Cayman service providers adjust to the demands of global regulation
By James Williams – “In 2012, our voluntary application got approved by CIMA to have a regulated director services model, called DMS Fund Governance. What that means is that just like an auditor or an administrator in the Cayman Islands, we are regulated by CIMA as a service provider to hedge funds,” confirms Kathleen Celoria, Executive Director (New York) DMS Offshore Investment Services. With over 80 full-time directors and associate directors, DMS is the world’s largest provider of fund governance services.
What is revealing in Celoria’s comment is that it shows DMS has been some way of ahead of the curve with respect to adopting professional standards for its directors and best practices for fund governance; something that CIMA only decided to codify in its Statement of Governance for regulated mutual funds (SoG-MF) last month. In Celoria’s opinion, it was important for Cayman to look at the Weavering case and underscore what professional directors should look like to the world. What the SoG-MF does, in effect, is harmonise what is required to be a professional fund director.
“When I look at CIMA’s SoG, these are guidelines that DMS already operates under,” says Celoria. In total, there are around 11,000 funds registered in Cayman but only a tiny percentage of those have locally appointed directors as it is not currently mandatory to have a locally appointed representative. The Cayman Islands Directors Association (CIDA) has around 215 members, all of whom are Cayman-based full-time directors including those at DMS. Up until now, Cayman has been exposed to the risk that, aside from CIDA-registered directors, the vast majority of fund directors have not necessarily applied the same professional singular focus that DMS’ directors have. The SoG-MF addresses this point.
“With the SoG, Cayman is setting out the importance that every director, globally, adheres to professional standards no matter what their full-time occupation is. It’s a way to clarify what those minimum obligations look like,” says Celoria.
One of the first points CIMA addresses in the SoG is for the oversight, direction and management of a regulated mutual fund to be conducted in a “fit and proper manner”; i.e. that the Operators and Governing Body are themselves fit and proper. That this now applies globally is an important development for Cayman as it looks to uphold best practices in the eyes of the global investment community but for DMS, such adherence is well established.
“CIMA will inquire on a director’s financial soundness, reputation, integrity, competence, regulatory reviews and many other areas through its Fit and Proprietary Assessment process which determines that a director is fit and proper to act as a director of licensed entities. DMS has already subjected its directors to that process. We were embracing this need for fund governance best practices back in 2012,” stresses Celoria.
Other fund governance firms like the IMS Group, another major player on the Islands, are well placed to provide the kind of robust independent directorship services that institutional investors are increasingly calling for. What is hoped is that the SoG-MF will now encourage all directors of Cayman funds to embrace the esprit de corps and uphold Cayman’s integrity as the world’s leading offshore fund domicile, even if the vast majority are not independent. The only other alternative would be to insist that every fund has at least one Cayman-based director; with 11,000 funds in the system, it goes without saying that such an option would be impossible to implement.
Aside from keeping pace with corporate governance, the two major focuses of attention for Cayman service providers are the AIFM Directive in Europe and FATCA regulation in the US. Both impinge on Cayman funds and both require dedicated resources to ensure that managers are provided with adequate solutions.
Taking the Directive first, Monette Windsor, Head of UBS Fund Services (Cayman) Ltd says that there are two big opportunities to support its clients: firstly, through the provision of management company services in Ireland and Luxembourg, where UBS will act as the AIFM on behalf of managers. And second, by providing key services as the independent depository, either under full compliance with the Directive or by offering an ‘AIFMD lite’ solution to managers who chose to continue with private placement.
“We think there’s a lot of opportunity for our Cayman, Dublin and Luxembourg offices to provide the ManCo and depository services. It’s important that we are able to offer a broad spectrum of services under the AIFMD for different clients to avail themselves of,” says Windsor.
Managers who remain outside of full compliance and who require AIFMD lite solutions have the advantage of retaining their existing prime brokerage and administrator relationships for two of the three core functions of AIFMD: namely cash management and safekeeping of assets. All they need to do is add the oversight function, which the fund administrator is well placed to support. They will not, therefore, need to appoint an independent depository.
