The Cayman Islands funds industry remains in good health, but there are still challenges that must be faced. Cayman Funds invited industry leaders to Ernst & Young’s offices on the Island to discuss the major issues.
Peter Scott, Cayman Funds Mag
|Jeffrey Short, Ernst & Young
|Monette Windsor UBS Fund Services
|Rafael Elias, Trident Fund Services
|Glen Trenouth, BDO
|Tim Buckley, Walkers
|Geoff Ruddick, IMS Fund Services
|Ian Dillon, Campbells
|John Ackerley, Carne Group
Peter Scott: We hear a lot in the UK about the Cayman funds industry. I suspect the perception is rather different from reality, so how is the funds industry doing in Cayman at the moment?
Jeffrey Short: Even though the December 2012 versus 2011 numbers according to CIMA’s website may reflect slightly lower numbers of registered funds, we need to discuss here the whole story, which is in fact a positive one.
PS: Do those numbers tell the whole story? Is that how you assess the health of the industry? Or is there a bit more to it?
Glen Trenouth: That’s a good question—how are we assessing that? Is it absolute, or should we be comparing those numbers to the world economy in general, and how it’s doing in North America?
I think it’s very difficult to benchmark, or whether you should count quality as well as quantity of funds. A lot of small funds start up and deregister very quickly because they do not survive. Perhaps we shouldn’t be including those, maybe we should look at a more consistent portfolio, which stays and survives year on year, because they have the management in place and the right people in place, and they are better quality funds.
John Ackerley: Certainly from the segment of the industry we see, we’re seeing more set-ups in recent years than we would have done, so it looks healthier from that perspective, but obviously this is still a small slice of the industry. I don’t know what anybody else around the table would say.
Geoff Ruddick: I’d still say that there seems to be a trend: the big are getting bigger—there continues to be consolidation in the industry. A lot of that comes simply from break-even cost levels being higher than they have been historically. It’s harder to come out with a launch these days at $25 or $50 million and survive. Therefore, numbers in isolation I don’t believe are indicative of the health of the industry.
I think there are further influencing factors such as increased regulation and corresponding costs, etc, that weren’t there before and therefore a lot of firms are bigger now; there are some healthy sized groups out there due to cost pressure and consolidation. Additionally, performance wasn’t all that great last year so we are seeing some of the smaller funds fade away, but I believe the general trend towards alternatives is pretty healthy.
JA: Also, just to go back to Glen’s comment, I think the quality of the start-ups we are seeing today is probably better than it has been in the past, partially because the barriers to entry are higher than they were previously. People are a bit more thoughtful about how and when they launch.
PS: Anecdotally, do you find that there’s been a general improvement in that since the financial crisis hit, in the professionalism of the operations and the attention to detail?
Rafael Elias: We’ve seen more professionalism where new launches are concerned and also a move away from the one or two-person investment manager model. Because the cost of compliance is much greater, investment managers are coming to the table with significantly higher seed funding, to ensure they can both deliver a good return and cover their overheads.
Tim Buckley: I think the flight to quality is an important trend that continues. To reiterate what Geoff said about start-up costs: recently in the US a manager I was meeting with said that they thought it would be hard to justify starting up with less than half a billion initial capital because of the compliance cost in their market. From our perspective, we see a lot of our bigger managers continuing to form funds—we see some start-up work, it is better quality, but there’s still very much a flight to the quality managers at the moment.
PS: What are the major threats to the continued success of the industry?
GT: In the start-ups that we see it is cost burden. Unfortunately we just recently had someone taking the view that “we’ll reassess in the next 12 months, and then consider re-domiciling to the British Virgin Islands”. Cayman costs in terms of the service providers here, regulation, and everything else is just becoming prohibitive for setting up.
JA: I still think that there’s a premium on Cayman. No-one sets up $20 million to stay a $20 million fund. They’re saying: “Next year I’m going to be a $100 million fund, therefore I need to be in Cayman,” but that premium may be at a tipping point now, where that value of thinking: “I’m going to get bigger in the future” versus the initial cost of setting up in your jurisdiction is now a point to be considered.
PS: Is cost the main driver of external competition?
JS: I think it’s trying to find a balance between being an over-regulated jurisdiction versus having the right amount of regulation. I think Cayman over the years has balanced that appropriately relative to some of our competitors.
GT: I still think that the vast majority of funds that are being invested into from an institutional perspective are Cayman funds versus other offshore jurisdictions.
So it’s what investors expect to see, and that plays a lot into the decision process for managers—they would like to have Cayman products. But there is that inflection point at which they say “the cost is prohibitive”, and we can talk around the BVI structure and the BVI legislation and whether we’ve decided to take that option. But to go to Cayman perhaps would prevent us from going into business in the first place due to costs.
