With more consolidation expected in 2016 within the hedge fund administration space, those that thrive and survive will likely be ones with a strong reputation, a robust operating model that is able to support managers of all shapes and sizes, and a clearly defined multifarious revenue stream.
In the Cayman Islands, administrators are continuing to see a stable start-up market, but as Jack McDonald, President and CEO at Conifer Financial Services points out, there has also been a good level of takeaway business as managers look to rotate out from their existing administrator into a new one. "At Conifer we've seen growth over the last 12 months in both those segments".
"As we've grown to approximately USD120 billion in AuA we've been able to engage in discussions with different types of prospective clients that previously would have been more challenging given a smaller AuA level. It's been an interesting phenomenon for us," says McDonald.
One of the reasons that Conifer Financial Services – which was itself acquired by Carlyle Group last year – merged with Vastardis Capital a few years ago was to put together services and technology that could benefit both single managers and multi-managers of asset allocators (pensions and large family offices).
Technology prowess is becoming a key differentiator and is helping administrators to keep pace with the changing habits and fund structuring requirements of alternative fund managers. One trend that has been emerging in offshore jurisdictions over the last couple of years, largely in response to renewed investor appetite for illiquid assets, has been the establishment of hybrid funds, which combine elements of both private equity and hedge fund strategies.
Daniel Leblond is Managing Director, Fund Services Administration at Conifer Financial Services in New York. He says: "We are structured well to handle these hybrid funds, especially with respect to the investor reporting requirements. We are building technology to increasingly set ourselves apart from other administrators by working with managers and their investors who wish to increase transparency regarding the various components of the portfolio that they hold.
"We have seen a substantial uptick in hybrid fund activity. We are talking to some PE managers who are launching hedge fund vehicles (with side pockets) to take advantage of some of the research processes they have in place."
Where hedge fund administrators are seeing real competition for revenue streams, however, is with respect to directorship services, as managers increasingly look to adopt an independent governance board to appease institutional investors and regulators.
Directors Registration and Licensing Law
The introduction on 4th June 2014 of the Directors Registration and Licensing Law (`DRLL') means that the Cayman Islands Monetary Authority now has a clearer picture of Cayman fund directors. Each relevant entity is defined in the DRLL as a "Covered Entity".
Internationally, it is a good move for Cayman to have a register of directors to be able to take more of a supervisory role and blacklist directors, if required; a key part of the regulatory theme among authorities in other jurisdictions that perhaps Cayman was missing.
CIMA's intention with the DRLL is to have greater control over directors and apply greater scrutiny over their activities. From CIMA's point of view it enables them to evaluate information that previously wasn't provided to them. Now they can monitor the appointment of directors more closely.
"The Directors Registration and Licensing Law could potentially be used by CIMA to limit the number of directorships of covered entities which can be held by any one director," suggests Matt Mulry, Partner, Financial Services, Dillon Eustace (Cayman). "The law provides that CIMA may not license a professional director or a director that is a company unless satisfied that they have capacity to carry out their duties but these provisions were specifically excluded when the legislation was enacted. This feature was a key part of the initial drive for implementing the legislation and we may well see the relevant sections coming into force but that will require a discussion about how best to assess capacity across the diverse range of covered entities operating in Cayman."
"Increased supervision of the industry by CIMA is welcome, as is regulator-to-regulator dialogue. From my perspective, the key is to refine the process to ensure that the regulatory data held is current and accurate," adds Colin MacKay, Group Director, Elian Fund Services.
Section 30(3) (c) of the Mutual Funds Law already gives CIMA the power to require the substitution of any director of a regulated fund. The DRLL goes further and provides for, inter alia, the effective disqualification of hedge fund directors through Section 25(2).
"The register maintained by CIMA under the DRLL, which includes contact details, is a useful tool as the law does place an obligation on the registered or licensed director to keep those details current. This is an important provision for the regulator (and investors) when funds are in any type of distressed situation and communication with all directors is essential," comments Don W. Ebanks, Managing Director, DMS Offshore Investment Services Ltd, the Cayman Islands' most recognised and established fund governance group.
Independent directors & split boards
One important driver behind the adoption of independent boards of directors is that it helps fund managers to demonstrate best practices to investors, and remove any threat of duplicity that an internal board of directors might potentially create. Independence is the name of the game, and this is proving to be propitious for the islands' directorship services community.
Ralph Woodford is one of the co-founders of ICG Management Limited (`ICG'). In his view, it is better to have a complementary mix of expertise that, collectively, brings independent directors of various backgrounds and levels of experience to bring to the table.
"We don't believe there is, or needs to be, a prescriptive formula for "1 accountant, 1 lawyer and 1 portfolio manager/risk manager". What matters more is the complementary blend of individuals' general industry experience, specific hedge fund director experience and practical knowledge of how investment funds operate. This blend of skills and experience allows for insightful and thought provoking discussion of issues facing hedge funds today and effective corporate governance," says Woodford.
In November 2014, Walkers released their Global Hedge Funds Outlook 2015 survey. According to the survey, combined boards (utilising both independent directors and internal directors) made up 67 per cent of Cayman funds registered in 2014, compared with 52 per cent in 2013.
Approximately 81 per cent of combined boards were found to have a majority of independent directors, although Ebanks questions this. Whilst he contends that the use of independent directors has become the norm, "a majority of independent directors on offshore fund boards is not yet universal.