However, as Windsor points out, for those managers who plan to become fully compliant, they will want reassurances that their chosen depository will support their existing multi-prime relationships. UBS Fund Services will indeed support such requirements while others may only support one prime broker. “Given the importance of mitigating counterparty risk, our ability to be a depository and allow the manager to maintain their multiple prime broker relationships is important,” asserts Windsor.
Canover Watson is the Managing Director of Admiral Administration (now part of Maitland Group). Watson provides an update on the firm’s business development activities. He informs us that that the firm has applied for an AIFM licence in Luxembourg. On obtaining authorisation, the firm, through its authorised entity will be in a position to provide management company services to Alterative Investment Funds (AIFs) which are compliant under the AIFM Directive.
“We are in the process of talking to fund managers as a possible solution for them if they are thinking of setting up an onshore structure in the European Union. There are opportunities for us as a firm, globally, to be able to offer managers that go beyond the usual fund administration services of fund accounting and reporting.
“We are in discussions with a number of fund manager groups regarding the firm’s white labelled solution. We are in the process of establishing a multi-compartment Specialised Investment Fund (SIF) platform. As an umbrella product, it will provide clients with the facility to set up their own sub fund on the platform. The SIF appoints the authorised AIFM entity mentioned above so as to ensure compliance under AIFMD. This will bring with it the EU passport to market and distribute to professional investors in the EU. It will also enable us to provide the SIF with the necessary range of AIFMD compliant services which will leave clients with the ability to focus on their core fund management activity.
“The depository will be an independent third party entity with no organisational links to the firm. At the same time a seamless flow and exchange of information for the depository’s duties and oversight functions is being established,” confirms Watson.
Dealing with the legal complexities of the Directive is itself a major undertaking for most managers – particularly non-EU managers – as they need to be perhaps more focused than ever on their marketing strategies; is it worth pursuing private placement? If so, which markets are important? Or is it materially beneficial to establish an EU presence and become fully compliant with the directive?
In this regard, Admiral is ideally placed because of the extended capabilities it can draw upon as part of the Maitland Group.
“We have legal service capabilities with offices in London and Luxembourg so we are able to offer clients access to information and help guide them on what requirements they need to meet for their particular circumstances. These regulatory changes are playing to our strengths as a group which are far more comprehensive than your typical ‘fund administrator’,” says Watson.
Michael Padarin is a partner in the Investment Funds Group at leading law firm Walkers. He notes that US managers have been reacting relatively slowly to the directive. Many of the queries Walkers is receiving are one-off queries in relation to specific markets and technical questions about how to navigate private placement rules in countries like Italy and Spain.
“We’ve put together a good database of advice as we’ve now dealt with enquiries in relation to the distribution of Cayman funds into almost all EU jurisdictions. We’re able to help advise US managers as to whether or not they can privately place in certain countries, and whether or not certain exemptions apply such as reverse solicitation.
“In fact, reverse solicitation enquiries are at the top of US managers’ minds right now. If they’ve got a one-off potential investor they don’t want to have to deal with updating offering documents, or appointing additional service providers such as a local paying agent, or distributor which may be required in Switzerland. They want to understand the extent to which they can get the capital introduction team of the prime broker(s) they use to initiate the marketing process and then rely on investors coming to them directly. That’s the main topic we’re focusing on at this stage for our US managers – can they actually rely on reverse solicitation?” says Padarin.
A recent event on AIFMD hosted by DMS at the Harvard Club in New York found that 30 per cent of hedge fund managers in attendance were focused on setting up an AIF in Europe. That figure will surely rise as private placement regimes across Europe slowly get phased out (possibly in full by 2018).
Windsor says that most of UBS’ clients are in a holding pattern right now with one or two clients wishing to become compliant and still deciding on whether to become the AIFM themselves or appoint UBS. What seems clear, at least in Windsor’s opinion, is that Cayman is not under risk of shrinking under the directive.
“I’ve yet to hear of any manager closing their Cayman fund to move onshore. I think the question is do they set up a new EU fund so that they don’t burden their other non-EU shareholders with the costs and added complexity of complying with the directive.
