Despite the trials and tribulations of 2008, unprecedented falls in assets under administration and a general contraction of the hedge fund industry, Cayman Islands fund administrators are positive about the future. Margie Lindsay looks at some of the challenges facing the industry

Despite the political rhetoric of past months, the Cayman Islands as a hedge funds jurisdiction is thriving. Carlyle McLaughlin, chairman of the Cayman Islands Monetary Authority (CIMA), believes the jurisdiction is at a crossroads. According to him Cayman will be able to find a productive niche, guaranteeing its future as an international financial centre.

CIMA expects there will be many changes needed to reflect tighter onshore deregulation of funds and the need for greater overall transparency for the industry. However, it is not rushing into anything.

According to Cindy Scotland, CIMA managing director, although it is not business as usual, she believes “every situation/crisis presents opportunities”. For Cayman this means getting itself into positions so that when it is clear about just what needs to be changed, it will be able to remain a key player in the global financial markets but with new products and services.

To do this, says Scotland, CIMA needs to continue its dialogue with the private sector, as well as maintain and increase its international links and intensify cooperation with other national regulators and organisations. Diversification and developing relationships with other regions are high on her list of priorities.

While Scotland describes the current times as “unprecedented”, she also has hopes that the hedge fund sector will be able to recover from the significant impact the crisis has had. For CIMA, she believes the regulator will need to be clearer in its objectives and speaks of “enhancements” that will be needed to advance the industry, meet expected international standards and keep the jurisdiction competitive.

While the enhancements to the various existing rules will not be made public for some time (and will also be subject to the usual consultation), some of the likely changes could affect directors of companies, as well as the regulation of hedge funds, where transparency will be high on the agenda.

Yolanda McCoy, CIMA’s head of investment and securities, echoes many of Scotland’s concerns and hopes. She is confident the good working relationship between the regulator and the private sector - particularly the local branch of the Alternative Investment Management Association (AIMA) - will ensure the jurisdiction has workable standards and codes as well as more formal rules for the future.

Work with AIMA and other industry partners is expected on “enhancements” to the Mutual Fund Law. One of the priorities McCoy forecasts that both CIMA and the industry will need to tackle is increased transparency. She believes CIMA has already led the way for hedge fund jurisdictions, with its introduction of electronic reporting documents, and that its impact “cannot be over-emphasised”.

The reporting is fundamental to CIMA’s push towards greater transparency. Further changes aimed at streamlining the documents and making more of the information available is expected this year. She believes other hedge fund jurisdictions are likely to take the lead from CIMA’s ereporting regime and believes Cayman can further develop and improve what it is doing.

Already, she says, the statistical information has proved invaluable for both the regulator and the industry. It is also another example, says McCoy, of Cayman’s lead in the hedge fund sector. Making such information available has helped give a clearer picture of the industry not only in Cayman but globally. When other jurisdictions follow Cayman’s e-reporting initiative, the combined statistics should give a much clearer idea of the size and scope of the industry.

Staying on top

Whatever the future holds for the jurisdiction, the Cayman Islands is unlikely to yield its premier position. Not only does it have a higher concentration of industry experts than any other hedge fund domicile, it has the determination and political will to keep ahead of the field. While there may be further unjustified attacks on the islands, Cayman’s private sector and its government are determined that the international financial centre will not only continue to exist but will thrive in the new global economic environment. In the fund administration sector, the story is similar. Many challenges face the sector as the hedge fund industry in general goes through a period of intense and extraordinary change.

For Cayman fund administrators the landscape was already changing before the events of 2008. Some, like Goldman Sachs, have decided to move the bulk of their operations to lower-cost centres, like Canada. Although maintaining a presence in the jurisdictions, some found the high costs of keeping staff and increasingly tough conditions for bringing in new workers too costly and time-consuming.

The slimming of the industry has also hit administrators operating in the jurisdiction. Several have made staff redundant or are slimming down through natural wastage. Assets under administration (AUA) have shrunk as hedge funds experienced high redemptions and poor performance.

While AUA is down, the workload is up. Gates, side pockets and other ways of coping with illiquid assets are giving fund administrators more work than usual. But because fees are based on assets under management (AUM), the cost of servicing funds has risen while revenue has declined.

Some hedge funds have even fallen below the minimum size accepted by their fund administrator, while others are simply struggling to stay in business.

Coupled with the general uncertainty of the market, this has prompted Cayman’s fund administrators to take a hard look at their operations. Despite the fall-off in fee revenue, they all see the value of having a presence in Cayman.

One of the oldest administrators in the territory, Citco Fund Services, has had a presence in Cayman since 1994. It started with a few funds previously managed from its operation in Curaçao, according to Patrick Agemian, the company’s managing director. While he admits the Cayman operation is “a small cog in the big wheel of Citco”, the office is substantial, employing 56 people on the fund side, including 20 fund accountants.

