Overview

The Cayman Islands are a long-standing and well-established jurisdiction for corporate holding structures. The jurisdiction remains the leading domicile for investment funds, especially out of the North American and Asian markets but also for Gulf Cooperation Council (GCC) based players where investor familiarity, flexibility, ease of operating, tax neutrality, cost-effectiveness and a high degree of legal certainty in a politically stable jurisdiction are highly valued criteria. Internationally driven, increased regulatory compliance requirements (eg, more detailed reporting in respect of anti-money laundering and countering financing of terrorism as well as economic substance compliance), while presenting some challenges, have not been seen to outweigh those beneficial features.

The world has seen significant macroeconomic, social and political changes and events around the world over recent years – Brexit, the COVID-19 pandemic, the rise of ESG, fintech and cryptocurrencies, China's One Belt One Road initiative and (most recently) the war in Ukraine, to name a few. These have created uncertainty and risks on the one hand, and opportunities on the other, across markets and sectors.

Any number of the resulting activities and situations have, and are expected to continue to, trigger related acquisition finance activity. These include: 

• where adversely but not fatally impacted industries (such as the retail, travel and hospitality sectors) need to find sources of funding and/or restructure balance sheets potentially leading to divestiture of parts of the business; 
• industries facing continued turbulence or disruption (eg, in oil and gas, and related industries) with market participants responding by either divesting parts of their business or investing in new technologies (including through acquisitions) as another tool at their disposal;
• businesses seeking to protect growth and profit margins against rising costs, not in the traditional way through cost cutting or efficiency improvements but instead through company splits or business spinouts, an M&A trend that some market participants see increasing; and 
• distressed restructuring in situations where businesses are no longer viable – with asset and business sales potentially following. 

Acquisition Finance – Underlying Trends and Cayman Activity

With varying corporate valuations, global markets (with plenty of pent-up investor demand for deployment of capital) saw numerous opportunities for cross-border M&A. A number of the factors that create those opportunities may also cause transactions to progress a little less quickly while parties work through volatility or some uncertainty. Nevertheless, a significant increase in closed deals kicked off during the second half of 2020.

That momentum carried through 2021, which, according to research by McKinsey, saw a 67% increase in global deal value for deals exceeding USD25 million and a 37% increase in the volume of such deals. While corporate M&A accounted for the majority of that activity, private equity funds also significantly increased their activity to new heights of deal value reportedly up to USD1.3 billion in 2021. Profitably deploying the record amounts of dry powder (said to be around the USD2 trillion mark) can be expected to remain at the forefront of investors' minds in 2022, and their ability to be nimble will likely be beneficial in markets that seem set to continue to shift as they adapt.

Since buyers, whether in fund-based acquisitions or more traditional corporate M&A transactions, will typically include some degree of leverage in their funding plans, the underlying triggers for the plentiful and diverse acquisition finance activity undertaken throughout 2021 appear to be present in 2022.

Fund formation activity in the Cayman Islands, a jurisdiction of choice for key players in this space, has reflected the increase in global M&A deal volumes. The overall number of fund formations and launches increased markedly in 2021, reaching the highest level of regulated mutual funds registered with the Cayman Islands Monetary Authority by the end of Q3 2021 (with 30 of those being so-called “mega-funds‟, each raising more than USD5 billion). As of that same point in time, more than 14,000 closed-ended funds had registered in the short time since registration of such funds became a statutory requirement in the Cayman Islands in mid-2020. A sizeable portion of the capital collected through these funds will have been put to work in acquisitions (including leveraged deals) undertaken throughout 2021.

Non-traditional lending is no longer an occasional feature and seems here to stay, having branched out into several growing types, including online lending, peer-to-peer lending, crowdfunding, Fintechs and secondary market loan packaging. Some of these products and sectors are still nascent, ie, not intended to target or for the time being unlikely to represent major contributors in the types of transactions that substantively feed into the global acquisitions (and, therefore, leveraged finance) markets. As there is growth and evolution in this space, some of the entities themselves are likely to become targets or principals in acquisitions. 

