Walkers Review: Private Equity Activity Expected to Grow; Asia and Dubai will continue to attract new funds

Walkers, the global offshore law firm, says that 2005 will be another record year for the registration of hedge funds in the Cayman Islands.

Paralleling that growth is the record volume of private equity transactions that have closed in the last 12 months.

Together, these trends are being driven by the continuing inclusion of greater segments of the global marketplace, particularly Asian and the Middle East, and the growing demand for higher returns on the part of institutional and individual investors alike. For the first nine months of 2005, the Cayman Islands Monetary Authority (CIMA) reported that more than 960 funds have been formed, with an increase of 361 funds in the third quarter of 2005, a 15 percent increase over the same time period in 2004. In 2004, a then-record 1,405 new hedge funds were formed in Cayman during the entire year.

Overall, the level of assets invested in hedge funds around the world rose in 2005, largely as the result of pension fund assets that were invested into alternative investments vehicles, with a special emphasis on Japan. More than USD 2.5 billion in pension funds were invested in alternative vehicles in Japan in the first nine months of 2005, primarily through hedge funds domiciled in the Cayman Islands. This growth was also reflected by increased activity in Walkers' Hong Kong office.

Importantly, pension funds are also driving new hedge fund structures, including the use of side letters, a type of special arrangement for select fund contributors.

"Side letters are often needed to allow a pension fund to invest in a hedge fund without violating the terms of the pension fund's charter documents or the provisions of ERISA," Mark Lewis, Senior Investment Funds Partner for Walkers, said. "Driving this trend is a significant increase in the funds allocated to the alternative investment sector in all jurisdictions   from Japan and Dubai to the UK and the BVI." Mr. Lewis added that this trend is likely to continue well into 2006, especially given the anemic performance of major global financial indices.

"In addition, side pocket allocations are becoming more standard," Mr. Lewis continued. "Fund managers are constantly trying to generate higher rates of return in an increasingly competitive marketplace, and are using side pocket investments as off-market and illiquid vehicles."

The coming year will also bring increased regulation of hedge funds by the U.S. Securities and Exchange Commission (SEC) given the approach of the February 1, 2006 registration deadline and the work being done by investment managers to prepare their filings.

"It is widely anticipated that the increased burden of regulation will increase operational costs for the start-up managers, although many are electing to offer shares in their funds with 25-month lock-ups to avoid registration," Jonathan Tonge, co-lead of Walkers' Investment Funds Partner, said. "We also expect a year of consolidation in the market place as many smaller fund managers look to merge to achieve scalability of size."

Like hedge funds, private equity funds also saw a steep increase in activity in 2005 for a wide range of reasons, and in a variety of jurisdictions.

"Private equity funds and hedge funds seem to be moving closer in terms of structure and strategy. We anticipate seeing even more of this and we are actively working for our clients on a number of these 'hybrid' funds which will be launched early in the New Year," Iain McMurdo, an Investment Funds partner for Walkers, said. "In addition to an increase in activity in jurisdictions such as Asia, the sheer size of private equity deals continues to grow as groups continue to take business units, or entire companies, private."

Mr. McMurdo pointed to the recent acquisition of Dunkin' Brands Inc. by Bain Capital, The Carlyle Group, and Thomas H. Lee Partners; the purchase of Toys 'R' Us by a group lead by KKR Group, Bain Capital, and Vornado Realty Trust; and the acquisition of Agilent Technologies' semiconductor business known as Agilent Semiconductor Products Group (SPG) by Silver Lake and KKR as evidence of this trend. Walkers was involved in fund formation and portfolio acquisition in both the Toys 'R' Us and Agilent deals.

In 2005, the Walkers team formed a number of new private equity funds for existing clients and was heavily involved in a number of portfolio sales and acquisitions by its clients. Key deals for the private equity group included the sale of Japan Telecoms by Ripplewood to Softbank, the subsequent spin-off of Ripplewood's private portfolio and of RHJ International, the spin-off of the Soros Private Equity Group to form TowerBrook Capital Partners, and advising Stone Point Capital in the capitalization of Harbor Point Limited.

Another area of expected growth in 2006, according to Walkers, will be Shariah-compliant investment funds, or funds that comply with Islamic law. With the continuing emergence of the Dubai International Finance Centre (DIFC) as a major global financial hub, the importance of Dubai in the capital markets is anticipated to increase.

Over the past two years, the equity markets in Dubai have been among the world's top performers, with a 41 percent increase in the private equity industry since 1998. Today, private equity investments total around USD 1 billion. Current estimates call for this trend to accelerate and reach a total of between USD 2.1 and USD 2.6 billion by 2007. In addition, more than 80 per cent of the investment in the region is currently offshore, increasing the need for the local business community to draw on international expertise.

Walkers opened the first fully transactional offshore law firm in Dubai in November to offer in-country expertise its large portfolio of Middle Eastern clients, as well as to help build the legal service offering in the region.

"The top 30 global asset managers consider the Middle East to be a significant area of growth, with many of them   including UBS, Morgan Stanley, Deutsche Bank and Fidelity International   already active in the region. And the number of Islamic mutual funds has grown from 127 in 2002 to 445 by Q3 of 2005," Grant Stein, Walkers' Senior Partner said. "With offices in London, Cayman, Hong Kong, the BVI and now Dubai, Walkers brings connections with the major financial centers, as well as knowledge of financial products, to better serve our clients around the world."

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