“All of our global offices for alternatives use the same technology platforms to make it uniform for our clients. If they are used to dealing with the Cayman office and they want to launch a fund in Ireland, all of the reporting will be identical. If managers start to launch regulated European funds it will still be business as usual for us,” comments Windsor.
Mike Saville is Director, Recovery & Reorganisation for Grant Thornton Specialist Services (Cayman) Ltd. He isn’t quite as certain as Windsor that the directive will not impact on Cayman. Theoretically it shouldn’t, says Saville because Cayman has done everything necessary to support managers but the reality is no one yet knows what the impact of the directive will be.
“As the current leader in the hedge fund industry if I were to speculate and say there’s going to be a loser in all of this, it’s possibly going to be Cayman. Simply put, Cayman has the most to lose by any change. You’ve got a lot of concerns among managers in the US and the risk is they will decide to do something different – possibly by establishing European-compliant funds instead of purely offshore funds.
“Given that it is the world’s leading offshore jurisdiction, if there is to be a loser it’s probably going to be Cayman, even though it’s doing all the right things,” posits Saville.
As for FATCA, foreign financial institutions (FFIs) have less than 100 business days to go before the 1 July 2014 deadline when FFIs must identify and report to the IRS all US citizens holding assets abroad. To that end, getting the right compliance and reporting framework in place is imperative if managers wish to avoid getting hit with a 30 per cent withholding tax should they continue making payments to non-compliant entities and individuals.
DMS’ Celoria confirms that the firm started preparations for becoming FATCA ready on 18th June 2013 and is now well placed to assist Cayman funds with their FATCA obligations in 2014.
“DMS is able to appoint an officer to serve as the FATCA responsible officer (FRO) which is the party that will be designated during the registration process to meet FATCA obligations for the foreign financial institution (FFI).
“Fund stakeholders including managers recognise that in a constantly changing regulated environment it’s important to have strategic partners to get guidance on changes and be presented with solutions to meet those changes. We have built out a team of seven highly qualified professionals based in Cayman managing the FATCA side of the business,” comments Celoria.
Unsurprisingly, fund administrators have had to make significant investment in their technology to keep on top of regulation like FATCA, which, controversially, has powers of extraterritoriality. In fact, since the global financial crisis, wave after wave of regulation has continually pushed the technology envelope and forced administrators – among others – to innovate. Windsor notes that changing investor habits are also playing their part as more and more institutions choose to invest in funds-of-one or segregated managed accounts to avoid the potential risks of investing in commingled funds. The common denominator in all of this is transparency.
“UBS has been at the forefront of developing a lot of this transparency reporting and supporting products such as funds-of-one and managed accounts. We’ve built most of our business internally and grown organically. A lot of that growth has come from large institutional investors who’ve chosen us as their administrator for their manager mandates e.g. from fund of fund managers.
“Their request for transparency and daily reporting has driven our technology development. We’ve subsequently developed and bolted on a FATCA services solution to our platform. We can support regulatory reporting under AIFMD and we have a fund portal for investors to access,” says Windsor.
One major development over the last 12 months, says Windsor, has been to develop a solution that connects to clients’ portfolio management systems. The client’s PMS automatically sends their trade files to UBS Fund Services where the portfolio data is processed and updated for transparency purposes.
“Thus our platform is well placed to handle the various transparency requirements. We’ve gone through a retroactive sweep of our clients’ investors for FATCA to educate them on what the next steps will be,” adds Windsor.
Watson confirms that under FATCA there are three key areas to focus on: “First, remediation of the existing client base to ensure that we have all the client fund documents in place and that they are FATCA-compliant. Second, is the new onboarding procedures which will have to be implemented for fund investors. Third, is reporting to the tax authorities in different countries depending on whether it’s a model 1 or model 2 inter-governmental agreement.
“We have announced to clients that we have a FATCA solution in place and we are FATCA ready.”
Cayman service providers are clearly well placed to help managers overcome the myriad compliance and reporting challenges imposed by FATCA and AIFMD. And with corporate governance standards taking more of a central stage, Cayman appears to be taking all appropriate measures to adapt to global hedge fund industry demands.
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