How to Set Up a Hedge Fund in the Cayman Islands

Starting a hedge fund in the Cayman Islands?

 

This guide will take you through the entire process to set up a hedge fund in the Cayman Islands, covering everything from selecting the ideal structure to launching your hedge fund and onboarding investors. Although this article is centered on establishing a hedge fund in the Cayman Islands, you can explore more details on hedge fund setup in my comprehensive start-up hedge fund guide.

 

Given the complexities involved—multiple stakeholders, investor expectations, and time-sensitive market entry—getting it right from the start is crucial, especially for first-time fund managers.

 

Let’s begin your journey to creating a successful hedge fund in the Cayman Islands.

 

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Why set up a hedge fund in the Cayman Islands?

With over 29,000 registered funds, the Cayman Islands is a leading jurisdiction for hedge fund formation, drawing fund managers and institutional investors from around the world. Renowned for its business-friendly environment, tax neutrality, and strong legal framework, the Cayman Islands provides a sophisticated infrastructure designed specifically for the alternative investment industry. For more than two decades, it has been the preferred domicile for hedge funds, offering a regulatory environment that expertly balances investor protection with operational flexibility.

 

The Cayman Islands also boasts access to top-tier talent, including world-class legal and tax firms, financial service providers, banks, and other essential professionals. This makes setting up a fund a seamless process, backed by the expertise of industry leaders.

 

Its proximity to the U.S. further solidifies the Cayman Islands as the top offshore jurisdiction for American fund managers looking to establish master-feeder structures and attract international investors.

 

Best structure for a hedge fund in the Cayman Islands?

Before setting up your fund, the first crucial step is choosing the right legal structure. This decision hinges on several factors, including your investors’ preferences, the fund’s investment strategy, whether the fund will be close-ended or open-ended, the expected duration, and the number of investors involved. The Cayman Islands offers a range of fund structures, each designed to meet the specific needs of different investors and strategies. The main fund structures available are:

 

#1 Exempted Company

#2 Exempted Limited Partnership

#3 Limited Liability Company (LLC)

#4 Segregated Portfolio Company (SPC)

#5 Master-Feeder Structure

#6 Unit Trust

 

Exempted Company

The exempted company is the most popular structure to start a hedge fund in the Cayman Islands. It allows the company to conduct business outside the Cayman Islands with minimal regulatory burden. The key features include:

 

• Limited Liability: Investors’ liability is limited to the amount of their investment.
• Separate Legal Entity: The company has its own legal identity, which can enter into contracts and own assets.
• Flexibility: The structure supports a wide range of investment strategies and can issue various classes of shares.
• Confidentiality: Shareholder information is not publicly accessible.

 

Why it’s commonly used:

The exempted company is favored due to its operational flexibility, ease of setup, and strong legal protections. It suits both single-manager hedge funds and complex fund-of-funds structures, providing a balance of investor security and administrative simplicity.

 

Exempted Limited Partnership

The exempted limited partnership (ELP) is a popular choice for hedge funds targeting institutional investors. It consists of general partners, who manage the fund, and limited partners, who are the investors. The general partner has unlimited liability, while the limited partners’ liability is restricted to their capital contributions.

 

Legal framework:

The ELP is governed by the Exempted Limited Partnership Law, which provides a high degree of flexibility in structuring the partnership agreement. This includes provisions for profit-sharing, partner withdrawal, and fund dissolution.

 

Suitability:

The ELP is ideal for private equity and venture capital strategies where a partnership model aligns better with the fund’s objectives. It is also beneficial for investors seeking a structure with pass-through tax treatment.

 

Read more about how to set up a venture capital fund in Cayman Islands.

 

Limited Liability Company (LLC)

The Limited Liability Company (LLC) is a relatively recent addition to the Cayman Islands fund structure options, modeled after the Delaware LLC. It offers a hybrid structure that combines the flexibility of a partnership with the limited liability of a corporation.

 

• Flexible management: LLCs allow for significant flexibility in management structures, enabling members to tailor the governance of the company according to the needs of the fund.
• Limited liability: Similar to other Cayman fund structures, members of an LLC benefit from limited liability, protecting their personal assets from the debts and obligations of the LLC.
• Pass-through tax treatment: LLCs can elect to be treated as a pass-through entity for U.S. tax purposes, which is advantageous for U.S. investors.
• No share capital: LLCs do not have share capital, which simplifies the capital structure and allows for more flexible distribution of profits.

 

Why it’s used:

LLCs are particularly attractive to U.S. fund managers and investors due to the familiarity of the structure and its tax advantages. They are also well-suited for funds that require a high degree of operational flexibility and tailored governance arrangements.

 

Segregated Portfolio Company (SPC)

The Segregated Portfolio Company (SPC) is a unique structure that allows for the creation of multiple segregated portfolios (sometimes referred to as cells) within a single legal entity. Each segregated portfolio is treated as a separate legal entity with its own assets and liabilities, independent of the other portfolios within the SPC.

 

• Asset protection: The assets and liabilities of one portfolio are legally separated from those of other portfolios within the same SPC. This provides a high level of protection for investors, as the risk is confined to the specific portfolio they are invested in.
• Operational efficiency: An SPC allows for the operation of multiple strategies or investment products under one umbrella structure, reducing overall administrative costs.
• Flexibility: New portfolios can be added without the need to establish a new legal entity, making it easier to launch new funds or strategies.

 

Why it’s used:

SPCs are particularly favored for umbrella fund structures, where multiple sub-funds or strategies are managed under a single entity. They are also popular for funds that wish to offer different classes of shares with varying risk profiles, as the segregated nature of the portfolios ensures that liabilities are ring-fenced.

