Considerations for Alternative Investment Funds During COVID-19: The Cayman Islands — Sea, Sand, Sun, and Fun(ds)
By Isatou Smith, Managing Director, EisnerAmper Governance Services Ltd.
Renowned for the relentless tropical climate and alluring beaches, the Cayman Islands entices people year-round to experience its beauty. Year after year, the white sandy beaches never disappoint or change but the same cannot be said for the regulatory landscape of the private funds industry. Even before the pressure the funds industry has felt from the global COVID-19 pandemic, primarily in response to pressure from various external regulatory bodies, the funds industry in Cayman has seen its most recent years filled with changes occurring in significant fashion.
The Cayman Islands has long been regarded as the domicile of choice for certain alternative fund structures. The most recent publications from the Cayman Islands Monetary Authority (CIMA) indicate that Delaware, New York, and California continue to remain the most popular worldwide domiciles of investment managers of Cayman-regulated funds. Delaware has surpassed New York for the top spot in recent years, which may be primarily attributed to Delaware legislation introduced in 2017 for blockchain technology. In 2013, the jurisdiction recorded its highest number of funds at almost 12,000 regulated funds. While the following years marked decreases in registrations, during the last three years numbers were steady at around 11,000 regulated funds. It might be convenient to draw a correlation between the decrease in fund registrations during some periods to that of increased regulatory scrutiny. However, it should also be noted that during these same periods, there was also significant market turmoil and movement away from the current types of funds that CIMA regulated. 2020 will see another unprecedented year of change as the industry will catch a glimpse of the previously unknown: the number of unregulated fund vehicles.
However, in February 2020, the Cayman Islands implemented its most recent change: the Private Funds Law 2020, which brought into scope closely held funds (funds with less than fifteen investors) and closed-ended funds (traditionally private equity funds). These funds, that were previously below CIMA’s direct radar, have now come into the full scope of the regulatory framework. While it is suspected that for most of these structures the changes may be administrative at best, only requiring managers to now add CIMA filings to their list of things to do; for others the tasks are a bit more momentous. The appointment of an auditor, including a local audit sign off from an approved Cayman auditor, a minimum of two directors that have been approved by CIMA and specific valuation procedures are amongst the requirements that existing private funds have to put in place by August 7, 2020.
Despite adopting several legislative changes, the implementation of the aforementioned came a few days too late, which resulted in the Cayman Islands being added to the European Union’s (EU’s) non-cooperative tax jurisdiction list in February 2020. The immediate effects to the industry of being placed on the list have yet to be seen, as the EU does not impose any sanctions on countries being placed on the non-cooperative tax jurisdiction list and, further, EU investors can continue to invest and remain invested in Cayman Islands funds. It is expected that the Cayman Islands will be removed at the next update of the list in October 2020.Other proposed changes in the pipeline include continued enhancements to existing legislation and the creation of a new framework to regulate the business of issuing and providing services with regards to virtual assets. The latter would be done by way of a series of changes to existing legislation and through the introduction of a new virtual asset (service providers) law, which would aim to govern the service providers as opposed to persons who engage in business with virtual assets.
Critics assert that the plethora of enhanced regulation will continue to deter funds from choosing Cayman as a domicile due to the increased costs of implementing these changes into their operations. However, statistics aside, the opposing view is that investors are welcoming the additional reporting and oversight and will vote with where they choose to put their money. Across all the legislative changes for the industry, the underlying theme is good corporate governance which leads to enhanced investor protection and ultimately the reduction of risk posed to and by the jurisdiction from being misused or seen as being a threat to global financial stability, which is what the Island is accused of.
Amidst the global pandemic, which will no doubt bring changes to the global funds industry in the short-to-medium term, Cayman continues to show strength in its infrastructure. Despite the lock down measures implemented by the government aimed at the threat posed by COVID-19, the Cayman funds industry continues to thrive seemingly seamlessly with everyone, private and public sector alike, working remotely and servicing their stakeholders. A common sentiment being expressed in the Islands throughout the current crisis is that “things must change in order to stay the same.” The Cayman Islands continues to make changes to build out its regulatory infrastructure and it is expected that these changes will allow the retention of its presence as a premier fund jurisdiction.