While most of the number-crunching happens in Toronto, New York and San Francisco, the Cayman office does handle a full range of services, particularly as some clients want everything done out of Cayman. The main focus, however, is on investment relations services.

Like others in the industry, Citco’s AUA has been reduced. Although the company made some redundancies in October 2008, cutting staff by around 10%, Agemian is confident about Citco’s business overall and its commitment to Cayman. Banking and trustee services are also offered on the island, requiring 90-100 staff in addition to the fund administration team.

Although Citco does not restrict clients on size alone, Agemian admits a fund with less than $10 million AUM might struggle to pay the minimum fee. However, even the small funds are not rejected - Agemian says the company looks at who is behind the fund and the track record of its managers. He is confident his company can cope with almost any strategy.

Like the majority of fund administrators in Cayman, his clients are mainly USbased. Around 85% of his clients are USbased managers “with a handful of Canadians”, says Agemian.

As the industry overall begins to emphasise liquidity and transparency, Agemian believes Citco is well placed to handle increased requests for more detailed reporting for both managers and investors. The company already offers a suite of risk reports, which is expanding.

Warren Keens, managing director of Close Fund Services, part of Close Brothers (Cayman), is also positive about the future of Cayman. The company offers a range of international financial services including banking, fund and fund fiduciary services, investment management and trust and corporate services.

With 70 people in the office, around a quarter of the work focuses on registration and transfer agency (RTA) work, although the company also handles full fund administration. With around $10 billion in AUA, Keens is pleased with the mixture of funds. Most are in the medium-size range with few over $1 billion.

Despite the turmoil in the hedge fund world, Keens says none of its funds has had to close, although like others AUA has fallen. However, he expects some fund closures this year. Overall Close Fund Services has not experienced a massive reduction in AUA. He believes the fact the company services a broad range of funds has sheltered it somewhat, with niche funds doing relatively well throughout the market turmoil.

His criteria for new clients is relatively simple, assessing in the main the long-term viability of a fund. There is no minimum limit to the size of fund Close will accept and points out that many of the funds administered by the company have started small and grown into “quite significant funds”.

Like others in the business he has seen reorganisation of funds and also an increase in requests from funds that have had to change administrator (as they have fallen below the minimum required AUM) as well as from US-based self-administered funds looking to use independent administrators.

Keens is pragmatic about the future. He thinks it will be “a tough year but an interesting one, yes.” He agrees that administrators will need to adopt a “wait and see” approach to what regulation will impose on the industry and the consequences it will have on the industry overall.

He believes capital raising, a key issue for funds throughout 2009, will remain difficult. Like others he believes investors will have more voice in future and has detected a “flight to quality” with an emphasis on corporate governance and operational risk controls.

With 42 employees primarily focused on investor servicing for Cayman-domiciled offshore hedge funds, Citi is another fund administrator with a large presence in the jurisdiction. Globally, Citi has around $400 billion in AUA.

Liam McMakin, director of global transaction services at Citi in Cayman, is aware of the threats to Cayman’s domination of the offshore industry. He believes increased regulation will create pressure to control costs and efficiency. With a decrease in AUA, administrators will also be looking at their operational structure, he says.

Some of the larger administrators, says McMakin, such as Citco, UBS, Butterfield, Fortis and Admiral, are all looking at their operational options. He believes it will be a “delicate balance between pushing to lowcost jurisdictions and not losing experienced people.”

McMakin expects many will move the lower-paid job functions to other jurisdictions and keep client-facing quality control aspects in jurisdictions such as Cayman that have a lot of experience with hedge funds.

McMakin also believes there will be a reduction in the number of administrators overall. As investors push funds to be more transparent over segregation of duties, more outsourcing opportunities will be created. However, they will also want to see large and reputable companies providing that administration work. He forecasts consolidation in the industry.

Looking at the new services Citi could offer, director Peter Hill says the company is undertaking an initiative in the hedge funds service area to introduce what it calls a “global operating model”. This is an accounting framework that will enable Citi to put all of its business onto one platform that can integrate with the middle office.

Essentially, according to Hill, Citi will offer a full suite of products to the hedge fund manager from front, to middle, to back office, including post-trade support. The idea is to have this up and running by the fourth quarter of 2009, although Hill expects it to happen in the first months of 2010.

One of the reasons for expanding and upgrading services, says McMakin, is a reaction to demands from institutional investors for higher-quality administration. Independent audit firms are coming in and evaluating operations to help Citi from a marketing perspective too. Citi is “looking at processes”, he says, adding that the firm believes there is an opportunity for Citi as an administrator to have a strong, controlled environment and become a wellknown, larger company.