Credit funds, however, have quickly become major and regular participants in the non-traditional lending arena - in light of their sophisticated, well connected, informed and deeply resourced sponsors, credit funds are now lending across different types of debt transactions, including acquisition financings, and may also look to take hybrid positions. The recently announced closing of Carlyle Group's capital raising of USD4.6bn for its second credit fund would seem to be a clear indication of the extent of market appetite for this type of ready-to-deploy non-traditional source of debt financing. From a Cayman Islands perspective, this is a further source of opportunities at both the fund level and in the corporate structures for acquisitions, in particular as many of the main parties will be accustomed to and comfortable with the jurisdiction and the options available in it.

Restructuring of financially distressed entities has not, during 2020 and 2021, triggered the flood of processes initiated that global markets feared would ensue as a result of the COVID-19 pandemic. Much of that is credited to swift and prolonged government support programs around the world and the application of early consensual liquidity management techniques by lenders and borrowers alike. Leveraged loans, by their very nature, are particularly sensitive to financial stress (whether on borrower balance sheets through decreased valuations or on cash flow due to business downturns) so this segment of the debt market will have benefitted.

Notwithstanding government support, we have continued to see numerous restructurings in the Cayman Islands, in part as a result of entities registered in the Cayman Islands forming part of corporate structures but importantly also due to the Cayman Islands being a stable and creditor-friendly jurisdiction in which financial counterparties have ultimate recourse to the common law court system. One development in this space is the introduction of a new restructuring regime in the Cayman Islands, which at the time of writing has been passed into law and is expected to come into force soon. This new regime would allow for the appointment of a restructuring officer to a Cayman Islands company and trigger an automatic global moratorium on claims, providing an opportunity for the company to implement a restructuring. The proposed changes have been welcomed in the Cayman Islands market and will provide the Cayman Islands with a modern, flexible restructuring process, similar to equivalent regimes in other jurisdictions such as the US and England.

Other sources of activity affecting the loan markets, including leveraged loans, have been: 

• the spate of debt re-profiling that has (thanks in part to COVID-19) seen a surge across financings, including acquisition facilities; and 
• LIBOR transition in respect of the vast number of LIBOR-based debt transactions around the world (again including existing acquisition facilities) requiring amendments to reflect increases, extensions, or changes to other terms.

Many of the impacted transactions feature Cayman Islands based entities acting as holding companies, guarantors, providers or subjects of share security, or as borrowers, keeping all parties busy dealing with the effects throughout 2020 and 2021 and now, in certain markets (notably Asia), into 2022.

Since the 2016 legislation introducing Cayman Islands limited liability companies (LLCs) as a new flexible corporate vehicle, LLCs have gained momentum with players in the US market due to the similarity to (and parties' resulting familiarity with) Delaware LLCs. We have observed a steady increase in LLC formations in the Cayman Islands, with 2021 formations increasing more than 50% over 2020 numbers (which had matched 2019 numbers). Records for the first quarter of 2022 already show around 300 LLC formations, indicating the year may be on track to match last year's levels. Cayman Islands LLCs are frequently used in fund structures (including feeder funds) but may also be indicative of parties collaborating through an incorporated joint venture (JV). JVs, alongside co-investment platforms, set up in the jurisdiction have recently experienced an increase in use as a means through which parties combine pooled capital and market expertise, and in recent years have been employed more frequently in M&A activity for asset classes such as distressed loans or real estate.

Segregated Portfolio Companies (SPCs), while not a new vehicle, were initially legislatively very restricted with respect to their uses in the Cayman Islands. Subsequent changes to the Cayman Islands Companies Act have removed those restrictions. A 2012 Cayman Islands Court of Appeal case acknowledging the segregated nature of the portfolios within an SPC has bolstered their popularity, including in the funds and structured finance space. While formations dropped in 2020, numbers rebounded in 2021 to their pre-pandemic figures. Based on the registrations of SPCs during first quarter of 2022, this year could match or exceed last year's figures.

