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May 30, 2018  

Funds Brace for Money-Laundering Rules

Hedge fund lawyers and administrators are busy helping managers of offshore funds comply with stricter anti-money-laundering regulations in the Cayman Islands.

The new rules, finalized last month, apply to established funds starting on Oct. 1. But they take effect immediately for any funds launched between June 1 and Sept. 30.

“There’s a bit of a scramble,” said Dan Viola, a partner in the hedge fund practice at law firm Sadis & Goldberg.

The Cayman Islands Monetary Authority has long had “know-your-customer” rules in place aimed at preventing criminals from using offshore funds to launder money. But the new regulations, initially proposed in October 2017, impose additional obligations on fund operators.

Perhaps most significantly, managers are required to create three new positions: anti-money-laundering compliance officer, and chief and deputy anti-money-laundering reporting officers. The three officers will be responsible for monitoring the effectiveness of a firm’s policies and procedures.

As of 2016, the Cayman Islands was home to more than 11,000 hedge funds, making it the largest offshore jurisdiction by far. Viola said he has heard from some managers who are concerned they might lack adequate staff to fill all three positions.

“There can’t be any overlap,” he noted. “The rules do require certain types of competency. You can’t just throw somebody into the position.”

If a fund-management firm lacks the necessary staff, it has two options: hire one or more professionals with six-figure compensation packages, or outsource the functions to a law firm, administrator or other service provider.

Michael Regan, general counsel for Citco Fund Services USA, said he has been reaching out to fund-manager clients to ensure they’re aware of the new rules and are taking steps to comply. “Law firms and industry service providers have put out a large awareness campaign,” he said. “It’s about accountability and transparency. Importantly, this reaches beyond investor-related [anti-money-laundering] issues and compliance and extends to the fund’s investment activities.”

Regan estimates Citco clients will spend an average of $6,000-8,000 per fund to comply with the new rules. Citco caters to funds run by SEC-registered and exempt managers with a combined $1.1 trillion of gross assets, according to Hedge Fund Alert’s Manager Database.

“There is going to be a cost to do this,” Regan said. “There is basically more monitoring and reporting of the fund’s [anti-money-laundering] control environment. Whoever you decide to appoint, they will need skills, experience and access to data. Many of our clients have expressed a desire to work with us rather than do it themselves, or appoint another third party.”

Lucy Frew, a partner at Walkers — a Cayman Islands law firm that works with many of the largest hedge fund managers — said she expects most will take the regulatory changes in stride. But she said the new rules could create headaches for some administrators that previously relied on so-called Regulation 8 exemptions when processing subscriptions for hedge funds.

Under the existing framework, administrators don’t have to verify the identity of offshore investors, as long as the money is wired from a bank regulated in the U.S., Europe or other trusted jurisdiction. The assumption has been that a bank already would have performed due diligence on an investor. But the new rules require independent verification.

“Those minority of fund administrators who were relying on the Regulation 8 exemption are now having to familiarize themselves with the more detailed verification requirements,” Frew said.