With the global hedge fund industry transitioning into a new era of heightened regulation and stricter fund governance, the Cayman Islands are extremely well placed to respond to the associated challenges.
The oversight of a pragmatic regulator – the Cayman Islands Monetary Authority – which operates with a relatively light tough, alongside a responsive legislative drafting committee and one of the most stringent anti-money laundering regimes in the world, means that the Cayman Islands will have little difficulty meeting any new global standards that have not been already achieved – or, in many cases, far exceeded.
The flexibility and innovation that the Cayman Islands’ funds sector has displayed in the years following the financial crisis have served this jurisdiction well in its ability to withstand the difficulties that have plagued global financial markets. It demonstrates a remarkably robust investment funds model now emerging largely unscathed from the worst conditions faced by the industry in generations.
Alongside the implementation of FATCA globally, the AIFMD in Europe and the Dodd-Frank/Volcker Rule legislation in the U.S., the review and consultation exercise on corporate governance by CIMA has attracted most attention in the Cayman Islands in recent months. A survey, undertaken by Ernst and Young, found that investors are demanding an ever increasing level of representation by truly independent directors on fund boards, with board selection being based on a combination of relevant experience and individual directors being able to demonstrate that they have sufficient time to dedicate to the proper performance of their roles.
Investor consensus welcomes the depth of knowledge and expertise in the collective body of independent directors who sit on the boards of Cayman investment funds; however, questions have persisted regarding individual director capacity. Rather than imposing a regime of stringent compulsory regulation, in its December 2013 ‘Statement of Guidance for Regulated Mutual Funds’, CIMA has set out a variety of enhanced provisions covering directors’ duties and stipulating funds-specific measurements to benchmark desirable corporate governance standards.
These measurements include, inter alia, regular monitoring and supervision of delegates, suggested bi-annual board meetings, active management of conflicts of interest, with an overall emphasis on frequent board level review and oversight of all aspects of the fund’s operations.
Going forward, CIMA intends to seek an amendment to the Mutual Funds Law to ensure that its full suite of supervisory powers can be unleashed in the event that a regulated fund is in non-compliance with the Statement of Guidance, thereby ensuring that the principles outlined in the Statement of Guidance will bite.
The likelihood remains that some form of additional regulation for fund directors will be introduced in the future although, for now, CIMA has confirmed that they are not intending to place a limit on the number of directorships held by any one individual. Instead they are mandating that specific information on directors is supplied with the registration of new mutual funds, with a view to introducing a public database of registered fund directors, trustees and general partners in due course. The database aims to provide stakeholders with information on the capacity, experience and knowledge of a director, thereby allowing investors to make an informed assessment as to whether a particular director is suitable for their fund.
Taken as a whole, the guidance from CIMA reinforces many of the themes surrounding transparency, information exchange and good corporate governance that emerged following the financial crisis. It also reflects the principles and issues coming out of the Weavering case, which largely inspired CIMA’s renewed focus on issues relating to fiduciary duties and corporate governance. Given that the guidance suggests the minimum desirable operating standards for a fund, there are few proposals that a well-managed fund, particularly post Weavering, would not be doing already; however, it is undoubtedly helpful to have formal guidance in this evolving area.
According to a survey conducted by Walkers of the funds established for our clients in 2013 it does appear that, for the most part, Cayman Islands hedge funds are already implementing standards beyond the levels that CIMA have specified as the basic requirement for good governance. The survey showed that approximately 76 percent of the CIMA-regulated funds set up by Walkers in 2013 had some form of independent director, with 26 percent having wholly independent boards and 50 percent utilizing a combination of independent and internal directors.
This position, whereby in excess of three quarters of new funds appoint one or more independent directors, is an increase from 72 percent in 2012 and 64 percent in 2011. In keeping with the greater focus on corporate governance, our survey also revealed an increased trend towards funds structured with all voting shares (35 percent), compared with the more traditional structure of voting management shares and non-voting participating shares (65 percent), although the later still accounted for the majority of funds.
Looking back on the past 12 months of activity in the Cayman Islands hedge fund sector, one of the common threads has been the strong demand from international investors to gain exposure to the U.S. economic recovery, while other investment markets have been less certain. We have seen strong inflows of capital globally, notably from Asia, the Middle East and Latin America, directed to U.S. securities, whilst Japan has seen a resurgence of interest in hedge funds after a very positive year for financial markets.
Another notable theme has been the activity in the acquisition of illiquid assets. We have seen several managers enter this arena by acquiring assets that have typically been languishing in a fund that is no longer actively investing. For locked-up investors, this activity provides a welcome boost to liquidity and being distressed assets, acquiring funds are often able to purchase these holdings at a discount.
Despite the recent upturn in the markets, concerns do persist amongst managers over the ever increasing cost of compliance following the waves of international regulation that have been introduced. Clearly the larger and more established managers have been better able to absorb these higher costs and we have continued to see the more sizeable managers launch ever bigger funds into the market. Whilst start-up managers have still been fairly active, typical launch periods have increased as investors spend longer on the due diligence phase.
Elsewhere, the entrepreneurial spirit in the hedge fund sector is alive and well. In addition to managers spinning out from bank trading desks, in response to the Volcker Rule, we have seen managers with a good track record leaving their current shops in order to start their own funds. Alternative investments remain a key asset class for institutional investors who are sitting on high levels of cash, so with a good flow of new managers gearing up for their debut offshore fund, 2014 is looking bright for Cayman Islands hedge funds.