“Personally I think the Segregated Portfolio Company (SPC) structure has the potential to become a nightmare,” states Mike Saville (pictured), Director, Recovery & Reorganisation for Grant Thornton Specialist Services (Cayman) Ltd. “The structure is a way to spread administration and directorship costs but because an SPC is typically composed of multiple cells operating under one legal entity investors are setting themselves up for additional risks should problems arise.”
Each cell within an SPC will have its own assets, liabilities and shareholders. Also, each cell is protected from claims by creditors of other cells against its designated assets.
Cost efficiencies are an attractive potential benefit for today’s investment manager given the rising costs of regulation and compliance. Simply put, an SPC offers economies of scale.
Only one set of directors and Memorandum and Articles of Association is required whilst individual cells cater for investors who may not want their investment mixing with others. Such structures may be controlled by one manager controlling all cells, or several managers, effectively providing a hot house for emergent funds; the latter is typically seen in incubator platforms.
By leveraging a common set of directors, fund administrator and auditor, individual managers benefit from reduced costs. Yet the director responsible for the SPC is not dealing with one fund but rather multiple funds, adding significant complexity to the corporate governance function.
“Whether there are five or 55 cells the administrator will need to ensure a strict segregation of individual assets and liabilities between the different cells. Without this, the foundation of the SPC will be undermined. Directors should understand and monitor each manager’s investment strategy, keeping an eye on each cell’s balance sheet. In essence their duties are multiplied by whatever number of cells exist,” comments Saville.
The first significant risk of using an SPC is whether robust corporate governance is being applied by the directors. How can this be significantly cheaper if the director is doing their job properly?
“The only thing managers can really save on is the filing fees to CIMA. Pretty much everything else has to be done for that one cell as it would be if it were a standalone fund. The cell will still have admin fees, audit fees and still require its own governance.
“If directors are charging the same for an SPC as they would for a standalone fund management company, you could argue that they’re not doing their job properly,” says Saville.
The second risk is what happens if the SPC fails. Case law on SPC insolvency is practically non-existent as opposed to the well-used option of liquidation for non-SPC structures. It’s not possible to liquidate a segregated cell because liquidation only applies to the SPC as this is the legal entity, not the cell.
“Following my appointment as receiver to a cell, the Axiom Legal Financing Master Fund, SP, a segregated cell of JP SPC4, I found out that the law in this area is vague. Specific application had to be made to the Court for amongst other things guidance on the extent of the receiver’s powers.”
In theory all other cells in the SPC should remain untouched but there is a risk that they, and their investment managers, could become tainted by association should a cell go into liquidation.
“An SPC that fails and becomes insolvent is a rare creature. If it’s going to go wrong, you want certainty for what will happen but what you’ve got in the interim is uncertainty. The risks outweigh the advantages in my view. Users should be aware of the additional problems that can arise if things go wrong.”