The danger there of course is that today’s $20 million manager is tomorrow’s institutional manager, and we really need to capture those managers because we need to perpetuate industry through the interaction with the manager, not just today but tomorrow.
PS: How do we do that?
TB: Perhaps this is just reflective of the managers that we act for, but we don’t actually see a lot of arbitrage of BVI against Cayman on a cost basis at all. What we see is a developing uncertainty about Cayman itself, particularly in institutional investors.
From time to time, and more often recently, our bigger managers ask us what are the other options? Should they be looking at Bermuda and the Bahamas? What they are looking for is consistency and certainty from the jurisdiction, and not rushed or disruptive regulation of legislation. It is that certainty and stability with which they sell the jurisdiction to their investors.
We see a real concern among our bigger institutional investors at the moment that Cayman’s perceived stability and desirability as a home for institutional money is under threat more because of things Cayman has done, and not because of things in the outside world. All things being equal, we’re still the right choice, but we don’t want to be doing things that cause managers to think again on that.
Perhaps there is a level of manager that does play the arbitrage, but not like we used to see back in 2006 or 2007. I think the biggest threat that we see is what Cayman may be doing to harm its reputation as a solid, stable place to have a hedge fund.
PS: What are the specifics of the problematic things that it is doing?
TB: When you talk about the institutional managers, for example, they want quality service providers in their own time zone. For those managers, it’s not a question of whether they choose to have to work outside their working hours to get things done by service providers based in Cayman; they will just look for a jurisdiction to get things done in their time zone, and that’s a concern. We don’t want to be doing things that make it harder for them to go about their business.
I think, without being political here, that anything we’ve done in the last 12 months or so to make us look less stable is a negative. What I can see from our perspective is we have had a lot more enquiries recently from our big institutional clients as to what is going on, what is the outcome, what are the other jurisdictions they should look at?
ID: I agree with Tim on that pretty much 100 percent. I think the stability is what our clients are after.
It’s not even the big institutional ones, we see a lot of $20+ million managers who have issues with costs and they’re certainly concerned about that, but their biggest question is “why do I keep seeing you in the press and why is it negative?” It’s not a good thing for us, it just isn’t. And whether we’re the ones making the noise because we’re upset about unexpected and often unnecessary change without proper consultation, or whether it’s coming from external sources, the noise around Cayman is not good, you don’t hear that about the other jurisdictions.
I think we still have that top position but we just have to be careful not to let the gap close between us and the people behind us. The lack of stability sometimes does that.
I’m not dismissing cost as an issue—for a lot of the smaller managers that is still a massive issue for them. We’ve had guys walk away from the project as a whole, not even tried to go to another jurisdiction because Cayman is where they wanted to have the fund but they say “you know what, we just can’t do it ...”.
GR: We can’t be complacent; we need to continue to be innovative. From a cost perspective, if someone’s launching with $20 million, and they’re expecting subscriptions to flow in quickly and be at $100 million shortly, I think they’re less concerned about costs.
Their greater concern is explaining to investors why they did not go to Cayman. We are considered the best and at the top of our class, so I think the explanatory aspect of them having to explain that they decided to go to another jurisdiction due to a few thousand dollars is of greater concern if they were anticipating becoming the next $1 billion manager.
For smaller managers who come out of the gates and do not expect to get to size quickly, the increased costs are certainly more of a concern. Therefore, as a jurisdiction, it’s critical that we are innovative and that we’re not complacent. Stability is critical as well—economically, politically, etc—we’ve had a number of mishaps, for lack of a better word, in the last few years.
TB: We simply don’t need to score any own goals.
PS: Is there anything that the industry can do to mitigate what isn’t obviously an industry problem, or do you just have to hope for the best?
TB: Well I’d be interested to know the last time the industry, the regulators or anybody from Cayman put something positive out in terms of creating that stability. You look at the Bahamas for example, or Bermuda to some degree, there’s a lot of effort and endeavour by their regulators at the moment to advertise that they are stable, well-serviced jurisdictions that are open for business—I just wonder when the last time was that Cayman put that message out.
GT: Cayman Finance does a good job.
TB: I agree they do a good job, but lately everything seems reactive to every article that comes out of the US. We’re reacting to every article that comes out, many of which are poorly informed and simply incorrect. Recently, there have been some dreadfully scathing articles written about Cayman, which are factually incorrect. What we seem to be doing is responding to criticism rather than trying to create some kind of perception that all is well in Cayman, that the regulation is stable, the system is stable and we’re not going to do anything to change that. In my mind that’s the greatest threat to the industry.
Monette Windsor: Communication and education are important factors not just with the investment managers but also with large institutional shareholders. I spend a tremendous amount of time on the road meeting with these institutional investors who are conducting due diligence. Just being there in order to answer questions they have about the jurisdiction and the services that we provide gives people comfort.
