It is impossible to understand the current success of the Cayman Islands as an offshore financial centre without an examination of the hedge fund industry. Cayman Funds hears from Ernst & Young.
While the Cayman Islands is a full-service financial venue with well developed sectors that include banking, insurance, company registration—and a shipping register that includes more super yachts than anywhere else—it is the fund industry that has now taken centre stage.
Approximately eight out of 10 new offshore hedge funds are domiciled in Grand Cayman, the Island’s financial capital, and nearly all the wide-reaching financial infrastructure of the Island, which includes sophisticated international law firms, the Top Four and numerous mid-tier accounting firms, and dozens of small practitioners, to one extent or another services the hedge fund industry.
A leading participant in this space is the accounting firm of Ernst & Young, which for more than 25 years has been the preferred international service provider for hedge funds.
The Ernst & Young hedge fund practice globally is led by highly skilled professionals including more than 200 partners, principals, and executive directors and 2,000 industry-focused professionals.
Teams are located throughout the world to service clients where they need service, providing first-hand insight into local market trends and accounting tax and regulatory issues.
As part of Ernst & Young’s commitment to the hedge fund sector, the firm conducts a series of symposia in 20 locales across the globe, including the Cayman Islands. The theme of the Cayman-hosted 2011 event was New Responsibilities. New Expectations, where panels addressed the emergence of Brazil as a growing economic power, Ernst & Young’s 2011 Global Hedge Fund Survey, ‘hot topics’ in the industry, and a keynote discussion on Global Hedge Fund Trends.
Flavio Peppe, financial services partner, Ernst & Young Terco, Brazil, led the panel discussion on opportunities for Cayman service providers in the burgeoning economy of Brazil.
Complying with FATCA
While the symposium put the spotlight on Cayman’s growing opportunities in the hedge fund industry, a number of issues that will have an impact on the asset management industry were also discussed, including the Foreign Account Tax Compliance Act (FATCA).
Signed into legislation in 2010 to prevent offshore tax abuses by US citizens, this act will have a significant impact from 2013. Among the requirements is that foreign financial institutions must report directly to the US Internal Revenue Service (IRS) certain information about financial accounts of more than $50,000 held by US citizens. Those who fail to do so face paying a 30 percent withholding tax on payments made from American and foreign participating financial institutions to other foreign financial institutions (FFIs), beginning in 2014. Non-US banks, trusts, and investment funds are all considered FFIs.
Though final regulations are still pending, there is no indication that FATCA is going away. Thus, those institutions that begin to tackle the process of compliance early will later be the institutions best-positioned to be leaders in the marketplace. Investment managers and administrators would be well advised to start, and several have already begun to put policies, controls, and systems in place, effectively to address the requirements that FATCA will impose.
Navigating the act’s rules and regulations is a challenging task for many foreign institutions seeking to be compliant. The costs associated with understanding FATCA, data analysis, and systems changes are the primary hurdles for entities to overcome.
Professionals at Ernst & Young are already well-versed in the intricacies of FATCA, and can provide assistance with achieving compliance. This is accomplished by guiding clients through a three-stage process:
• Assessment of their current situation, including an evaluation of the quality of data, systems, and processes;
• Implementation, including any changes which need to be made to update data and processes; and
• Compliance, which includes the actual collection and validation of the data and, ultimately, filing with the IRS.
Mike Mannisto from Ernst & Young in the Cayman Islands, says, “There are lots of competing regulatory changes happening at the moment and prioritising all of these changes is a challenge. We are now seeing FATCA being placed as a top business priority as clients understand that non-compliance is not an option. Much work still needs to take place in a very short time to get ready for FATCA, and that will require training, client communications, updating legal documents, changing policies, procedures and related controls, as well as changes to systems.”
Preparing for Form PF
Advisers should also be aware of impending changes in reporting regulations that will affect three types of funds: hedge funds, liquidity funds, and private equity funds.
The US Securities and Exchange Commission (SEC) has begun the process of standardising risk reporting, and advisers will now report on a similar basis across the private fund universe. This will change the way private fund advisers conduct business. Investment advisers registered with SEC who manage private funds will be required to report risk exposure on a consistent basis, starting June 15, 2012, on what’s known as Form PF. Many private funds are within the scope of Form PF and subject to various levels of reporting dependant on the type and size of the funds; private funds with less than $150 million in assets under management and venture capital funds, however, are not required to report on Form PF.
Form PF will require considerable time and effort as it is a process, not a report, and demands the obtaining of extensive information. Firms are well advised to begin the process quickly in order to file on a timely basis.
“Form PF is not something which most advisers can complete over the weekend before its due date. It will require much time, effort, and advance planning in order to complete accurately,” says Jeffrey Short from Ernst & Young in the Cayman Islands.
Navigating Form PF can be daunting, as it requires investment advisers to collect and report data that they may never have collected before. For example, many firms don’t stress-test portfolios uniformly across the various funds they manage. Funds may only stress-test certain portfolios for major exposures. There are many types of data that may be calculated but are not widely disseminated to investors or calculated on a consistent basis from one fund to another. Advisers who file Form PF will have to devote considerable time and effort to ensure the relevant data for these questions are indentified, verified, aggregated, and stored.
As the SEC works out the kinks in Form PF, investors are likely to begin to ask for access to the data in order to make meaningful comparisons between possible investment alternatives. Though it means more resources and effort, the effort may provide valuable results in investor relations.
To make this turning point easier for private fund advisers, it’s a good idea to seek out expertise. It’s advisable to work with professionals who have the experience of making detailed, frequent filings to regulatory bodies and ratings agencies. This can help determine how to access the required information quickly and give a sense of how to design processes to deliver the information more easily in the future.
Conducting a trial exam
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), sections of which are implemented by the new Form PF rule, also amended the Advisers Act to require investment advisers of hedge funds and private equity funds of more than $150 million to register with the SEC. With the required registration, private fund advisers are subject to the SEC’s regulatory oversight, rules and, possibly most worrisome, examinations. These exams can be challenging, and time consuming.
Careful planning for compliance scrutiny is vital to ensure readiness for this possibility. Long before hearing from the SEC, firms should create an examination strategy for achieving full regulatory compliance, for engaging the right response team to participate, and for making sure all books and records are up to date.
With a comprehensive plan in place, firms will be in a position to react in a timely and responsive manner to examiner requests for information, as well as to their criticisms. This can make the overall process less painful—and, perhaps, less frequent.
The best way for a firm to know that its exam strategy is effective is by doing a trial run. A mock examination will validate the readiness of a firm’s programmes and personnel to regulatory scrutiny, reveal any problems with the plan and help them to be addressed quickly.
Given the scope and depth of the examination, it is often smart to hire an experienced service provider to conduct the mock exam to test and evaluate all facets of a firm’s compliance programme. Ernst & Young routinely gets involved with examinations of a client’s operating procedures and understands the key areas of focus during an SEC examination. As a result, being the market leader in serving the hedge fund industry, Ernst & Young is in a unique position to add value to firms getting ready for an examination.
About Ernst & Young
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