 

Master-Feeder Structure

The Master-Feeder structure is a common structure to set up a hedge fund in the Cayman Islands, especially for funds targeting both U.S. and non-U.S. investors. In this arrangement, there is typically a master fund, where all the investment activity occurs, and one or more feeder funds, which channel investments into the master fund. U.S. investors typically invest through a domestic feeder (often a U.S. LLC or partnership), while non-U.S. investors invest through an offshore feeder, commonly set up in the Cayman Islands.

 

When to use it:

This structure allows fund managers to pool assets from different types of investors into a single master fund, enhancing economies of scale and simplifying the management of the investment portfolio. Additionally, it provides tax efficiency, as U.S. investors can benefit from pass-through tax treatment, while non-U.S. investors can invest through a tax-neutral offshore feeder.

 

Why it’s used

The Master-Feeder structure is highly popular among U.S. fund managers who want to attract both domestic and international investors while maintaining operational efficiency and tax effectiveness. It is especially favored for hedge funds that require substantial capital and wish to streamline their investment management.

 

Read more about Master-Feeder structure.

 

Unit Trust

A unit trust is a legal arrangement where trustees hold the fund’s assets on behalf of investors, who hold units in the trust. This structure is less common but can be advantageous in specific scenarios, such as when targeting certain Asian markets where trust structures are more familiar to investors.

 

When to use it:

Unit trusts are particularly useful for fund managers who wish to capitalize on specific tax treaties or when operating in jurisdictions where trusts are favored over corporate or partnership structures.

 

Read our full article about Cayman Island fund structures

 

Regulatory framework

The primary regulatory authority overseeing hedge funds in the Cayman Islands is the Cayman Islands Monetary Authority (CIMA). CIMA ensures that funds operate in compliance with local laws and international standards, focusing on investor protection and financial stability.

 

Compliance requirements

Hedge funds must adhere to various regulatory requirements, including:

 

• Licensing and Registration: Most hedge funds register as mutual funds under the Mutual Funds Act. Depending on the size and complexity of the fund, it may require a CIMA license or registration.
• Ongoing Obligations: Registered funds must file annual returns and audited financial statements with CIMA. They must also adhere to anti-money laundering (AML) regulations and appoint service providers like auditors, administrators, and custodians.

 

Step by step guide to set up a hedge fund in the Cayman Islands

Step #1: Choose the hedge fund structure

As discussed above, selecting the appropriate structure is the first and most critical step. Considerations include the fund’s investment strategy, target investor base, and desired regulatory framework. For example, an exempted company might be suitable for a broad investor base, while an LLC could be ideal for U.S. investors seeking pass-through tax treatment.

 

Step #2: Engage legal advisors

Legal advisors are essential for navigating the complexities of Cayman Islands law and ensuring compliance with regulatory requirements. Fund administrators and auditors play crucial roles in the ongoing operation of the fund, from investor onboarding to financial reporting.

 

Step #3: Engage with service providers

Early engagement with key service providers is essential for a smooth fund setup. At this stage, it’s important to negotiate terms and secure agreements in principle. Input from service providers—such as fund administrators, audit firms, custodians, and brokers—is crucial for drafting the offering documents. Depending on the type of fund you’re establishing, you may be required to appoint an external fund administrator and an audit firm before the fund can be registered. Below is a list of the main professional service providers to consider contacting:

 

• Corporate Services
• Fund Administrator
• Audit Firm
• Onshore Counsel (if needed)
• Bank/Custodian
• Prime Broker

 

Here is a list of top 25 service providers in the Cayman Islands.

 

Step 3: Draft and file fund documents

The next step involves drafting the fund’s legal documents, including the offering memorandum, subscription agreement, and articles of association. These documents must be meticulously prepared to comply with Cayman Islands law and provide clear terms for investors.

 

Step 4: Register with CIMA

Registering with CIMA involves submitting the fund’s documents along with the appropriate fees. The registration process typically takes a few weeks, depending on the complexity of the fund and the accuracy of the submissions.

 

Step 5: Open accounts and appoint service providers

Establishing banking and prime brokerage relationships is crucial for the fund’s operations. Additionally, appointing reliable service providers, such as custodians and fund administrators, ensures smooth day-to-day management and compliance with regulatory obligations.

 

Step 6: Launch your hedge fund in Cayman Islands

Once all the preparatory steps are complete, the fund can be officially launched. This involves inviting potential investors during the initial offering period, completing the subscription process, and ensuring that all compliance checks are in place.

 

Benefits of setting up a hedge fund in the Cayman Islands

Key advantages

Setting up a hedge fund in the Cayman Islands offers several distinct advantages:

 

• Tax Neutrality: The Cayman Islands does not impose corporate, income, or capital gains taxes, making it an attractive domicile for tax-efficient fund operations.
• Confidentiality: The jurisdiction offers a high level of privacy for investors and fund managers, with stringent confidentiality laws.
• Robust Legal Framework: The Cayman Islands has a well-established legal system based on English common law, providing a secure environment for fund operations.
• Flexibility and Accessibility: The regulatory framework allows for a high degree of flexibility in fund structuring. The Cayman Islands’ global reputation also enhances access to international investors.

Conclusion

The Cayman Islands continues to be a top choice for hedge fund managers due to its favorable regulatory environment, tax neutrality, and flexible fund structures. By understanding the various fund structures and following the correct setup process, fund managers can effectively leverage the benefits of this jurisdiction.

Looking ahead, the Cayman Islands is expected to remain at the forefront of offshore hedge fund formation, with ongoing regulatory enhancements that support the evolving needs of the global investment community. For fund managers seeking a stable, efficient, and investor-friendly jurisdiction, the Cayman Islands offers unparalleled advantages.