PS: We hear a lot in the UK about various developments, particularly the Alternative Investment Fund Managers Directive (AIFMD). How much do these regulations actually have an impact on Cayman specifically, as opposed to on the industry generally?
MW: A few clients have approached me about this, even though the regulations aren’t final. They’re now considering launching a Luxembourg product or an Irish-regulated product, where in the past they’ve always launched Cayman funds. To meet the demand of their European investors they’re now looking at other jurisdictions. We have offices in Ireland and Luxembourg, so we can provide our clients with a global offering with the same systems and service. I think that we won’t necessarily see a decrease in the number of funds that are in Cayman, but we might have managers who will be opening up European-domiciled funds as well.
Ian Dillon: We would agree with that. AIFMD is a funny one because if the own-country rules remain, it’s not necessarily going to automatically negatively impact Cayman funds by what it does. What it’s more likely to do is provide opportunities for managers to use within Europe. It’s quite a useful tool if you are a European manager or you want to market to Europe, if you don’t have an Irish fund or a Luxembourg fund and the right European structures then you can’t use the tool, so it’s not that it’s going to prevent managers without those structures from getting access to European markets, but we just have the same local marketing rules as currently apply and they can’t avail themselves of the advantages.
Some other managers we’ve been talking to have been saying “I don’t want to get rid of the Cayman fund, I want to keep it but I’m not going to sell it to the Europeans—I’ve got a different product for that.”
It could get worse than that of course, because if they do manage to get their act together and come up with rules against outside funds, or make it difficult for Cayman funds, then it may get worse. But at the moment I think, that’s as bad as it’s going to be—which isn’t great but it’s still okay.
PS: Is there a feeling that this is something that has been designed to target, or to compete against, Cayman and those sort of jurisdictions?
ID: That’s the job of European regulators: to protect citizens from the outside world to some degree. I think you can’t fault that that’s what it’s aimed at doing, at protecting these things. I think the idea is that European investors will say: “Let’s just go with stuff that’s regulated in Europe and leave the offshore stuff out.” How practical that would be in the end I don’t know, but I think that’s probably the overall aim.
PS: And what about on the US side, with Dodd-Frank and FATCA?
MW: FATCA (the Foreign Account Tax Compliance Act) is currently one of the biggest issues our clients are looking at this year. It’s on the top of their lists, not because they are concerned that they have investors who are US tax evaders, but because FATCA will impose a large operational cost on their back office. FATCA compliance is one area in particular that they’re looking to us as a third party administrator to do the heavy lifting for them; to help them with the gathering of information, assessing the information and doing the reporting. It’s something that we will be spending a lot of time working on with clients this year and for years to come.
TB: I would say that from a Cayman perspective, we reacted very quickly to that two years ago at least. From a legal perspective it’s very easy, the documents are straightforward.
JS: As a jurisdiction though, what are we going to do? Are we going to enter into an intergovernmental agreement 1 (IGA1), 2, or do nothing, is the big question right now.
GR: I think the consensus is for a Model 1 IGA.
TB: I would say that this is a far bigger problem for the BVI fund industry. I think, given how institutionalised Cayman is, this is not of great concern to Cayman.
JS: BVI came out early and stated they were going to enter into an IGA1.
TB: I would imagine the administrators are far happier looking after a Cayman fund, with the types of investors you typically see in Cayman funds than in BVI.
JS: But what is the cost if Cayman does go IGA1? That’s the question, as well who is going to bear that cost.
ID: We can’t afford the regulation we currently have. This becomes a very local question then, because it comes down to the hole in the Cayman budget, which doesn’t allow for any increasing regulatory staff of any kind of quality. The current regulator politely, but firmly is screaming “I’m having difficulty doing what you’re asking me to do now.”
GR: On the FATCA side, as administrators, how are you defining the cost? Are you charging specifically, packaging it up? It seems like an opportunity.
RE: We’re agreeing the specific model with specific clients. Some of the main concerns have to be the changes needed to both software and processes to meet new requirements to capture, document, analyse and ultimately report on investor information. Previously we could rely on a number of exemptions, but we will now need to execute documentation concerning any US ownership.
Making sure that one has all the required information in order to be able to make a determination as to whether the ultimate beneficiary has any US indicia that will trigger reporting is of paramount importance.
In some instances, our clients have appointed other professional service providers, for example audit firms, to take the lead on these initiatives. In those instances we are the service provider making sure that the systems and processes are in place in order to ensure that all relevant information is available.
PS: Is Dodd-Frank something that you’re thinking about?
GT: I put together quite a radical, long-term thought on this, with the form PF and the amount of detail and information. What I was wondering is if, since the various accounting standards brought out new disclosures for financial services, anyone’s done a study to see if it’s ever been worthwhile information from an investment analyst point of view.
