The structuring of investment funds as unit trusts has been and continues to be the structure of choice for mutual funds aimed at Japanese investors, primarily for reasons of onshore tax and investor familiarity.
However, unit trusts have been shown to be an increasingly useful fund structure for those promoters and managers alike who wish to maximise flexibility.
This was recently demonstrated in a transaction involving an “umbrella” unit trust with multiple sub-trusts where the existing investment manager sold the right to manage the assets of a particular sub-trust within the umbrella unit trust structure to another prominent manager.
This was effected on the basis that the relevant sub-trust was separate and distinct from the other sub-trusts and the relevant assets were thus ring-fenced from the assets held by the other sub-trusts within the unit trust.
The unit trust structure allowed for a relatively straightforward transaction, in contrast to what would arguably have been a vastly more complex and expensive process should the fund in question have been structured as a corporate vehicle or partnership.
What is a unit trust?
A trust is essentially a relationship that exists between one person (the trustee) who holds property (the trust fund) as legal owner on trust, to hold, invest, manage, administer and dispose of for and on behalf of other persons (the beneficiaries or unit holders or investors). In simple terms, a unit trust is a mutual fund or collective investment structure taking the form of a trust.
Comparison of a unit trust to a traditional corporate vehicle
One of the primary differences between a unit trust and a corporate entity is that a unit trust is a relationship between the trustee and the investors. It does not have separate legal personality and, unlike a company, cannot sue and be sued in its own name.
With a company, there are directors who manage the affairs of the company, and with a unit trust, there is a trustee, which in most cases is a licensed trust company specialising in providing trust services.
What is interesting about the board composition of a company is that a company will often have a member of the promoter or investment manager sit on the board of directors, however, with a unit trust, the trustee is normally an institutional trustee so the promoter or investment manager would never have access to a seat on the board of the trust company.
There are neither Cayman residency requirements for directors of a company nor are there Cayman residency requirements for a trustee, although, if the trustee is a Cayman Islands entity, it will be subject to licensing regulation in the Cayman Islands.
In a unit trust, the equity interests are commonly referred to as units as opposed to a company in which the interests are referred to as shares. In many respects, certainly economically, a unit is similar to a share in that both can be issued in different classes conferring different rights and obligations on the holders and are in general freely transferable.
One of the principal advantages of a unit trust is that it can be structured as an umbrella unit trust so that each sub-trust is separate and distinct from all the others in the umbrella unit trust. The effect of this is to ring-fence the assets in each sub-trust and therefore prevent one sub-trust’s assets from becoming subject to the type of cross-class liability to which corporate funds are subject.
The closest analogy in the corporate context in Cayman is a segregated portfolio company which is structured to limit liability by ring-fencing assets in distinct segregated portfolios.
Another notable difference between a corporate vehicle and a unit trust is that there is no statutory insolvency regime in respect of a unit trust. Whilst this may appear at first glance to be disadvantageous, it actually gives sovereignty to the contracting parties at the drafting stage of the trust deed to provide for bespoke provisions in the event that the fund has insufficient assets to pay the debts of the fund.
Some of the differences discussed above show the usefulness of the historic trust relationship applied in modern times. The flexible nature of the unit trust is highlighted in this article by our experience in a recent transaction discussed below.
A recent example where the practical utility and flexible nature of the umbrella unit trust structure was demonstrated by the acquisition of the European long/short equity business of a prominent manager (the “seller”) by one of Europe’s leading boutique investment houses (the “European manager”).
The transaction involved the purchase by the European manager of the right to manage the assets of two sub-trusts of an umbrella unit trust established and managed by the seller. The seller would continue to manage the numerous other sub-trusts under the umbrella unit trust structure.
The individuals managing the relevant assets were also moving from the seller to the European manager so there was very little change for the investors and the objective of the parties was therefore to ensure a smooth transition for all those concerned. It was determined that no consent of the unit holders would be necessary pursuant to the provisions of the trust deed relating to modification of the deed.
The existing unit trust structure was originally set up with a master declaration of trust constituting the master trust (the “trust deed”) and supplements to the trust deed each constituting a sub-trust of the master trust.
The trust deed provided that each sub-trust was “separate and distinct” from the other sub-trusts and so it was clear that it would be possible for the European manager to be appointed as the new investment manager of the relevant sub-trusts without taking over the management of the other sub-trusts forming part of the master trust. The trustee of the master trust, who was also the trustee of each of the sub-trusts, would remain the same.
The main steps taken in relation to the transaction were as follows:
- A negative consent procedure was undertaken, as provided for in the
trust deed, whereby the unit holders in the relevant sub-trusts were
provided with notice of the proposed change and permitted to redeem
their units without limitation or penalty prior to the change taking
- The trustee executed an amended and restated declaration of
trust in respect of each sub-trust on substantively the same terms,
consolidating any amendments made by the supplemental trust deeds into
one restated deed and changing the names of the sub-trusts to refer to
the name of the new investment manager.
- The existing investment
advisory and administration agreements were terminated and new
agreements entered into in respect of each of the relevant sub-trusts
and separate new agreements were entered into in respect of the other
sub-trusts managed by the seller.
- The prime brokerage agreements and
other third party contracts were amended and restated to remove
references to the relevant sub-trusts and separate new agreements were
- The separate offering documents in respect of each sub-trust were amended accordingly.
relevant sub-trust was registered with the Cayman Islands Monetary
Authority and with the registrar of trusts as exempted trusts.
This particular transaction was a good example of the flexible nature of the unit trust structure being put to effective use in a modern commercial context. Achieving the same end result with a company would have been far more complex and costly, principally because a new entity would likely have been required, and complicated measures taken to separate the relevant assets out of the company to allow for management of such assets by a third party manager.
Although corporate funds undoubtedly remain the most popular structure in the investment funds space, managers and promoters should not forget the commercial possibilities offered by the flexible nature of the unit trust structure and the continued relevance of historic trust principals to the modern business environment.