"An independent majority is something that institutional investors typically look for and I have seen voting shares being held in trust arrangements more often in the last few years. Split boards are certainly used a bit more now, but the important question seems to be the overall board composition and function, which is addressed in the CIMA Statement of Guidance ("SoG") for funds," says Ebanks.
During 2015, DMS added a number of US-based independent directors to its established team of directors in Cayman, Ireland and Luxembourg.
"The new members of our team come from diverse backgrounds including serving as a COO of large hedge funds and leading Operational Due Diligence teams for alternative investments at major global banks.
"Our directorship solutions combine market-leading expertise with state-of-the-art technology and compliance with SEC fund governance standards. In addition, we provide fund stakeholders with transparency and accountability with unique reporting systems, such as our Fund Governance Transparency ReportSM, which shows the governance "touch points" in a specified period, and Independent Directors' ReportSM ("IDR"). The IDR provides confirmations regarding issues of concern to prospective investors (e.g. no material litigation or regulatory issues) from an independent source," adds Ebanks.
Such is the demand for independent directors to sit on split boards that in recent times the Cayman Islands has seen a number of directorship firms open shop.
"Many of the independent directors offering services in Cayman bring expertise developed in large international law firms, investment houses, administrators and brokerage firms and the directorship services firms here are recruiting a wider pool of talent to broaden the range of experience they can offer to fund managers," observes Mulry.
Crestbridge is one such firm that has just opened an office in Cayman with Jonathan Bain, Director of Crestbridge (Cayman) confirming that they are already serving on a number of split boards for larger, more established managers with institutional investors.
"That being said, there are still a number of funds that choose to utilise a board composed of two directors from one professional services firm, with a third director from the Manager. From our perspective, the fact that we bring different skill sets and backgrounds as compared with other directors, places us in an ideal position to benefit from boards diversifying their skill sets or otherwise moving to split board compositions," says Bain.
"Our core services, initially, will be the provision of independent non-executive directors to hedge and PE funds, with a few ancillary services such as board support services also on offer. Additionally, we provide corporate and fiduciary services to SPVs utilised in capital markets transactions."
Independent boards for PE funds…?
It would appear that the hedge fund community's desire to incorporate independent directors into their board composition is proving manna from heaven for directorship firms. One future driver, which could further increase demand for their services in Cayman, is the gradual adoption of governance boards by PE managers as an adjunct to the Limited Partnership Advisory Committee (LPAC).
Adopting a similar approach to that applied to advisory committees for hedge fund limited partnerships, the private equity equivalent could be a form of governance board comprised of a combination of GP/manager appointed members and members independent of the GP/manager, with the specific role and responsibility for overseeing the actions of the GP/manager in its dealings in the assets of the partnership.
"This would not replace the primary function of the LPAC, which would remain the conduit for limited partners and GPs/managers to discuss and debate commercial strategy, priority and planning, but would avoid the perceived expansion of the LPAC's role into areas of executive approval, ratification or waiver," says MacKay.
"The LPAC serves a different purpose; when you've got a limited number of investors, as is often the case in private equity, from a General Partner perspective you want to give the LPs a clear line of sight into the investments and also the strategy that you intend to apply in future. Limited partners like to see that. So the LPAC would remain in place, even if PE managers start to eventually adopt a governance board, as it serves as a vital link between the GP and the limited partners."
MacKay confirms that Elian Fund Services have already been engaged by a few PE managers on this matter, and are entering discussions with investors currently investing through traditional PE-style structures, who wish to find out what could be done with respect to independent oversight.
AIFMD impact on directorship activities
Increased regulation is, in many ways, the "new normal" and is fairly bedded in, according to Ebanks. He says that whilst DMS directors spend more time focused on regulatory issues, "it's not a dramatic change".
"AIFMD is one of the most important pieces of regulation, as improper marketing to EU investors can come with significant penalties.
"One issue that I saw last year was a quarterly market update for one fund that mentioned the manager's new fund with a short description of the strategy. I immediately checked if there were any EU investors and raised the issue with the manager, noting that such information may be considered marketing under AIFMD and should be removed. Directors don't have to be experts on every issue, but having a basic awareness is essential as we are ultimately responsible for regulatory compliance," explains Ebanks.
This is why, in Woodford's view over at ICG, it has become more important to have multiple levels of board monitoring to allow the most effective corporate governance overview of a fund.
"Working with the fund's corporate secretary to keep a schedule of board monitoring, or forward-looking action points, ensures there is a robust governance process in place and that the requisite reports are available for the board members at each board meeting.
"There's typically an annual review cycle that pertains to reviewing the valuation policy and can encompass reviewing the fund administrators (both in person as well their SOC 1 report as the quality of their reporting). With managers being becoming more regulated, the SEC and CFTC have 90- and 120-day filings and more compressed filing deadlines for fund's financial statements, versus 180 days at CIMA for regulated funds, so the timelines can be tight for those audits," states Woodford.
In conclusion, MacKay suggests that whilst AIFMD is not having any "direct impact" on Cayman directors, there is an evolution underway in key areas such as risk assessment and management, regulatory compliance, FATCA/Common Reporting Standards data collection and reporting, cybersecurity and management controls, strategy adherence and investor relations.
"Combined, these topics increase the technical discussions at board meetings and they are also driving an increased frequency for board meetings, given the scope of some of the topics and the propensity for circumstances to change over shortened periods," concludes MacKay.