Because I have never, in 15 years, ever have had anyone come and say “We’re setting up a fund, we’d like to go US GAAP rather than IFRS, because the investment analysts of our investors say they prefer the financial disclosures.” I’ve never heard that, ever. Which begs the question: what are we doing this for?
And now if you have a form PF there is an enormous amount of information which will be produced except for those under $150 million, which may come down. And investors are going to be pressuring to know that information, why do they need financial statements? Won’t it e that we end up as auditors doing agreed procedures on the likes of form PF?
GR: Based on feedback from managers as well as investors, the usefulness of the information is definitely in question. Whether or not it is driven from a regulatory or an investor’s viewpoint, various constituents are always going to ask for more information. They are going to continue to ask for as much information and transparency as they can get, but a lot of the time, the information is of no use to them. So what it leads to is additional prodding and more questions which is taking up more time and resources from the managers themselves.
JA: It sometimes comes down to the discussion as to how we deal with the cost.
Ultimately it’s a matter of where is the regulatory burden? I’m not going to get into the detailed arguments as to whether it should be paid out of the fund or whether it shouldn’t, but if there is a cost being borne by the fund, there’s certainly a stronger argument on the investor’s side that they should have access to it because they’re paying for the reporting—the utility of that information is a completely different issue. I personally don’t know precisely what the Securities and Exchange Commission (SEC) is going to do with the information, but one has to hope that at some point it will become a useful task rather than just a perfunctory regulatory issue.
The governance proposals
PS: What about some of the on-Island stuff? How do the governance proposals look to you?
GR: I’ve always been a huge proponent of Cayman as a jurisdiction in terms of governance. Cayman is a disclosure-based domicile and transparency is important—we need to, however, bear in mind what product it is we’re offering, namely private investment funds to sophisticated investors. If Cayman needs to be more transparent and investors need additional information to perform their due diligence, that’s fine, I don’t have a problem with that. It’s the proposed approach that comes into question.
There are a number of drawbacks to what has been proposed right now from a jurisdictional, industry, and individual company standpoint; from a competitive standpoint; a confidentiality standpoint; as well as from administrative and cost standpoints. I just don’t believe that it has been fully explored and thought-out. I think there is a way to get to the end goal, which is transparency, however, I don’t necessarily agree with the proposal in its current form.
ID: I always have issues with these sweeping proposals and suggestions that significant change is an absolute must. It’s been raised before in relation to fund registration rules as well, and although that’s now taken a bit of a back seat to this corporate governance paper that is more recent, it’s going to rear its head again. I often struggle to understand exactly why we are doing this.
We all hear CIMA’s answers to those questions when they’re challenged and I don’t ever feel that it’s a good enough reason. If we are a disclosure-based jurisdiction, that has been doing this well for a number of years, that hasn’t been the cause of the financial crisis, what is the problem we’re trying to fix? We’ve got issues, but no jurisdiction is perfect, there are always improvements that can be made, but this has been approached as if the jurisdiction is fundamentally flawed, and it isn’t. So why are we doing this? That’s the question we should be asking or trying to answer.
Why does CIMA feel the necessity to do it this way with such a massive sweeping approach that threatens such significant change? Why is the change necessary? And I think that if you can’t answer the question, or CIMA can’t answer the question particularly as to why the change is necessary for this jurisdiction to survive, then I don’t understand what we’re doing.
GR: Investors are the parties pushing for change. Although it’s a minority; they are influential and persistent parties and, as the saying goes, the squeaky wheel gets the oil. Transparency, in the right form and medium, is critically important, however, it’s unfortunate that things have been proposed in the manner and form they have been recently. I believe that sophisticated investors make valuable contributions, however, at the same time they are looking at things only from their perspective as well. There is a balance and limit to transparency and ultimately if they’re not getting the information they need they can vote with their feet. Unfortunately, for some investors, and the media in particular, numbers have become synonymous with capacity, which is completely and utterly ridiculous, to be blunt. If numbers are the sole determination of capacity, they are misinformed and need to be educated otherwise.
By the time they sit down with a professional director and understand the composition of the director’s portfolio they serve, and then go a little bit deeper it becomes apparent that numbers do not equal capacity—capacity equates to time. Once they figure out what a director does with their time then I think they’ve figured out the capacity query and are making an assessment as to whether they are comfortable.
There are a number of different models which service different tiers of the industry, and I’m comfortable with many of them, in fact all of them, depending on the circumstances. The market can decide. There are one-man band models all the way through corporate directorship models, where although there are often individuals serving on the boards rather than a corporate entity, it is effectively a corporate directorship model. Is either end of the spectrum a bad thing? Not necessarily, depending on the circumstances, and there are many like us who have models in between.
