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The Cayman Islands are lovely.

Located in the Caribbean between Cuba and Jamaica, this collection of tropical islands enjoys a wonderful climate, great sailing and diving, and is home to only about 50,000 people. More importantly, perhaps, registered companies in Cayman significantly outnumber its population.

Cayman’s great achievement over the past fifty years was to establish itself as a leading financial center. By some estimates, it is the fifth largest in the world. As a result, Caymanians enjoy the highest standard of living in the Caribbean, in addition to being able to live tax free. The Cayman government derives its revenues solely from fees and indirect taxes on the many legal entities and businesses based there.

In addition to banks and insurance companies, many hedge funds are formed using Cayman companies. Private equity funds also now make use of Cayman partnerships and companies as needed. This high level of activity by the Caymanians has, on occasion, drawn criticisms from those in a position of power and influence elsewhere. For example, President Barrack Obama went out of his way to single out Cayman as a tax haven in a speech he gave in May 2009. Unsurprisingly, Caymanians, and the alternative investment industry and its investors, were not amused.

Comparisons can readily be made between Cayman and the US state of Delaware, which has established itself over the last 100 years as the jurisdiction of choice for establishing companies and other business organization in the US. Opponent of offshore finance would stress that there are a number of important differences between the two, including no doubt the quality of diving in Delaware Bay.

Regardless, in recent years, the Cayman Islands has established itself as one of the most popular jurisdictions for the establishment of funds. One of the most popular approaches is to establish limited companies that issue shares to investors. Their constitutional documents will generally consist of its memorandum of association and articles of association, which deal with matters related to the internal workings of the company and authorize the directors to transact the business of the company.

Just as in Delaware or England, the directors of a Cayman Island company are responsible for the management of the company. They exercise all the power of the company, absent explicit restrictions in the memorandum and articles. All companies, as artificially created legal persons, must act through their agents. The board of directors acts as agents of the shareholders to manage the company in accordance with the memorandum and articles and the provisions of applicable laws. Since private equity and hedge funds are typically externally managed and lack executive officers and employees, such agents will predominantly be the directors themselves.

Ultimately, much of the Cayman Islands’ success in attracting both fund managers and investors to use their vehicles as funds is derived from the confidence that Cayman laws and government officials inspire. Of course, just as confidence can be built over time, it can also be lost.

Unfortunately, in December 2012, the stability and predictability of the Cayman Islands was given a slight knock when the country’s Premier, McKeeva Bush, was arrested on charges of misuse of a government credit card and importing explosive materials without proper permits. In the months that followed, the Cayman Islands continued to successfully launch private equity and hedge funds of various shapes and sizes. However, competition between offshore jurisdictions is higher than ever.

If not the Cayman Islands, what about Bermuda, Bahamas or the Seychelles? Prefer a timezone more favorable to Europeans? What about the Channel Islands (Jersey or Guernsey), or perhaps the Isle of Man?

Today, there are many choices available, each with its own particular advantages and incentives. The important point to remember about offshore financial centers is they exist solely and exclusively to the extent that onshore financial centers permit them. Simply put, they are a convenient way for onshore regulators and tax authorities to turn their back on difficult and knotty problems that they lack the political prowess or conviction to solve directly.

As a result, it appears that offshore jurisdictions will continue to have an important role to play in international finance for some time to come.

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