At Spectrum Global Fund Administration, Wayne Ross tells a different story. The company provides middle- and back-office outsourcing, traditional fund administration, advanced reporting, compliance services and financials relating to the US Generally Accepted Accounting Principles. With offices around the world, the firm set up the Cayman office to handle RTA work. Overall AUA is $13 billion, almost half of what it was at its peak a short time ago.

The Cayman office has now shrunk, with most of the work being done in the US. This, admits Ross, is mainly due to two factors: cost and staff retention. He believes young people coming to work in Cayman are finding it tough to cope with the high local prices for food and housing.

Like other administrators, Ross is seeing more interest in due diligence from investors. They want to know how the administrator handles funds, where it is located and whether it can provide to references from other clients. Most want big-name administrators, but Ross points out that smaller funds or those with esoteric or complicated strategies are not always accepted by the larger outfits. Spectrum is open to any fund, servicing managers ranging from $5 million to $2 billion AUM.

One administrator with a small presence on the island but which sees Cayman as “an integral piece” of its operations is GlobeOp. While there are only a few staff employed on the island, president and chief operating officer Vernon Barback believes it is important to maintain a licence and company there.

After Madoff

While fund administrators overall are gloomy about the market, he sees at least one cloud with a silver lining. The Madoff scandal has pushed self-administered funds in the US to seek independent fund administration. He believes this is a trend that will bring more business to the industry. He says the post-Madoff era will also bring investors focused on valuation and service integrity. They will want independent fund administration and assessment of net asset value (NAV).

At UBS Global Asset Management, managing director Darren Stainrod has not yet had to reduce staff at the 180-strong operation, although a few people have left and have not been replaced. He hopes this will be enough to help the company avoid redundancies until the industry picks up again. The UBS fund administration operation provides a full service both for single hedge fund managers (around 25%) and funds of hedge funds (75%). UBS is able to offer daily NAV, middle-office and other services. Most of the accounting functions are onshore in the US and Canada with the shareholder and corporate services carried out in Cayman.

Stainrod believes coming under the UBS umbrella has been a benefit to the Cayman operation. Using the UBS bank, he is able to push the cut-off on wire transfers, which can help when receiving last-minute entries.

He also agrees with others in the business that technology is increasingly important. UBS has its own in-house systems. While many of the fund-of-fund processes cannot be automated, UBS has cut them to a minimum. And with 120 qualified accountants, he believes the company is able to provide funds of hedge funds in particular with a good service.

He also agrees with Ross that the “Madoff effect” is generating more enquiries from self-administered funds looking to move to full independent administration.

Stainrod also notes that every company is looking at how it can improve or trim its costs. He confirms UBS is assessing outsourcing arrangements for various aspects of its operations.

Clayton Burton, country manager at Fortis Prime Fund Solutions, is upbeat about the prospects for fund administration, despite recent setbacks. Fortis, which operates from what was once a hotel where Queen Elizabeth II stayed in the 1950s, is pragmatic about the future. With what now looks like amazing foresight, Burton reviewed client relationships and staffing needs in 2008, creating a leaner and more efficient team, while cutting some clients from the books.

As the Cayman operation is focused mainly on US funds, Burton is optimistic about attracting more onshore fund administration work as self-administered funds move to independent service providers.

Although the Fortis label is a mixed blessing - the tripartite-country ownership of the bank was at the core of the group’s problems last year - the hedge fund business is now firmly under the control of the Netherlands government, which has said it intends to put Fortis back into private hands in the next few years.

While there was some disruption to business at the time, the company has retained its clients, despite AUA being a “tear-jerking” 30% down. Like other administrators, Burton’s revenue has decreased as expenses and workloads have increased. He admits the work on a fund that is down from $1 billion to $700 million is the same, with the same number of people working on the account.

Burton does not see (or expect) a lot of growth in new clients this year. Generally, the Cayman operation services US-based funds and, with demand down overall in the US, he does not expect much activity.

Burton does not expect to see much consolidation in the industry, despite persistent forecasts to the contrary. He believes small administrators are likely to remain, although as technology becomes more costly and necessary as a service offering, some might struggle.

Overall, Burton expects more scrutiny from institutional investors, increased due diligence and a focus on greater transparency. He is cautious to predict where Fortis will be in 12 months, but thinks regulation of hedge funds and a strengthening of their fiduciary duties will be good for the industry. Whatever happens, he is confident Fortis is well positioned to take advantage when the turnaround comes.

At Butterfield Fulcrum, Greg Bennett, managing director and head of business development for the Americas, is also confident. While AUA is “under a bit”, he believes the recent merger with Fulcrum will make the fund administrator stronger. Cayman, he says, is a “very important centre” for business operations. It is where the “heavy lifting” happens, as well as client relationship management. The Cayman operation is the production centre for the fund-of-hedge-funds businesses. With North and South American clients and operations in 10 locations, the company is able to provide 24/7 coverage for clients, something he believes is important.