We disclose the number of relationships we serve, but not the names of the entities as we think there’s a competitive issue from a firm as well as jurisdictional perspective, and that with full transparency there is a risk that others are going to start poaching clients. Additionally, there will be a media frenzy of people going on about so-and-so who lives in the Cayman Islands and serves as a director on X number of boards, etc, without really understanding what a professional, non-executive independent director’s role is in relation to private funds.
Now it could be positive, in the sense that everybody’s numbers will be more comparative rather than the current forums that are out there through various non-profit groups, as the information they currently have is incomplete. Perhaps what is needed is for CIMA to be mandating that directors disclose the number of Cayman-domiciled funds they serve, which can be maintained and distributed from the director, rather than being on a centralised database for everybody to access.
But then the question becomes who do we have to disclose it to? For example, a current or prospective investor, who arguably needs such information to make an informed decision would make sense. Maybe that’s the approach to take, but some kind of broad-based, public database I believe will be bad for the entire industry, and Cayman as a jurisdiction.
TB: Who does it better than Cayman? There’s no jurisdiction that comes remotely close to providing independent director services of the quality Cayman does. I just wonder why all of a sudden we feel the need to shoot ourselves in the foot, because one thing we’re going to get criticised on is the number of relationships that individuals have and the number of directorships individual directors have, and we’re looking at publicising that. What we should be saying is we think we’ve actually got the best quality by a long shot of independent director services.
GR: I want to be doing my job, I don’t want to be fielding media questions for a whole bunch of hype. Capacity equals time and at the end of the day, these things are taking up more and more time. The reality is, as fiduciaries, we need to be focusing on what we’re supposed to be doing. I think a lot of this is people looking for a niche to promote their services. There are good people on all ends of the spectrum from the one-man bands to those who have highly levered models, with a lot of support staff. Everyone has a different outlook on the role of fulfilling their fiduciary duties and everyone is also looking for the perfect marketing pitch. In my opinion, respectfully, caps are the perfect example of a marketing pitch. How can you compare one relationship to another relationship? It’s virtually impossible. To me there’s only one reason for caps—they are a marketing pitch.
JA: We as a firm do not necessarily agree with there being a prescribed regulatory limit to the number of directorships, or of relationships, that should be a function of the model. It should be a function of how you work and how you approach the discharge of your fiduciary duties, and our cap of 30 was determined through practical experience in terms of investors’ needs and wants, in terms of the composition of our portfolios and the types of relationships we’re taking on board.
There may be a marketing component but ultimately many investors are looking seriously at the number of relationships you have and it makes sense to assure them, as a confidence issue to go to investors and tell them this is the level we’ll go to, we will not break this. In fact if you look across the 20 individuals we have acting as directors across our six offices internationally, nobody has 30 relationships because we each constantly review our capacity with reference to the time it actually takes to proactively service each one. So it’s an Investor confidence issue for us, it’s the way we approach our business and one way we prove the proactivity and engagement of our model.
ID: We tend to forget here very quickly that if we make the number the issue, if we introduce a cap, how are we as a jurisdiction going to serve 8,500 funds, not to mention master funds? It’s just not possible. The number is not the issue, and we have to stop pretending that the number is the issue, or giving credence to people who say it’s the only issue.
RE: Perhaps it would be best to focus on the number of hours spent rather than the number of funds, because not every fund requires the same level of time commitment.
TB: I don’t know about that either because they’re just going to divide one by the other and ask, “How could you have spent 3 minutes and 47 seconds on this fund the whole year?” That I think isn’t going to work either. The only sensible way to approach this is to look at the directors themselves, police that part of the industry. Ensure the quality, ensure that they have to make proper reports, ensure that they are monitored in professional ways. We need to work closely with the managers and the investor representative groups in the US to be able to give them the information they need on directors to give institutional investors the comfort they need to continue to choose the jurisdiction.
GR: I’ve seen the numbers game and caps work against the principles of good corporate governance. Someone reached that magic number, whatever their cap was. The next higher-paying client came along, and they abandoned the other client. How is that good governance?
PS: In the broader sense, there seems to be a lot of criticism about the proposals from CIMA. Where do they come from, if not from you? How do these proposals get put out in a way that isn’t right?
ID: The explanation from CIMA as to where the fund registration rules come from was a response to the various reports and investigations that were done here by OECD groups—concerns about lack of registration funds, certain types of funds, and also concerns about the inability of CIMA to refuse registration. That appears to be the biggest concern.
The example I heard at the time when they made proposals for pre-approval registration was, and this was primarily because it was topical at the time the proposals came out was: “What if Bernie Madoff comes along and wants to set up a fund? We would have to allow him in. We would immediately kick him out, but we’d have to let him in first and that’s a ridiculous situation that we can’t have.” That just wasn’t the way and still isn’t the way as I understand it that the industry feels. It’s part of our ability to market Cayman, it’s the speed to market.
