By Selma Lee Arch

In the wake of the Dodd-Frank Wall
Street Reform and Consumer Protection Act of 2010, U.S. private
equity firms have been subjected to a variety of additional
regulation, from Form PF to Securities and Exchange Commission
registration. These firms have beefed-up their compliance and legal
teams following the entry into force of these new regulations.

Nevertheless, private equity firms
seeking to grow overseas still have favorable opportunities for
establishing new funds in Europe, as well as the Cayman Islands, even
with the latter looking to enhance private equity regulation.

In response to findings in an
assessment by the Caribbean Financial Action Task Force (CFATF)
indicating needed areas of improvement in the Caymans’
anti-money-laundering (AML) and counter-financing of terrorism (CFT)
framework, the government of the Cayman Islands considered 11 bills
to amend financial laws and disclosures. They include:

• The Limited Liability Companies
  (Amendment) Bill of 2019, which would require the names of directors
  and all other basic information about limited liability companies
  (LLCs) to be publicly disclosed, and punish those LLCs that fail to
  maintain up-to-date information.
  
  
• The Limited Liability Partnership
  (Amendment) Bill of 2019, which would require all basic details
  about a limited liability partnership (LLP) to be readily available
  at the LLP’s registered office, and also subject LLPs that don’t
  maintain up-to-date information about beneficial ownership to
  penalties.
  
  

Both of these bills were among those
passed by the Cayman Islands Legislative Assembly on July 26, 2019.

Furthermore, the Cayman Islands’
Ministry of Commerce proposed—and the Legislative Assembly
passed—changes to the British Overseas Territory’s Trade and
Business Licensing Law, which mandate that the licensing board
consider a license applicant’s compliance with AML and CFT
regulations prior to granting, renewing, or revoking a license.

The proposals for additional Cayman
Islands financial services and investment regulations are not
designed to punish or drive away private equity and other foreign
investments from the U.S. and other countries. They are in line with
global efforts to enhance AML and CFT infrastructure.

Tara Rivers, Cayman Islands Minister of
Financial Services and Home Affairs, said in an official statement:
“The government is committed to addressing the recommendations
outlined in the CFATF fourth round mutual evaluation report to
further cement our standing as a responsible and responsive
jurisdiction in the global fight against money laundering and
terrorist financing.”

The spirit of strengthened Cayman
Islands legislation is what private equity firms should consider when
evaluating the Caymans as a domicile for new funds. The Cayman
government remains friendly to new investment, and the territory’s
adherence to British law, common use of English in everyday affairs
and in business, and proximity to the U.S. will continue to make the
Cayman Islands a favorable destination for private equity fund
registration and growth.

The European Connection

Certain European nations such as
Luxembourg are also receptive to foreign private equity firms
establishing and registering new funds on their soil. The Grand Duchy
of Luxembourg is a member of the European Union and is politically
and economically stable. It is already home to a number of private
equity structures and is a European hub for private equity firms in
the U.S. and around the world.

Since the 1990s, Luxembourg has enabled private equity firms to structure SOPARFI (société de participation financière) investment vehicles, which allow them to make international acquisitions through the Grand Duchy. Today, EY estimates Luxembourg is host to more than 25,000 SOPARFIs. These investment vehicles can be structured in three different legal forms, all of which are subject to limited disclosure.

In the 2000s, Luxembourg introduced two regulated investment vehicles for the benefit of private equity firms—the SICAR (société d’investissement en capital à risque, or investment company in risk capital) and SIF (fonds d’investissement specialisé, or specialized investment fund). SICARs enable private equity and venture capital firms to make direct or indirect investments in assets they plan to strengthen and exit, and are not subject to risk-spreading rules. SIFs, meanwhile, require a minimum 30% investment diversification in exchange for flexible regulations and tax neutrality.

Luxembourg was also among the first
nations to implement the Alternative Investment Fund Managers
Directive (AIFMD) framework, which permits EU-domiciled alternative
investment funds to be distributed in any other EU member states
without requiring further authorization or registration criteria to
be met. If the AIFMD creates a trusted brand for private equity funds
comparable to the UCITS designation for their traditional
counterparts, then this framework may make private equity funds more
accessible and attractive around the world. More recently, in 2016,
Luxembourg introduced an innovative and cost efficient fund vehicle,
the Reserved Alternative Investment Fund (RAIF), which combines the
flexibility of the SIF and the SICAR while conforming to the AIFMD –
thus offering the best of all worlds.

In addition, another EU member state,
Ireland, beckons for U.S. private equity firms. Many private equity
managers and funds in London are expected to relocate to either
Luxembourg or Dublin following Brexit, according to Thomson Reuters,
and based on Mergermarket data, private equity may account for up to
one-quarter of M&A financing in M&A this year. Dublin, like
the Cayman Islands, offers political stability, widespread fluency in
English, as well as closer proximity to the U.S. than other
domiciles.

Private equity firms in the U.S.
seeking to grow and invest overseas still have some very attractive
and welcoming options. With the help of compliance and legal
partners, private equity firms can successfully navigate the
regulations in these alternative jurisdictions.

Selma Lee Arch is Managing Director
and Country Delivery Director for the Cayman Islands at IQ-EQ,
a leading investor services group supporting fund managers, global
companies, family offices and private clients operating worldwide,
including top private equity firms.