Outlook

The end of 2021 and very early part of 2022 saw many markets and industry sectors welcoming an air of optimism. In many countries, COVID-19 was felt to be either noticeably declining or at least better understood and manageable, with the opening of many borders and scaling back of restrictions kicking off an increase of activity in particularly hard-hit sectors, such as travel, leisure and tourism. There was a general sense that businesses across many major industries and markets could re-focus their efforts from pandemic-driven firefighting and management to strategic and proactive management of positions – “ordinary‟ business activity could kick-start and drive through 2022 with prospects of a real global recovery.

That optimism was slightly tempered by an expectation that 2022 would also be the year in which the true cost of the pandemic on some businesses would begin to crystallise, resulting in increases in distressed restructurings, especially in light of further roll-backs of government support programmes (in some cases those programmes will likely come to an end). Leveraged loans, by their nature, could be likely to require at least some degree of restructuring. Meanwhile, additional factors such as, accelerating inflation, rises in central bank rates (with indications of more to come) and certain traditional bond markets drying up, have begun to put pressure on some sources of previously readily available cheap funding that helped keep businesses operating. 

One quarter into the year, the waters have become rather muddier with a sentiment of unpredictability featuring more prominently. Continued supply chain squeezes, resulting from the long tail of COVID-19, and in some countries resurgent episodes of increased restrictions or even lock-downs, compounded by the effects of the war in Ukraine, and equity market volatility further contribute to and increasing general market sentiment that 2022 could be another challenging year. 

Rising inflation and interest rates are expected to put additional or renewed pressure on some business sectors. The introduction of a series of significant sanctions packages in respect of Russia and Belarus (with more conceivably on the table) will add to that pressure and overall business momentum may take a hit. At the same time, governments may consider extending existing or introducing new support measures to cushion some of these effects but, for the moment, the sense of unpredictability appears most common.

In terms of restructuring, a degree of restructuring appears inevitable (especially in sectors such as travel, hospitality, retail and real estate) but the extent of that activity is unpredictable and will vary regionally. 

There have been reports of a first quarter 2022 increase in bankruptcy filings in the US. A slowdown of just over 30% in global M&A activity (according to Dealogic), while steep on its face, follows a record-setting year 2021 and is viewed by some players as a short-term setback heavily impacted by the geopolitical situation revolving around Ukraine. At the same time, in the first quarter 2022 M&A in the technology, media and telecommunications sector (according to data from Mergermarket) remained strong at levels, in terms of volume and value, well above pre COVID-19 pandemic levels, albeit not quite reaching the record-setting 2021 levels.

In some industry sectors (such as cryptocurrencies, fintech, cybersecurity, oil and gas – especially in light of ESG pressures – and defence), the continued market demands and challenges which are creating a sustained need for change may make continued activity inevitable, including M&A (and, by extension, acquisition finance). For example, recent estimates suggest the United Arab Emirates alone will require additional investments around nearly USD700 billion to achieve its 2050 net-zero targets. While that investment may come in many forms, it is expected that the public and private sector will have major roles to play, including private equity, traditional and non-traditional credit providers. It seems inevitable that as this sector grows, it will spurn M&A activity and, therefore, a need for acquisition financing. We have already seen a number of new sustainability-linked facilities closed in recent months and are watching with interest the trend towards uniformity in ESG benchmarking and monitoring, which is an important part of allowing sustainable finance products to mature. With a significant amount of dry powder in global private equity houses, that source of funding appears to remain available for the right opportunities. 

As has been the case in the past, we expect that a number of the macro-economic situations playing out in the global markets will be replicated in market and deal activity in the Cayman Islands. This could be in restructuring situations where there is a direct impact on Cayman Islands entities (which may be key due to their placement in holding structures or roles as issuers of deal specific securities) or as a result of corporate M&A or funds activity, extending to related acquisition financings. What does seem certain is that 2022 will be another varied and engaging year for principal parties dealing with and advisors operating in the Cayman Islands.