If you changed the registration rules to make it a more pre-registration, pre-approval-type jurisdiction, you’re pulling out this disclosure-based idea, you’re slowing down the speed for managers to get funds to market, and you’re turning it into a different product. I’m not saying there’s anything wrong with that product, but that’s not the product we’re selling.
There have been some proposals to create a different fund to deal with those particular issues, to create a new category of fund, and that one can meet all the requirements that you’re concerned about. But we still keep this current regime in place.
The master fund registration was a precursor to all of this, it was supposedly a reaction to the criticism that there are thousands of unregistered funds here. Master funds however were not what those concerned were referring to. The wrong response to the wrong question, or at least the wrong answer. This all fits in on top of that.
PS: So is this almost a land grab? Is CIMA just trying to be more involved in the original process?
ID: The industry are not the only people who are reactive. CIMA seem to be reactive as well—they get these criticisms and they react to them. They’re afraid of being overly criticised by these other regulator groups, or onshore regulators saying you’re not doing things the way we would like you to do them, and I think that there’s a fear and an inability to push back. But on the contrary, they have to push back because as a jurisdiction, that is what we offer—we’re very clear about what we offer, any sophisticated investor can see what’s on offer here. We’re not making any suggestion that these things are heavily regulated, you go in with your eyes open, but they’re only available to sophisticated investors.
PS: Let’s talk about fees. I would be interested to hear about fees in general and what the situation is. How are managers responding?
JA: I think it’s always been the case that managers have done different fee deals for different investors and the key really comes down to openness. Say one of the other investors has a different rate from you, and that this is going to benefit you because the funds are larger and have a greater ability to absorb the cost burden because of it. Fee breaks to key strategic investors can be a positive for investors as a whole.
PS: On the service provider side is this something you’re seeing more of, post 2007–08, or is it fairly standard in the industry?
JA: We haven’t seen a particular push. I know that with the larger funds the institutional investors are putting the pressure on it, but for the smaller ones, I haven’t seen a lot different from what’s happened historically.
TB: Single investor funds with big institutional money will need to negotiate much better rates.
MW: Managers, as well as their service providers, are feeling significant pressure. We talked earlier about FATCA and form PF and all the disclosures that we’re having to do. So that’s something—even if they’re not putting pressure to decrease fees, they’re asking for more. We have to deliver more, whether it’s integrating with their systems or providing daily feeds, so they’re able to gain efficiency on their back office side. They’re definitely asking for service providers to work harder for the fees.
PS: So does that make it into a leaner, fitter industry, or not?
MW: I believe so. From an administration point of view, innovation with systems and technology is really key in terms of growing our business. Being able to offer value-added services to the managers helps their operations run leaner.
ID: I think there is a less healthy side to it as well and there’s a bit of a lesson out there. There is the side that instead of getting more for the fee, managers are just demanding lower fees, and that’s tough for professional service providers such as law firms, etc, because there’s pressure on everyone to charge very low fees. We’ve seen a few of those and they just don’t work, because they never get the quality product. In some ways that’s good because it’s pushing that end of the market out.
GR: They’re a little bit more creative in terms of how they’re structuring. The typical ‘2 and 20’ structure seems to be gone. 2 and 20 are still there as the benchmark, but there are hurdles now, or fee-breaks in different classes in exchange for liquidity, etc. I don’t think there’s ever really been a standard.
JA: There are institutional investors in the market that simply won’t pay, they just don’t consider it to be appropriate. From the conversations we have with Investors it would appear that in the institutional market there’s a recognition that perhaps the 20 isn’t too egregious, but it’s the management fee that gets more pressure because ultimately if you’re performing and particularly if you’re over-performing, then investors are less concerned about the incentive fee. However, where managers are aggregating masses and masses of assets and not delivering great performance investors object to management fee accumulation being an incentive to grow. So I think that there’s a lot more constructive thought around how fees should be structured, whether it’s with hurdles, stepped fees or whether it’s with cuts on management fees.
RE: What we are seeing is that no matter at what level the investment manager sets their fees, they will still have pressure from some of the larger investors to provide them fees lower than those for other investors. So, whether it is 2/20, 1.5/15 or 1/10 you will still have the investment manager feeling some pressure from key investors looking to get preferred nation status and a better deal on the fees.
TB: We’re certainly seeing on any debt-based hedge fund, that the fee structure is being pushed right down, particularly the management fee. These pressures are passed on to us and our fees too. I would have walked away from more fee quotes in the last six months than I probably have at any time before that. There’s a bottom line below which you just can’t do the job properly and so as a practitioner you must walk away.
PS: So where do those people go—if you’re all walking away who’s doing the work?
ID: I still have fee levels that back in 2006 or 2007 I wouldn’t have dreamed of quoting. And you’re quoting them to try and get pieces of business from particular sources and they say, “well thanks very much but we’ll go with someone else who quoted a better fee”. As Tim says, you may be losing money on it but you’re doing it because you want to get that piece of business through the door, and you think it has a future.
