As Cayman shows no sign of losing its place as the jurisdiction of choice for new hedge fund registrations, the pressure on the Cayman fund service industry to keep pace with this growth has increased. Additional clients means not only an increased workload, but the clients themselves, and their investors, are placing ever more demands on the resources that administrators have at their disposal.
According to Ernst & Young’s 2007 Global Hedge Fund Survey, which surveyed over 100 of the top global hedge funds, 63% of hedge funds currently outsource fund accounting to an external provider, while 59% outsource the preparation of tax reporting.
For any industry to prosper, it must pay attention to its clients’ changing needs. The hedge fund managers surveyed by Ernst & Young were asked to identify the three services that administrators should focus on over the next two years. Technology ranked number one, with staff retention close behind, and accuracy of valuations/reporting and timeliness of valuations/reporting were close behind.
In order to continue to thrive in the burgeoning hedge fund world, Cayman’s fund service industry must be able to face the challenges the global industry is presenting, as well a few which are, perhaps, more Cayman-specific.
‘As a jurisdiction, we’re challenged by a number of the same forces that our competitors are faced with: primarily, what so many innovations in fund strategies lead us to have to stay in touch with, in terms of updates to technology and ensuring that infrastructure around servicing these clients is in place,’ says Rohan Small, partner in the Assurance and Advisory Business Services Practice of Ernst & Young in the Cayman Islands.
Mark Lancaster, director of new business development with Fortis Prime Fund Solutions, is very much in tune with the beliefs of the managers in Ernst & Young’s survey. ‘The key overriding issue in the fund administration market place is staff quality and development, and the creation and maintenance of capacity,’ he says. ‘If the fund administrators are serious about maintaining their market share or growing their market share they need to expand their capacity in any way imaginable, in a controlled framework.’
KPMG has recently published Convergence and Divergence: New Forces Shaping the Investment Universe, which concludes that the role of third-party administrators is set to grow in middle office activities like asset valuation, performance attribution, performance monitoring, risk and compliance; and that further institutionalisation of alternatives is likely to enhance the role of large multi-service administrators, leaving the niche players to serve the start-ups and independent boutiques.
The three key drivers of the growth of external fund administration within the alternative investment market are viewed as: investor pressure for external administration; the fund managers’ desire to focus on their key skills of investment rather than administration; and, increased complexity within the underlying assets. Interestingly, regulatory pressure to adopt external fund administration was only seen as a key driver of the current growth by a third of administrators.
‘What came out clearly from our global report was that there are huge opportunities across all of the administration centres,’ says Anthony Cowell, the report’s co-author and partner at KPMG in the Cayman Islands. ‘What we’re forecasting is what we have called a barbell effect in administration, where you’ll have large super asset service providers on the one end, which we believe will represent around 60% of the industry, and then on the other side you’ll have the niche players. At the moment there’s a massive gap in terms of expertise around valuation. The emergence of risk specialists and valuation specialists who are able to really fill the void that institutional investors will demand is a great opportunity for Cayman.’
KPMG’s report suggests that the niche administrators are more likely to welcome the smaller hedge fund start-ups, whereas the big players will increasingly put a lower end cap on the size of mandate they are willing to accept.
The growth of Admiral Administration, which started out as a niche player in Cayman 11 years ago, proves that the niche position can be a very effective one to take.
‘The role of the administrator is getting more defined,’ says Canover Watson, managing director of Admiral Administration. ‘When we started out, we mainly attracted smaller managers with funds of around USD10mn. Now we have more than 300 funds and USD40bn under administration. We found a niche, providing a tailored solution for our clients, with qualified accountants on the front line, and we have grown with our clients and evolved with the market,’ he says.
Admiral’s model of providing their clients with access to qualified, experienced staff places great emphasis on their ability to attract and retain talent, which remains a key challenge for Cayman fund servicers. Watson recognises that the talent war is alive and well, and that Admiral needs to continually focus on innovation in ways of motivating and inspiring their staff in order to retain them.