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GAIM Ops Cayman 2016 Poll Results
The results can be viewed below or a PDF version of the report can be downloaded here: GAIM 2016 Survey Results
- Hedge Fund Investor: What’s New and What’s Changed
- Calling All Regulators: Active and Recently Retired Regulators Prepare You for What’s Next
- The Evolving Business Model for Hedge Funds: Looking at the Future Model of Sustaining, Growing and Innovating
- Institutional Investor Perspective: The Future Partnership with Managers
In March 2016, EisnerAmper had the opportunity to participate in the annual GAIM Ops Cayman conference, one of the hedge fund industry’s leading operations and compliance events.
This year’s gathering brought together close to 500 operations, due diligence and compliance experts from the alternative investment industry. C-level personnel and fund managers made up the largest percentage of the attendees.
Over the course of the conference, the audience was polled on a variety of topics. The following report details those results.
As you review the responses, we want to offer our own insight to provide a more complete and in-depth look at the findings:
The Evolving Business Model for Hedge Funds
Fifty-five percent of respondents indicated the commingled hedge fund is not an endangered species.
While the commingled fund may not become extinct any time soon, the 2×20 pricing structure is long gone for equity based strategies. The 1.5×20 fee structure has grown in popularity due to pressure from the institutional investment community resulting from underperformance in recent years.
We anticipate that you will find hurdle rates incorporated into the incentive fee structure, wherein a manager must outperform a stated rate of return (e.g., 10-year bond) before the incentive can be taken.
Institutional Investor Perspective
More than 75% of respondents would consider increasing or beginning pursuing opportunities through liquid alternative products.
Liquid alternative mutual funds took off like wildfire from 2012-2014 as the number of new funds grew and AUM ballooned. However, for investors looking to gain access to certain strategies, the daily liquidity requirements for a liquid alternative mutual fund often prohibit certain securities and asset classes being included in the fund. These strategies are only accessible in a traditional commingled hedge fund structure.
More than half of the respondents felt it was important to meet personnel beyond the senior management team during operational due diligence (“ODD”) visits.
Post-Madoff, the role of ODD has grown dramatically. Whether investors are assigning the responsibility internally or outsource it to an ODD firm, managers must make sure their firms are of institutional quality from the front-middle-back office, legal/compliance, and infrastructure perspectives to win allocations.
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HEDGE FUND INVESTORS
What’s New and What’s Changed
Will the hedge fund industry continue to grow in assets or will there be consolidation among managers?
What is the biggest challenge facing managers today?
Where are fees heading over the next couple of years?
CALLING ALL REGULATORS
Active and Recently Retired Regulators Prepare You for What’s Next
Insider Dealing: Post-Newman, do you believe congressional action to codify “insider trading” would be beneficial?
Cybersecurity and cyber-related crime: Which elements of a cybersecurity program do you find the most difficult to implement?
Other policy and regulatory developments: Which of the following developments do you identify as the potential biggest threat to the hedge fund industry (Related to politics and regulations)?
THE EVOLVING BUSINESS MODEL FOR HEDGE FUNDS
Looking at the Future Model of Sustaining, Growing and Innovating
Is the commingled hedge fund an endangered species (and the 2 and 20 fee structure along with it)?
Which investor group(s) represents the most advantageous path for your goals in raising capital?
INSTITUTIONAL INVESTOR PERSPECTIVE
The Future Partnership with Managers
Who do you expect to win the U.S. Presidential election?
Demands for portfolio and operational transparency have increased dramatically over the last few years. How has your organization reacted to those demands?
Who are the most important people to meet during an operational due diligence visit?
Have you had Basel III-related conversations with your prime brokers?
Is your CCO function outsourced to a third-party compliance consultant?
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