TB: From our perspective, the margins and the fund part of the business can’t get any leaner, it really is incredibly competitive out there. On other parts of our business our margins are better. It really is at the bottom now I think.
ID: But do you think that some of that is because of the Cayman fees, the government fees, the cost? We have a concern that if you package up the cost of setting up a fund—here’s all of the registration fees, and here’s how much it’s going to cost you for the next couple of years etc,—that number, even with our professional fees being much lower, is bigger than it was a few years ago. And I think that’s still an issue.
PS: Presumably the other fees are much less flexible than your fees?
ID: It depends on what you’re trying to do. If you’re trying to do a single fund, it doesn’t look that bad. If you’re trying do a master feeder structure the fees stack up. They go away and talk to their service providers to find out what other fees they have to add on as well, and all of a sudden it’s difficult.
JA: I think that it’s across the board. At a macro level you have management fees being squeezed, you’re looking at a greater regulatory burden, which means more fees to pay, so you have to get registered with the SEC earlier than you used to so you havecompliance costs, you may have to have a chief compliance officer, these are significant costs. Investors demand a greater structure to the management entity, they want analytics around portfolios.
So I don’t think that it’s a Cayman issue, I think it’s across the board, and I think that every service provider is getting squeezed, even from a directorship perspective, as minimal as our fees may be in the life cycle of a decent-sized fund.
TB: And only some of the fees can move—obviously the fixed government fees can’t and therefore the only fees that can move are those of the professional service providers.
ID: There’s also a cultural difference between how different regions/jurisdictions will view these fees, some guys come back a couple of years later, see that the fees have gone up, overall, by only $1,000 or $2,000 and that’s still a massive issue for them. Clients from the US and Europe in particular tend to be much less fee-sensitive than say, Asia-Pacific clients, and always have been. I think this is where this competitive issue with other jurisdictions will come in. Cayman is still the premier jurisdiction for offshore hedge funds but if other jurisdictions could get their act together, we’re going to be in for bigger problems.
GT: There is an election coming up.
ID: There is, but no matter what happens at that election, if anyone’s suggesting that the fees that have all been increased or introduced in recent years are going to go down, then they are at best overly optimistic, and at worst deluded. The best we can hope for is that they won’t increase any more, and if we get that stability, that we’re not going to touch fees now for a while, then that may just be okay.
Every year, some large fee has either been introduced or gone up much more than it was before. Each year they’ve picked something to attack and increased revenue from it.
PS: What does best practice look like for accountants? What particular things are cropping up more, and how are you dealing with those at the moment?
GT: The challenge for everyone is talent retention, that’s probably across the board. From our point of view, there’s fee pressure coming down from the investment managers, use of cheaper jurisdictions and back office people. We have to try to reduce some of the cost burden. Increased deadline pressure—it used to be that you had your audit portfolio from January, with a deadline in June, but over the last few years a lot more investment managers are squeezing that June deadline back further and further. Plus there’s always the litigation spectre hanging over many of the audit firms as well.
JS: In addition to what Glen has said, another major challenge is keeping up with the changing regulatory environment.
GT: We have our own internal reviews in office, we have the BDO global review that comes around every three years and does an inspection, and we have a regional audit advisor that comes every two years and does a mini inspection. We are also registered with the ACCA, they come round every three years to give an inspection, we have the PCAOB due to do an inspection, we’re now signed on with the Irish regulator, the Japanese regulator and Cayman now it has its own auditor inspection regime.
You get to a point where you’re wondering where’s the time to do the work, compared to having to do the regulations.
JS: As a result of guidance which continues to be issued by regulators, the difference in performing an audit years ago compared to today, is quite significant.
We are focused on bringing more value to our clients, whether it’s keeping them up to date on regulations and their business needs, or supporting their global expansion.
JA: I guess just from the users’ side of the table, we certainly see much more of the auditors than perhaps we did previously. It’s certainly never the case that directors will receive a set of financials and simply be asked to “sign off” on them. We have conversations with the auditors at the very least at the end of the process and preferably at the planning stage also and we want to have transparency in the audit process and to receive the right information and have it delivered to us directly by the auditors to have that direct connection.
JS: That’s a perfect example of the change in our auditing standards and making sure we communicate with the board.
GR: I think the general level of communication has increased across the board which includes the end investor now. From my perspective, there’s more communication with investors, there’s more communication with service providers such as the auditors, administrators, prime brokers—effectively everybody. I think it’s great that the communication flow is increasing, but the problem with that is it all takes time.
GT: There’s far too much information and you have to have the right people to deal with it.
