By James Williams – With the search for alpha harder than ever, hedge fund managers are subsequently becoming more creative in how they trade: greater use of synthetic products and OTC derivatives has made the trading environment more complex, requiring hedge fund administrators to deliver better, more transparent reporting solutions, and provide close to real time NAVs and daily reconciliations across a range of asset classes.
Hedge fund administrators are responding to these demands in various ways. One trend in Cayman this year has been for smaller independent specialists, such as Admiral Administration, to consolidate their position in light of rising institutional demands and partner up with larger firms: in this case Maitland.
As Canover Watson, Managing Director, Admiral Administration, explains: “Although Admiral has been highly successful we couldn’t be recognised as an institutional player whilst still being privately owned. The merger with Maitland gives us more depth in today’s environment where scale is critical. You need to have critical mass to provide the right level and depth of support to managers.
“As a trend over the past few years, what we’ve seen is an increase in the cost of doing business coupled with continued downward pressure on fees.”
Nevertheless, new firms continue to open offices on the island. Already this year the law firm Dillon Eustace has established a footprint, and just last month Kobre & Kim LP opened a new office.
Tim Prudhoe, partner, Kobre & Kim (BVI) LP, says that the Cayman office reflects “client demand in respect of high quality work emanating from elsewhere in the world: often Asia (through our Hong Kong office) and the States”.
“Those client demands reflect the growing numbers of joint-venture and investment-related disputes with a link to either or both of Cayman and the BVI.”
As a litigation and arbitration-only law firm, Kobre & Kim is not looking to snatch clients from other leading international law firms on the island, but rather provide additional conflict-free services that should help complement the work other firms are engaged in.
Says Prudhoe: “We will never be a full-service law firm so I think there will be circumstances in which, in addition to existing client demand of our own, we will be useful to other firms who are more likely to experience situations of conflict. A law firm in the Cayman Islands could use us themselves without any concern that we were trying to snaffle their clients on a long-term basis.”
The corollary of that is that Kobre & Kim will undoubtedly be asked to do work that falls outside of its expertise, and allow it to become a source of work for the full-service firms: for example, it would never set up a fund structure or deal with the offering documents.
“Whether its private clients or corporate work, we will always have outbound referrals for others in the Caymans,” adds Prudhoe. James Corbett QC heads up Kobre & Kim’s Cayman Office.
Another area where Cayman’s service provider infrastructure is strengthening is in the number of fiduciary services firms sprouting up. This summer, for instance, Alric Lindsay, a former investment funds attorney with Maples and Calder, established Lindsay Fiduciary Services. One of the island’s largest firms is DMS Offshore, founded by Don Seymour in 2000, and he’s happy with the level of increased competition:
“Since 2000, there’s been enormous growth in the fund governance industry here in Cayman. CIDA is one of the fastest growing professional associations on the island. We now have more than 200 members. You can judge the strength of a jurisdiction by the quality of its Associations and from what I’m seeing, CIDA’s membership is growing daily.”
Darren Stainrod, Head of UBS Fund Services, Cayman, thinks the reason for Cayman’s continued evolution, and attractiveness as a fund domicile, boils down to the island’s sensible regulations.
“They protect investors but also allow a lot of flexibility for managers. Dublin as a fund domicile has increased substantially in terms of market share but not at the expense of Cayman, which remains the jurisdiction of choice for hedge fund managers.
“There’s a highly experienced infrastructure here. You’ve got quality law firms that will help you with structuring, all the top audit firms are here and still a number of top administrators so it’s very easy to set up: the speed to market is still a competitive advantage Cayman has over other jurisdictions.”
Stainrod confirms that Cayman remains an easy location to attract top talent and retain them. “We use that as a key differentiator. In our front office over 85 per cent of staff are qualified accountants, which adds a level of professionalism, not just for managers but for their investors as well.”
As well as attracting top talent, firms are investing heavily in technology to meet the higher demands of transparency and trading complexity outlined earlier. Whereas back-office support was once the primary offering among administrators, now it’s necessary to provide higher-touch value-added services: specifically middle-office reporting.
“To meet the deliverables being required from managers (daily NAV and reconciliation, valuations, transparency reporting) a more sophisticated infrastructure is required. The reality is that smaller players, in my opinion, cannot remain viable in this environment. As a result we’re seeing more consolidation, in general, among service providers. It’s a function of scale, depth and breadth of service,” says Watson, noting that the Maitland merger with total AUM of USD145billion will allow it to offer a wider range of services to clients including services to pension funds, traditional long-only funds and private equity funds.
“Midsize funds hovering between USD100-500million in AUM are not being serviced very well by the largest administrators and we think that’ll be our sweet spot. Our intention is to be the leader of the mid-tier space.”
Stainrod says that it’s not just the customisation and nature of reporting that has changed; the frequency of reporting has also been a big game changer. He notes that UBS Fund Services has had to build a global operating model to provide daily updates to hedge fund managers each morning, regardless of their location.
“Globally, we are servicing mainly Cayman-based funds but our accounting system is utilised by our offices in Europe, the Americas and Asia. We are augmenting our investor systems, adding risk reporting and daily flash P&L. Each client can build their own customised views and for us, by having a data warehousing system, it means we can easily aggregate data from various systems and provide reports in a quick, customisable fashion.”
