee has no right of recourse against the assets of another sub-fund.
The Cayman Islands is a preeminent jurisdiction for the creation of investment funds and offers a full range of fund structuring vehicles, including exempt company, limited liability company and exempt limited partnership. However, for Japanese investors and some other investors, a Cayman Islands mutual fund may be a more desirable structure.
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