The Cayman Islands is a leading global financial centre and has developed a reputation as one of the world’s most innovative and business-friendly places to operate. The jurisdiction offers a stable society and political system, judicial and legislative links to the United Kingdom, tax neutrality, sophisticated service providers, and a proportionate regulatory regime that focuses closely on the financial services industry, and in particular, those catering to sophisticated and institutional investors based elsewhere.
It is this reputation and these attributes that have helped the jurisdiction become an obvious choice for many of those proposing to establish fintech-related structures, whether it be in the form of a fund vehicle investing into digital assets, an exchange or initial coin or token offering, or the launch of a decentralised finance protocol or network.
Each of the Cayman Islands Government, the Cayman Islands Monetary Authority (“CIMA”), and industry bodies such as Cayman Finance and the Cayman Islands Blockchain Foundation acknowledge the importance of continuing to attract fintech and digital assets business to the jurisdiction and ensuring the further growth of the sector. They are also aware, however, of the need to balance this approach with maintaining the Cayman Islands’ commitment to the highest standards of financial probity and transparency and the specific considerations that can accompany digital assets.
Consequently, in May 2020, recognising the newly adopted international standards set by the Financial Action Task Force, a new framework for the supervision and regulation of virtual asset services businesses was introduced in the Cayman Islands, namely the Virtual Asset (Service Providers) Act,1 2020 (the “VASP Act”). The features of the VASP Act are described further in this chapter. However, it is important to note that at the time of writing, this new legislation is only partially in force; the VASP Act is being introduced in two phases, with the first primarily dealing with anti-money laundering (“AML”) regulations and requiring virtual asset service providers (“VASPs”) to be registered, and the second phase dealing with licensing and other matters. A specific date for implementation of phase two of the VASP Act has not yet been announced, but it is expected to be in the near term.
Overall, the new framework continues to make the Cayman Islands an attractive jurisdiction for virtual asset services businesses, as it provides a flexible regulatory foundation with a great deal of certainty for those wishing to operate in the space while furthering Cayman’s commitment to international standards.
Under the VASP Act, a “virtual asset” is broadly defined as a digital representation of value that can be digitally traded or transferred and can be used for payment or investment purposes. Specifically excluded from this are digital representations of fiat currencies, as well as “virtual service tokens”, which are digital representations of value that are not transferrable or exchangeable with a third party at any time (including digital tokens whose sole function is to provide access to an application or service or to provide a service or function directly to its owner).
To provide further clarity on the VASP Act, the Virtual Assets (Service Providers) Regulations (the “VASP Regulations”) were introduced in October 2020. The VASP Regulations include the registration application requirements and details of fees as well as providing some further guidance as to virtual asset issuances (as discussed further below).
The VASP Act clearly establishes the legitimacy of digital assets and cryptocurrencies in the Cayman Islands and regulates businesses providing services related to virtual assets. Virtual assets themselves and parties dealing with virtual assets for their own purposes are generally not subject to specific regulation in the Cayman Islands.
Under the VASP Act, all VASPs are required to be licensed or registered with CIMA, obtain a waiver or hold a sandbox licence. A “VASP” is an entity that is incorporated or registered in the Cayman Islands and that provides a virtual asset service as a business or in the course of business.
A “virtual asset service” for this purpose means the issuance of virtual assets or the business of providing any of the following services or operations for or on behalf of another person or entity:
exchange between virtual assets and fiat currencies;
exchange between one or more other forms of convertible virtual assets;
transfer of virtual assets;
virtual asset custody service, which is the business of safekeeping or administration of virtual assets or the instruments that enable the holder to exercise control over virtual assets or
participation in, and provision of, financial services related to a virtual asset issuance or the sale of a virtual asset.
Cryptocurrency and other digital asset businesses that are not caught by any of the above categories may still be subject to regulation in the Cayman Islands that does not specifically target digital assets, such as the Securities Investment Business Act (“SIBA”), the Money Services Act and AML regulations (each described further below).
As set out above, the issuance of virtual assets, the provision of financial services related to a virtual asset issuance or the sale of a virtual asset, as well as the transfer of virtual assets, if being carried out by a Cayman Islands entity as a business on behalf of another party, will likely constitute virtual asset services and require a licence or registration with CIMA under the VASP Act.