The adherence to a business model in which a client has one main point of contact at their service provider aims to address this issue, as well as being a major plus point for the client. Darren Stainrod, head of Fund Services for UBS Global Asset Management in the Cayman Islands, explains how this works at UBS: ‘Very much part of our model is building relationships. Most of our staff are qualified accountants and they deal with every aspect of the client relationship and hence we build up trust.’ The hedge fund managers participating in Ernst & Young’s global survey seem to agree. In the eyes of over a third of them, the principal differentiating factor between fund administrators is the level of quality, experience and knowledge of their staff.
Cayman’s administrators seem to be rising to the challenge of attracting talent. ‘Traditionally we’ve had people attracted to our shores to want to get that international experience, to add an international flavour to their résumé, and in time either move on to operate at home or move on to another jurisdiction,’ says Ernst & Young’s Small.
‘In some cases, alumni from the Cayman offices are cherry picked to lead up new operations in Hong Kong, Singapore, or the Far East, so almost as a testing ground, Cayman has continually proven to be a place where people can learn about the industry but also continue on in their careers and be successful and become leaders in other jurisdictions because of the Cayman experience,’ he adds.
As Stainrod points out, moving to other jurisdictions is not the only attraction for talented fund administration staff. ‘This is an industry with high turnover, and as accountants become more highly trained and sought after they can move into the more lucrative world of the hedge funds themselves,’ he says.
‘Our business model of relationship building with clients could be a two-edged sword, in that if a member of staff leaves it could be a bigger blow than when you have more of a process type of environment. However, from what we hear, our clients appreciate our model and find it less frustrating than other models, where they don’t know who they’re meant to be talking to and which part of the bank they need to contact on which particular transaction. Our staff also appreciate being able to have ownership and take pride in the relationships they have with clients and subsequently our retention rates are above the industry average.’
KPMG’s Cowell is in agreement that Cayman stands out in the talent stakes. ‘If I was going to pick one key differentiator for Cayman over other jurisdictions, the Cayman Islands have really specialised in attracting high quality talent, and largely chartered accountants, whereas if you look at some of the other jurisdictions, that tends not to be the case.’
There is little doubt that the talent in Cayman’s fund services industry will continue to be challenged by the ever more complex strategies and esoteric instruments that hedge fund managers are employing. ‘The role of accountants is growing more complex in terms of the instruments that funds invest in, as the managers look into the darker corners for new ways of finding alpha,’ says Stainrod. ‘As we know, almost daily there’s a new type of instrument being traded and having to re-model those positions and re-price them is a challenge – one of the biggest ongoing challenges that we see.’
A growing focus on corporate governance is another significant factor for Cayman’s fund administrators, believes Rohan Small. ‘We’re seeing an increasing focus on corporate governance, due diligence, and just the ongoing day-to-day operations and how they’re documented, how the actual processes and controls work to support the efforts that lead up to the financial statement close process and the monthly NAVs, or values that are disclosed to investors.’
‘Because of the institutionalisation of hedge funds, we’re seeing an increased focus on how rigourously that process is being developed and what transparency is in place, not only for the institutions, but also for other large investors that become interested in investment manager styles,’ says Small.
So with an increased number of funds to service, and the work required for each fund growing in complexity as well as quantity, what is actually in it for the administrators? KPMG’s Cowell believes that the findings of the firm’s report – that administrators expect the next wave of growth to focus on high value added services – will be a fillip for fund administrators’ ability to attract and retain talent.
‘One of the things that the report states, and what’s really encouraging for Cayman, is that unlike previously, when administration was sometimes viewed as a nickel and dime business – almost a commodity business – I think what you’ll start to see now is administration really becoming an anchor product. I believe that the days where administration was not particularly attractive, and there were challenges of retaining talent, are long gone. We’re really starting to see the whole sector institutionalise and far more emphasis be placed on the role of the administrator within the whole role of the fund.’
Something that comes through clearly from the views expressed by Cayman fund administrators is a hugely positive outlook for the future of both their sector and the jurisdiction as a whole.
As Cowell comments, Cayman’s future is looking bright. ‘There are challenges, but I think the challenges really stem from the success that we’ve had and are about retention of talent and attracting talent,’ he says. ‘It’s not the easiest thing, and I don’t think things like the exchange rate particularly helps that at the moment. The larger firms invest significantly in their human resource programmes to be able to attract the type of talent that we need here, but this is going to be a continuing issue for the islands".