Investors not happy with Cayman fund governance

(CNS): A survey of institutional hedge fund allocators’ views on the issue of corporate governance in funds, decribed by the firm as comprehensive, has found that 63% of those who took part in the research were unhappy with governance in Cayman domiciled funds and want improvements. The report by Carne Group, a global investment firm, revealed that many of those interviewed who said they were happy said this was because of the due diligence and oversight that they carry out themselves. The report found 83% of investors rated fund governance as ‘extremely important’ and 91% of allocators said poor governance would cause them to avoid investing in a fund, even if it met performance criteria.

Over the spring and summer of 2011, Carne Group surveyed the largest allocators to hedge funds globally. The firm approached the top 100 allocators and received responses from allocators accounting for over $600 billion in allocations, approximately 30% of all hedge fund AuM. The research revealed that 87% of allocators said that governance had become much more of an issue since 2008.

Examining four jurisdictions, the Cayman Islands scored the lowest ‘happy’ rating in the report compared to Ireland and Luxemburg, where around 15% and 20% of respondents were unhappy. Around 45% or respondents said they were unhappy with the level of fund governance in the Channel Islands. The authors of the report found that, given a choice, respondents would like to be able to place additional reliance on Cayman fund boards but are currently unable to do so.

“By contrast to the Cayman Islands, allocators are extremely satisfied with governance in both Luxembourg and Ireland, with high approval ratings for both jurisdictions. Satisfaction with the Channel Islands was mixed,” the authors stated.

The report is particularly topical coming in the wake of the decision of Justice Jones in the Weavering case, in which directors Stefan Peterson and Hans Ekstrom were found to be guilty of wilful neglect.

Former CIMA chair Tim Ridley described the report as fascinating and said it underscores how increasingly important good governance and transparency are becoming in the hedge fund business and in the offshore arena generally. It highlights how investors and their advisors are exercising greatly enhanced scrutiny of the structure and governance of hedge funds.

“This scrutiny clearly extends to the role and performance of the directors,” Ridley noted. “This is to be welcomed. But one can quibble with the list of the institutions that participated — many of whom are clearly embarrassed by the 'ask no questions' Madoff related failures.”

Ridley also wondered to what extent these institutions and their clients would recognise the next shoe to drop. “If the limits on and performance expected from directors are to be as listed in the report, it is absolutely certain that there will be a significant shortfall in qualified and willing persons to serve as directors and the fees expected by those directors will dramatically increase," he warned.

The report also revealed the problemof directors having too many directorships, a point raised frequently here in the Cayman Islands. The authors found that allocators overwhelmingly agree that the issue of the number of total directorships held by certain independent directors must be addressed. The leading concern, the report said, was that independent directors sitting on fund boards simply have too many directorships, particularly in the Cayman Islands.

Chris Johnson, MD of Chris Johnson Associates, who has often pointed to this issue, said Carne should be commended for taking the initiative to do the research and for preparing such a concise, topical report.

“It sheds light on the perceptions of investors on directors in the Cayman Islands and three competing jurisdictions. Notwithstanding that Cayman was adjusted the least palatable jurisdiction with regard to the thoughts of investors on directors of Cayman funds, it is clear that their main concerns extend to the number of directorships held by each individual and the relationship between the management and the directors.”

The report found that almost 60% of the investors felt that one individual should not hold more than 20-30 directorships, whilst over 30% felt the number to be 30-40 directorships.

“It is interesting to note that in Ireland the law only allows an individual to hold 25 appointments except in group situations,” Johnson said. “Such a number falls well short of those holding over 100 appointments in the Cayman Islands … CIMA and the industry need to address this as a matter of urgency to ensure that Cayman maintains its credibility in the industry. I recommend that they use this report and their own resources to take care of any other shortcomings that are mooted in the report before it is too late.”

The report notes that investors have been lobbying the Cayman Islands Monetary Authority for change as it becomes evident that the governance issue is acting as a drag on the flow of new investment into hedge funds here.

CNS contacted the local regulators, who said that the authority is aware that corporate governance is an extremely important component for hedge fund investors and the financial services sector as a whole.

“It is an issue that CIMA itself has been focused on for some time,” a spokesperson for the Authority said. “As we have publicly stated before, the authority has been conducting an in-depth review of the regulatory framework for corporate governance. This has taken some time because it is not just restricted to corporate governance of funds, but extends to all CIMA regulated entities in every sector for which CIMA is responsible.”

CIMA said it has been examining areas such as the ‘fit and proper’ framework, how directors exercise their responsibilities, the extent to which legislation codifies these responsibilities and issues of transparency.

“We have conducted comparative assessments of other jurisdictions’ standards, and taken into account the recent enhancement of international standards and requirements that are being promoted. We have also been doing a cost-benefit analysis of certain requirements, for investors, service providers, us as the regulator, and the jurisdiction as a whole. It is anticipated that there will be some adjustments to the regulatory framework as a result of this work,” the spokesperson revealed. “We expect that these will begin to be rolled out by 2012 after the necessary consultative and government review process.”

Don Seymour, the vice present of the Cayman Islands Directors Association and MD of dms Management, described the report as “a good effort” and he said it was always valuable to get market feedback, but he noted that despite these comments Cayman was consistently selected as the jurisdiction of choice.

“Although the report doesn't present any new ideas, it can be a useful starting point forthose new to the industry,” Seymour told CNS. “The report advocates a one-size-fits-all solution but governance today is far more complex.”

He said the global hedge fund industry is over worth over $2 trillion but only $500 billion is based in Europe, so any report on fund governance needs to consider the fund governance rules promulgated by the SEC to be considered truly objective.

“While we do understand the authors advocating for their jurisdiction, we do disagree with their conclusion about the Cayman Islands industry.  This is simply not supported by the facts.  In the Cayman Islands our regulators, directors and auditors all serve more funds than any other jurisdiction, yet our industry endured the crisis and thrived.  Stakeholders are free to choose any jurisdiction they wish and they consistently select the Cayman Islands.  The real test is market preference,” Seymour added.

See full report below.