Wed, Feb 26, 2020

Cayman Islands Private Funds Law, 2020

On February 7, 2020, the Cayman Islands Government published the Private Funds Law, 2020 (“the Law”), which introduces, among other changes, new provisions for the valuation of a private fund’s assets. Specifically, the Law provides for increased rigor around independence in the valuation process. For private funds that prepare valuations internally, the Law will likely require enhancements to their internal processes and associated documentation. At a minimum, private fund managers and advisors should become familiar with the new provisions to ensure compliance.

While the preparation of periodic valuations is not new, the Law requires a private fund’s valuations:

To be carried out at least annually;

To be performed by:

  • An independent third party that is professionally qualified to conduct valuations in a non-high-risk jurisdiction;
    • The manager or operator of the private fund, or a person who has a control relationship with the manager of the private fund, provided that:
    • The valuation function is independent from the portfolio management function; or
  • Potential conflicts of interest are properly identified and disclosed to the investors of the private fund; or
  • An administrator not falling under part (a) who is appointed by the private fund;

Where the valuation of the assets of a private fund is not performed by an independent third party in accordance with subsection (2)(a), the Cayman Islands Monetary Authority (“ the Authority”) may require the private fund to have its valuations verified by an auditor or independent third party.

To be carried out at least annually: On the surface, the annual requirement does not appear to be controversial. However, from an investor perspective, they need values that are estimated with the same rigor and quality every time the fund manager reports. This is because investors need fair value information to make asset allocation decisions, exercise their fiduciary duty and prepare their own monthly and quarterly financial statements. The new regulatory requirement is a minimum requirement, which may not meet the needs of all investors.

To be performed by an independent third party that is professionally qualified to conduct valuations in a non-high-risk jurisdiction/the manager or operator of the private fund, or a person who has a control relationship with the manager of the private fund/or an administrator not falling under part (a) who is appointed by the private fund: This will likely require many private funds to review their valuation process as well as their limited partnership agreements or other investor documentation to verify that their valuation process is performed and communicated appropriately. Many private fund managers perform their valuation internally. However, the actual processes and the level of independence vary widely. Smaller private funds, where the principals wear many hats (e.g. one individual may be an investment professional, the CFO and an investor relations professional), will be more challenged to perform their valuations internally than a large fund that has its own separate finance/accounting team. That said, even large funds will have to ensure independence in their process. From our experience, the most often overlooked impairments of internal independence are where deal professionals receive incentive payments based on unrealized gains. The Law provides for this as long as such conflicts are identified and disclosed to investors.

Pre-financial crisis, it was not uncommon for fund administrators to say that they were responsible for a private fund’s valuations. Post financial crisis, we’ve seen fund administrators become more precise in the level of responsibility that they take for a private fund’s valuations–especially where level 3/illiquid assets are involved. The non-scalable nature of these valuations had led most fund administrators to either: accept and document manager provided marks for level 3/illiquid assets as long as the value of such assets is less than or equal to the level allowed to be manager marked in fund documents; and/or to gather valuation data to verify/corroborate manager provided marks. Whether fund administrators decide to take more responsibility for valuations and/or to raise the bar for the quality of the valuations that they incorporate into their processes has yet to be seen.

Engaging an independent valuation provider such as Duff & Phelps enhances a private fund’s internal controls and will help private funds comply with the Law. The addition of internal staff who are independent (or appropriately disclosed to investors) will also help private funds’ compliance.

Where the valuation of the assets of a private fund is not performed by an independent third party in accordance with subsection (2)(a), the Cayman Islands Monetary Authority (“ the Authority”) may require the private fund to have its valuations verified by an auditor or independent third party: Leaves meaningful room for discussion. Absent independence in the valuation process, the Authority may require an external party to perform the private fund’s valuations. It has yet to be seen how the Authority will police independence in the valuation process.

The Cayman Islands Government has given private funds six months to comply with the Law.

We recommend that private funds read the Law in its entirety, review their valuation policy and limited partnership agreement (and/or other documents where investor expectations may have been set), and their valuation process to assess their compliance with the Law. Duff & Phelps is prepared to answer your questions as it pertains to the Law, specifically around the new requirements governing valuation. Please contact us if you have any questions on how you might adapt your valuation process to comply with the Law or to better understand how other private funds structure their valuation processes as you consider what would work best for your organization.

An independent third party is defined under the Law as: a person established in the Islands or a non-high-risk jurisdiction who does not have a control relationship with the private fund’s manager or operator.



Valuation Advisory Services

Our valuation experts provide valuation services for financial reporting, tax, investment and risk management purposes.

Alternative Asset Advisory

Heightened regulatory concerns and vigilance, together with increased investor scrutiny, have led to increased demand for independent expert advice.

Portfolio Valuation

Kroll specializes in assisting clients with the valuation of alternative investments, specifically securities and positions for which there are no "active market" quotations.