RE: The problem is the employment certificate limits. The stopgap for people is to stay in Cayman for a longer period of time. Now we have this cycle every seven years, but by the same token, because of the job situation worldwide, people do tend to stick on for seven years and then leave. So we have some benefit but on the other end there is an end cut which is the seven-year mark.
PS: Are there internal pressures that the industry should be addressing?
JA: I think that our industry is in an evolutionary stage; as a firm we’re also evolving constantly, evolving our process, we’re learning from all the parties around the fund that we deal with; what their concerns are, what the emerging trends are and trying to feed that into the governance process and ensuring we receive information to allow us to monitor these issues. We’re evolving towards a more robust reporting process that clearly evidences our directors are discharging their fiduciary duties on a regular basis. Whether that is through the formal process of quarterly board meetings or more regularly through less conversations, emails and physical visits with service providers and managers. I think the proactive, engaged model is becoming more commonplace than perhaps was the case historically.
GR: There are certainly themes out there stemming from the crisis as well as Weavering. For example, capacity which we discussed previously, is topical more now than ever. Different forms of governance are also very topical. The trend is to be moving towards quarterly meetings which is considered to be best practice. That being said, I really think it depends on the fund, the strategy, and ultimately on the underlying investors at the end of the day, etc—there are so many factors to take into consideration when you say ‘best practice’ because ‘best practice’ is not summed up in one sentence, let’s put it that way. So whether quarterly meetings or face-to-face meetings make sense, I don’t know or believe that there is a one-size-fits-all answer. Arguably you could say it’s not the case in many instances as it could simply be a burden in terms of time and cost.
The point being is that I believe good governance is about substance over form—as long as there’s good substance the form is less relevant. I think once you illustrate to investors that there’s been a thoughtful, measured, and substantive approach in terms of fulfilling your fiduciary duties that they’re happy.
JA: I think it’s an important point that there isn’t an appropriate structure we can lay across every product; there are many different products and the industry is so innovative that we will need to continue to evolve our processes to adapt to that innovation.
TB: I agree to some extent. I accept that substance over form is very important. I also think there is in fact a legitimacy issue. If this has to get looked at in hindsight, particularly if it’s getting looked at by a court in hindsight, directors need to ask “how am I going to look here?”.
Some practices in the past, whether they did work or didn’t work, would be irrelevant in terms of that examination and there are certain things we are no longer seeing—for example, involvement early on in the piece is seen as crucial now—it’s fair to say that sometimes in the past the directors were just sent the final copy of the package and you don’t see that any more because that looks bad in hindsight. I think that the practice of approving in retrospect looks bad in the courtroom, and I think that people are looking to avoid that kind of thing.
Not because it necessarily added value, but certainly because if you’re going to get examined in hindsight in the courtroom, it’s just not going to be easily justified, and more importantly it is really open to criticism.
JS: There’s no question that there are certain expectations that don’t necessarily equate to governance specifically.
GR: But you have to manage expectations and that’s part of managing clients. If perception is that it’s good governance to have four meetings, then wait a second—let’s take Weavering for example—didn’t they have quarterly board meetings? Was that good governance? It’s a perfect example of the form not necessarily being indicative of the substance.
TB: I agree but I think that in the hands of the skilled litigator in a courtroom, if you didn’t have board meetings, if you were approving things after the event, if you didn’t look at documents you’re going to get severely criticised.
PS: Thinking about opportunities for funds and trends, and looking forward, what does the future look like for Cayman funds?
GR: I will stick to the governance themes. What we’re seeing is people are getting a little bit more interested about what’s going on—investors seem to care more now. We’re seeing a mirroring trend between on and offshore funds, whether it’s an advisory committee or a control board, some of the powers that rest with the directors on the offshore vehicles are being put into place on the onshore side of things as well. So we’re seeing a trend towards increased oversight on the onshore as well as consistency between the on and offshore vehicles. The bar is being raised. It’s a good thing.
RE: From the perspective of the type of structures, we are seeing a marked interest in those that include arrangements similar to managed accounts, because they allow investors control as to where their funds are specifically being invested. It also gives the investor flexibility to deploy smaller amounts of capital and still enjoy greater diversification which they would not have been able to do on their own.
MW: I’m optimistic about future of Cayman. One of the things we talked about earlier was recruitment. As we’ve been growing, I’ve been doing a lot of recruitment for our office and have really strong resumes coming in. But more importantly we are retaining our quality staff and I think that makes a big impact in terms of our client service and bodes well for Cayman’s future.
PS: In five years’ time a lot might depend on the law of unintended consequences—how much of an impact are some of the things we’ve talked about actually going to have?
TB: I think personally that a lot of where we will be in five years will be determined by what we do now in Cayman and not what happens externally. Cayman itself can do the most in favour but also do the most damage to the industry. We’re at a point now where there is a massive amount of talk and legislation, and potential legislation coming in. I think those will either enhance or damage us, much more than anything in the outside world.