Rather than just receiving a PDF or word document, clients can now integrate more closely with UBS’s systems by downloading FTP files off the web, confirms Stainrod. “We’ve even developed mini data warehouses where we deposit the data and they can grab it using cloud-based technology. We’re looking to invest further in our web portal, it’s probably about 10 per cent of our IT spend.”
Mike Saville, Director, Recovery & Reorganisation, Grant Thornton Specialist Services (Cayman) Ltd observes that there is more of a feeling of stability on the island today: “I don’t think earlier concerns over the growth of the onshore market in Europe have necessarily gone away, but it’s certainly less prominent a discussion point than it was a couple of years ago.”
He caveats the point by adding: “Having said that, if you look at what’s going on in the States, that represents more of a concern. If the fiscal cliff is unresolved the US is going to look for new areas in which to raise taxation and potentially target some of the US tax-exempt structures; that could have a negative impact on offshore jurisdictions and is definitely worrying some of the key fund tax attorneys onshore.”
What is certain is that fund numbers in Cayman are improving. According to Yolanda McCoy, Head of Investments & Securities at CIMA, so far this calendar year CIMA has authorised 2,639 funds: this compares to 955 for the equivalent period last year.
“Full numbers for 2011 were 1,038 so we’ve literally doubled the number of funds already this year, helped in part by master fund registration which became effective on 21 December 2011. As of this week we have a total of 10,935 funds. We’ve had some attrition, which is normal for hedge funds, but the numbers remain robust.”
Morehouse says the measured approach by CIMA has been consistently applied “and we believe that is the right approach for both commercial and regulatory interests. We view continued fund manager confidence as a strong validation of the jurisdiction’s image and reputation.”
One of the consequences of the global financial crisis was the forced liquidation of insolvent hedge funds, which got caught up in being exposed to toxic assets. Some of the side pockets in insolvent funds remain. Saville notes that this year a lot of the firm’s time is still being spent on liquidation cases some two or three years old.
Saville further adds that when he meets with litigation attorneys in the US there’s still a lot of pent-up frustration among investors, even though, for whatever reason, many choose to remain in suspended funds and aren’t taking legal action.
“As ever in these cases, the control lies with the investment manager who has established the side pockets in the first place. Often their attitude will be that there will be some sort of recovery in the assets and they’re unwilling to sell at discount prices.
“Another grumble that I’ve been hearing about recently is an annoyance amongst investors where some funds have been in suspension for two, three years but the investment manager is continuing to take his management fee.”
Keiran Hutchison, restructuring partner at Ernst & Young, concurs and is seeing significant irritation among investors who are being told to sit tight while the manager still takes his fee.
“Valuations can be an imprecise science, and you might have a situation where the fund manager feels able to justify NAV at a high level even though the underlying assets aren’t capable of providing liquidity. End investors are unable to receive any redemption because they’re being told it’s not the right time to sell the assets, or indeed it’s impossible to sell.
“Situations where managers continue to draw fees on the basis of high NAV but illiquid assets and are unable to meet redemption requests obviously cause tensions with investors.”
Adds Jeff Short, AM partner at Ernst & Young: “Another frustration we’re hearing about stems from instances when investment advisers establish new investment vehicles without perhaps making the requisite effort to unload those illiquid positions in legacy vehicles.”
The adoption of best practices by investment managers is proving to be a propitious time for fiduciary service providers like DMS Group Ltd and Paul Harris’s IMS Limited. Don Seymour believes that the use of independent directors is now an integral part of a fund’s control structure, noting that whereas prior to the crisis around 40 per cent of funds had institutional investors “now that figure is well over 60 per cent”.
Harris says that whilst 2011 was a good year, “for 2012 new business is up over 10 per cent compared to the same period last year. One of the criticisms that Cayman has faced is that directors are sitting on the boards of too many funds. This is perhaps a misplaced concern. Cayman-based directors have not shirked their responsibilities or been involved in high-profile blow-ups like the Weavering fund. Corporate governance is a serious business.”
Says Harris: “The directors we employ take on an appropriate amount of directorships according to their capabilities and the demands of the boards on which they sit. We also have internal controls to see that this principle is being adhered to.”
DMS has 75 associate directors on its fund governance team alone, not to mention the 50-plus support staff. Factor in its high-quality technology systems and long track record and “we are, by any measure, the world’s leading fund governance firm. People hire us because we have more experience than anyone else,” says Seymour.
Ultimately, firms like IMS and DMS are committed to ensuring that funds are doing what they say on the tin and that shareholders’ interests are being upheld.
“Fund governance is a system of checks and balances that goes beyond any one director, and beyond the board meeting. We discuss with new funds the level of transparency that we provide to the fund’s stakeholders through our fund governance transparency report and our independent director reports, which are unique to DMS,” confirms Seymour.
However, whilst Cayman-based directors are fully focused on the governance process, what is of more concern to regulators, and which was underlined in the Weavering case, is how best to regulate funds that have no directors actually resident on the island says Harris.
“Most seem to be leaning towards mandating that every fund should have at least one resident director. Critics point out that there are not enough directors on the island to fulfil the positions and that standards will be diminished or the cost will be too much for small start up funds. However, market forces of demand and supply will soon ensure that there are sufficient numbers of sufficient calibre and fee concessions for small funds will be available taking into account the less work that has to be undertaken.”