He is seeing increased demand from managers for more frequent valuations and add-on services connected with transparency, including risk management reports both for fund managers and investors.

Chief operating officer Christopher Mulhern agrees that fund administrators will need to offer value-added services in future. While there is no one middle-office offering from administrators, with each defining what middle office means to its own clients, he is bullish about Butterfield Fulcrum’s ability to offer something useful and relevant to the market. Rather than waiting for clients’ requests, the company has decided to define its middle-office offering and has spent considerable time and effort investing in the technology needed to deliver this.

One of the items he expects to be standard for all funds will be risk reporting. He believes the system Butterfield Fulcrum will offer can help reduce costs, shift the “heavy lifting” needed internally by funds to the service provider and provide a cost-effective service.

Mulhern believes the valuation team he has built is “outstanding” and will be able to model and validate most assets. He believes the fund administrator bears responsibility for independent valuation and validation, and that this new service will be valuable and in demand.

State Street is one of the oldest fund administrators on the island, having opened in early 1990. The office went from six to around 40 at its peak, although it is now down to only six. Gary Enos, executive vice-president and head of business strategy and client relationships for alternative investments, is careful to point out that it is still important to have a base in Cayman, although most of the actual work is now done in Toronto and Dublin.

One trend Enos is seeing, confirming what others are saying, is the move towards independent fund administration by US self-administered funds. He says over the past couple of months he has received several unsolicited calls on this and expects State Street to offer a service built around this demand in the near future. He believes transparency and oversight will be key to fund administration services.

Bright outlook

At Admiral, Nic Corsetti, chief operating officer, and Canover Watson, managing director, are positive about the future of Cayman and fund administration in the jurisdiction. Admiral provides full backoffice functions, including NAV calculations, and RTA work, on the island. Only a short time ago the company was exclusively a “NAV lite” and RTA shop, says Corsetti. He has seen a steady increase in the number of clients wanting full services from Admiral and all new clients are signing up to full NAV.

With a US office already offering backoffice services, Corsetti believes the company is well placed to pick up new onshore clients, particularly selfadministered funds looking for independent providers in the post-Madoff climate.

According to Watson, the company’s middle office offers a wide range of services, including real-time reporting and risk reporting. Admiral can “slice and dice” portfolios, says Watson, any way a fund manager (or investor) requests. He believes that, from an investor’s perspective, receiving an independent report via the fund administrator is a useful service. As more fund administrators face falling AUA, Watson thinks the incentive to offer valueadded and add-on services will increase. Admiral is positioning itself now to be able to offer more middle- and back-office functions aimed at funds looking to outsource.

The company has about 150 clients with 300 funds. Most of the funds are onshore and are provided with full administration. Offshore funds are now being offered full middle- and back-office services.

Despite the possibility of increased onshore regulation, Watson remains positive about Cayman’s ability to adapt. He believes the Cayman Islands Fund Association, which helps promote the jurisdiction, will play a vital role as a sounding board for developments in the jurisdiction.

At Caledonian Holdings, assistant managing director and company secretary Bernard McGrath believes his company is well positioned to grow. While most of the fund administration is done from its Isle of Man office, or onshore in Florida for US funds, he believes Cayman is still an important base.

The move to a US base was driven, he admits, by the need to find a lower-cost centre with a good supply of qualified people. Caledonian also uses the Orlando office as a disaster recovery site, given that major hurricanes that hit Cayman have (so far) not hit Florida with the same ferocity.

The Cayman operation also includes banking and trust business.

Although Caledonian describes itself as a medium-sized player and relatively new to the industry, it is positive about its future. Over the past five years it has invested heavily in technology and believes it now has a robust platform that is able to offer the kinds of services hedge funds are demanding.

In particular, the system is able to cope with and reconcile multi-prime brokers for fund transactions. It has an automated accounting system that McGrath believes can “compete with any of the big players”. He thinks the fact that Caledonian offers competitive pricing and personal touch while providing a quality service will be attractive to funds, particularly those that are too small for some of the larger fund administrators.

The future of the hedge fund industry remains unsettled. However, fund administrators in the Cayman Islands expect to remain a key part of the jurisdiction’s offering. Although many administrators have slimmed down operations and moved the bulk of work to the US, Canada or elsewhere, all believe maintaining a presence in Cayman is essential.

Few are willing to predict what will happen over the next 12 months - particularly in the area of regulation - but all have confidence Cayman will survive as a hedge fund jurisdiction of prominence whatever obstacles onshore governments and regulators may throw at it.