Cayman's Fund governance: reigning the board of directors

Following similar steps by other jurisdictions  the Cayman Islands Monetary Authority ("CIMA") intend to update its corporate governance guidance  The regulator has posted a consultation paper on its website and has appointed Ernst&Young to perform an industry survey on the topic.

Beyond the reshuffle of its broad corporate governance principles, to align them with international standards, the CIMA is again questioning the right approach to directors supervision. The regulator is considering several improvements to govern the directors' population:

• Require all the individuals providing directorship services to Cayman's regulated entities to register with the CIMA
• Require individuals acting as directors on more than 6 regulated entities to seek approval from the regulator
• In order to improve transparency, the CIMA intend to develop a public database providing limited information on the directors of Cayman's regulated entities. 

Through the industry survey, the CIMA wants to evaluate the pertinence of other measures pertaining to the total number of directorship held by a director. The regulator is considering to require the total number of directorship to be disclosed in the fund's constituting documents and even to impose a limit on this number.

Those steps are clearly aimed at better controlling two categories of directors: the professional directors who sit on a large number of boards and the "blank check" directors who do not provide any oversight and just collect their coupon.

Comparing the current and proposed "Standards of Corporate Governance", the following changes are interesting:

• the requirement for directors to request regular information from their funds' service providers
• the new text emphasizes the need for a documented distribution of responsibilities between the various stakeholders and and appropriate oversight of those delegated functions
• the new standards require the setup of a compliance committee and other sub-committees as needed

Those changes will require from the directors a proactive stance in  seeking information from the service providers and the setup of an appropriate oversight framework of the delegated functions.

The proposed guidance is bringing the Cayman Islands closer to the standards used in European UCIT funds. Several improvements specific to the fund industry could be incorporated in the updated standards like:

• a majority of independent directors
• quarterly board meetings with at least one meeting per year with physical attendance by the directors
• increased transparency through the proposed public database (i.e, name of the service providers, last audit date)

Operational staff challenged by investors' expectations

In order to raise assets for your hedge fund, it is no longer enough to involve the portfolio manager and a client rep. Every employee of the firm need to work at meeting the investors' expectations.

The good news for investors is that, according to a poll recently released by SEI, it appears that CFOs are aware of this new obligation.

According to the poll, conducted recently at the company’s annual Hedge Fund CFO Forum, addressing new regulatory requirements and meeting evolving investor expectations are the biggest challenges for 2011.

Read the press release from SEI here.

Administrators become transparency providers

Hedge Fund managers are usually very cautious regarding the level of transparency they provide to their funds' shareholders. The reasons invoked by the managers for such secrety are usually their fear to see their investment strategy reverse engineered or other investors betting against them. Even if the managers provide investors with some granular information about the fund's portfolio, this information partiality can be questioned.

However, their is one person for whom the hedge fund manager has no secret.This is the fund's administrator. In order to perform its duties, the administrator needs to have access to detailed information about the fund's portfolio. In most cases the information is gathered directly from the fund's counterparties.

Following investors' demand for more transparency, some administrators understood,  that they were in the best position to provide this additional disclosure in an independent manner. Today, at least three of them (Citco, Morgan Stanley and Globop), are proposing transparency reports to investors for funds which have elected to propose this service to their shareholders. The managers can decide which level of transparency they want to provide.

A common layer of transparency proposed by the three administrators is a report providing information about the NAV calculation process. The information included in those reports can cover pricing sources, position reconciliations, fund assets and liabilities, counterparty risk concentration, portfolio liquidity and where assets are held in custody.

According to the Q4 2009 HFN Administrator Survey, the three above mentioned administrator had assets under administration at the end of 2009 totalling $582.44billion which represents approximately 25% of the total hedge funds assets.

The tools for more transparency into the opaque hedge fund industry are available, investors need now to use them and put pressure and  their managers and the fund's administrator for a broader generalization of those practices.

Related links
http://www.morganstanley.com/about/press/articles/9bcef2d6-5463-11de-96f6-3f25a44c9933.html
http://www.globeop.com/globeop/proserv/fund_administration/fund_performance_reporting/
http://www.citco.com/Divisions_Transparency_Platform.jsp

The brokers’ sword of Damocles over hedge funds’ heads

A very interesting article published by Hedgefund.net from Devi Koya, a partner at the law firm of Baker & McKenzie.

A decline in asset under management at a hedge fund has multiple consequences not only on the manager's revenue but also on its creditworthiness. Since hedge funds are using leverage extensively in their investment strategies, through cash borrowing or derivatives, their capacity to meet their liabilities is of the highest importance for their trading counterparties. The first mechanism of protection for brokers is their ability to call for additional margin or collateral to reduce their credit exposure to a fund. The other protecting clauses in the brokerage contracts are the Additional Termination Events clauses or "ATE". For example, if the funds breaches some predefine threshold is terms of assets under management, key man departure … the broker has the right to call for additional margin or collateral. The next step after an ATE occurrence will be the termination of the relationship by the broker and the liquidation of the fund's positions usually at fire sale prices.

Hedge fund's CFO should be very careful in negotiating their prime brokerage and ISDA agreements especially in regards to ATE. Furthermore, they need to obtained waivers from their brokers, after the occurrence of an ATE, to avoid being at the mercy of their counterparties during the next adverse market event (which will no doubt occurs sometimes in the future).

Competent legal, compliance and operations teams are no longer a luxury for hedge fund but a requirement in an environment where everyone try to pass the "hot potato" to its neighbor.

Devi's Corner: When the Banks Won't Call You Back - NAV Triggers' Effects on Hedge Funds
Between 2007 and 2009, many hedge funds declined in size due to investor redemptions and/or performance declines. These same hedge funds trade derivative agreements under an ISDA Master Agreement that typically contain provisions defined as Additional Terminations Events ("ATE") which can be triggered by the decline of a fund's net asset value...
Click here to read the article