Under the VASP Act, any issuance of virtual assets requires CIMA’s prior approval. For this purpose, an issuance means the sale of newly created virtual assets to the public in exchange for fiat currency, other virtual assets or other considerations. “Public” is not defined in the VASP Act, so it should be interpreted broadly for this purpose; however, helpfully, the VASP Regulations distinguish a “private sale”, broadly defined as a sale that is not advertised and is sold to a limited number of persons by private agreement from a sale to the public (meaning that registration under the VASP Act may not be required for certain sales). The sale of virtual service tokens will also be excluded from this requirement, and any transfer that is not for consideration (e.g. an “airdrop”) should be excluded.
Direct issuances will be subject to a prescribed maximum threshold, which, at the time of writing, has not been fixed. The threshold will not apply where the issuance is facilitated by way of one or more virtual asset trading platforms or obliged entities, provided that the relevant platforms are either licensed under the VASP Act or regulated in another non-high-risk jurisdiction.
An entity that operates as an investment fund that is formed or registered in the Cayman Islands and that issues digital assets may come within the ambit of the Mutual Funds Act (for open-ended funds) or the Private Funds Act (for closed-ended funds), and be required to obtain a registration or licence thereunder to the extent such digital assets constitute equity or investment interests. This will, of course, depend on a number of aspects, including the terms of the issue and the nature of the assets, and specific advice should be sought. For example, under the Mutual Funds Act, the definition of “equity interest” has recently been amended to include “any other representation of an interest”, which is likely broad enough to capture a variety of forms of digital assets.
Additionally, any pooling vehicle that is investing into the digital asset space, or accepting digital assets by way of subscription and then investing into more traditional asset classes, would be advised to seek Cayman Islands legal advice on the point.
Securities Investment Business Act
Pursuant to SIBA, an entity formed or registered in, or that is operating from, the Cayman Islands that engages in dealing, arranging, managing or advising on the acquisition or disposal of digital assets may come within the ambit of SIBA and be required to obtain a registration or licence from CIMA thereunder (which may be in addition to a registration or licence required under the VASP Act). This applies to the extent that the relevant digital assets constitute “securities” for the purposes of SIBA.
Notably, the definition of “securities” thereunder includes virtual assets that can be sold, traded or exchanged immediately or at any time in the future and that (i) represent or can be converted into another form of traditional securities (e.g. equity interests, debt instruments, options or futures), or (ii) represent a derivative of traditional securities. Consequently, consideration will need to be given on a case-by-case basis as to whether the digital asset in question falls within one of the above categories.
Offerings within the Cayman Islands
In relation to the offering, sale, or issuance of interests within the Cayman Islands, certain regulatory provisions should be borne in mind. For example, the Companies Act prohibits any exempted company formed in the Cayman Islands and not listed on the Cayman Islands Stock Exchange from offering its securities to the Cayman Islands public. The Limited Liability Companies Act includes a similar prohibition in relation to limited liability companies (“LLCs”). Even persons based, formed or registered outside the Cayman Islands should be careful not to undertake any activities in relation to the sale or issuance of digital assets that would constitute “carrying on a business” in the Cayman Islands. To do so may entail various registration and licensing requirements and financial and criminal penalties for those who do not comply. There is no explicit definition of what will amount to “carrying on a business” for these purposes and, consequently, persons who propose to undertake concerted marketing to the Cayman Islands public, particularly if it involves engaging in any physical activity in the Cayman Islands, are encouraged to seek specific legal advice.
In practice, however, these restrictions do not generally pose a significant practical concern for issuers given that:
the “public” in this instance is taken to exclude other exempted companies, exempted limited partnerships, and LLCs (which together comprise the majority of Cayman Islands entities); and
issuers’ target investors tend not to include other persons physically based in the Cayman Islands.
There are no income, inheritance, gift, capital gains, corporate, withholding or other such taxes imposed by the Cayman Islands Government, including with respect to the issuance, holding, or transfer of digital assets.
Stamp duty may apply to original documents that are executed in the Cayman Islands or are brought into the Cayman Islands following execution. However, the sums levied are generally of a nominal amount.
Entities formed or registered in the Cayman Islands may apply for and, upon the payment of a fee of a relatively small fee, receive a tax exemption certificate confirming that no law enacted in the Cayman Islands after the date thereof imposing any tax to be levied on profits, income, gains or appreciations shall apply to such entity or its operations. Such certificates will generally apply for a period of between 20 and 50 years (depending on the type of entity).
Source for more on this article: Global Legal Insights (GLI)