Despite losing work to lower-cost onshore locations, fund administration in the Cayman Islands continues to be an important business sector with some growth potential.

Despite problems and a massive loss of jobs over the past few years, Cayman’s fund administration business is not in terminal decline. However, there is no room for complacency and there is a need for some positive moves if the government is to reverse the trend.

Although it is true Cayman has lost a few hundred jobs to an exodus by fund administration services to lower-cost countries with abundant job pools, the industry itself has also changed. The financial crisis, in which hedge funds and funds of hedge funds (FoHFs) saw assets under management (AUM) plunge, deeply affected fund administrators whose fees are based on AUM numbers. At the same time many were forced to cut back on staff and restructure businesses with technological advancements making it easier to make ­efficiencies.

Many say fund administration itself has changed its model radically since Cayman first became a hedge fund centre. The industry, like its clients, has gone global. As managers spread operations around the globe, along with investors, fund administration needs to follow the sun.

A move towards daily reconciliation, more outsourcing of funds of middle and even front office functions as well as the rise of multi-prime brokers (giving administrators a chance to take on a more centralising role with funds) have given administrators an opportunity to diversify and add services. It has also challenged them to find ways of ensuring services are able to operate on a 24-hour day to give fund managers (and investors) the service they demand.

The Madoff scandal has also led to a move by mainly US-based hedge fund managers to outsource onshore fund administration to independent third parties. While this has helped the industry recover, it has further strengthened the need for placing large numbers of staff outside of Cayman.

The impact felt in Cayman centred on the more repetitive accounting functions. The industry in the islands is now more geared to the higher value-added end which needs more highly qualified people but in lower numbers.

It is important for Cayman to retain a serious fund administration presence, say many in and outside the industry. The service is seen as a training ground for movement into the now-burgeoning area of directorship service provision. Top fund administrators often see a career path that previously hit a ceiling expanding with the opportunity to become a director sitting on hedge fund boards. It is a way to use the expertise and experience gained at the sharp end of service provision for hedge funds in a challenging and lucrative area.

Another factor pushing large numbers of fund administration staff out of Cayman was what many saw as harmful government policies on immigration. Although the government has recognised the problem and is working much more closely with the industry to ensure the jurisdiction does not miss out on expansion opportunities because of an overly bureaucratic and restrictive system, no-one disputes the fact that the jobs lost to the islands are not likely to come back just because of policy changes.

What the government is doing, however, is actively courting new business and making those looking to set up shop in Cayman welcome with a speedy work permit process that also gives preferential treatment to key staff. This was certainly the case for HedgeServ which recently set up in Cayman.

It started operations last year with a relatively substantial operation culled from staff from Butterfield Fulcrum following its merger. Butterfield Fulcrum was subsequently bought earlier this year by private equity company BV Investment Partners in a deal brokered by Glenn Henderson and Tim Calveley, former executives of its predecessor company ­Fulcrum.

The Cayman operation of HedgeServ complements offices in Dublin and New York, is headed by Greg Bennett, formerly managing director responsible for business development and client relations at ­Butterfield ­Fulcrum.

The office will provide full fund administration and middle office services to both hedge funds and FoHFs. The company is rapidly growing and is understood to have almost doubled AUA to over $70 billion.

HedgeServ is hoping to be able to build a substantial business in Cayman and sees the jurisdiction as a natural jumping off point for growing business in South America as well as North America.

The government also confirmed that it offered significant guarantees to tempt the latest entrant to Cayman, Apex Fund Services, a rapidly expanding middle-tier fund ­administrator.

One of the largest independent global fund administration businesses, Apex opened an office this year as part of its overall global expansion. It is now providing high-end services from the island including independent directors, corporate secretarial services and registered office services in addition to more traditional fund administration services.

Dax Basdeo, chief officer for the finance ministry, confirmed the government had helped smooth the path for Apex. “This is a testament that the global financial architecture is getting back on track and that the Cayman Islands remains a top domicile of choice for hedge funds and company registrations. We are pleased that Apex Fund Services has recognised the benefits of doing business in the Cayman Islands and trust that their clients will take advantage of the new investment opportunities that this expansion will bring,” he said in a statement issued in February when Apex announced its presence in the jurisdiction.

The smallest presence of a trio of newcomers is Trinity. It opened an office in Cayman to much fanfare in late 2009. Brad Cowdroy is general manager. While he admits business has not taken off, he is “cautiously optimistic” there will be more opportunities in 2011. “I think our expectations and hopes have not materialised yet. We haven’t grown as much as we would have liked. We are busy establishing ourselves in the marketplace. The strategy is to do more work from here, continue business development,” says ­Cowdroy.

His game plan is to use Cayman as a base from which to tap into the US market. Cowdroy says it is still early days for Trinity and always thought the first two years would be spent establishing the name and getting known in the market. He is confident of Cayman’s ability to continue to attract business. “Historically Cayman was not good at selling itself as a jurisdiction. But it is recognised as the domicile of choice. Over the last two years, Cayman had to look at itself and assess the competition. They looked at Luxembourg and Ireland, both of which are good at selling themselves. Cayman is now doing that more actively,” he notes.

Like others in Cayman he is also confident of winning business from South America, particularly from managers based in Brazil who favour the jurisdiction as a domicile. “We are here to stay. We hope to grow and we believe it is important to have a presence in Cayman,” he concludes.

Aside from the newcomers some of the biggest fund administrators continue to have a presence in Cayman including Citco, UBS, Citi, State Street and Goldman Sachs.

At Citco, Paul Kelly is fairly low key in his assessment of business. He confirms the company’s head count has not changed and any decision to increase staff in Cayman depends on business developments. With 60 people providing a full fund administration service including accounting, prorate secretarial and other elements, Citco continues to be one of the larger employers in this sector.

Kelly admits clients want to see administrators with a presence in Cayman but future expansion in the jurisdiction would depend on whether clients wanted work specifically done there. He also confirms that the industry is working more closely with the government to help promote the industry more positively globally and to attract more business to the jurisdiction.

He believes Cayman will remain an attractive jurisdiction capable of attracting high-calibre staff. With other major services providers, like the law firms and banking sector also present in Cayman, he is fairly optimistic of the future. He also thinks the presence of good-quality shops in the jurisdiction will not disappear. While many think Cayman is seen as a higher-cost jurisdiction, Kelly says it may actually be less expensive in terms of salaries as employees are not taxed locally but thinks it is the lifestyle Cayman offers that tempts many professionals to work there.

Cayman structures, believes Kelly, should continue to be the logical choice and preferred vehicles for structuring offshore investment products in the alternative sector for some time.

Another heavy hitter is State Street. George Sullivan, executive vice president and head of the AIS business, confirms State Street has been providing fund administration and other services from Cayman since 1985.

“We’ve been in Cayman doing business for a long time. We are one of the leaders in servicing Cayman-domiciled funds,” notes Sullivan. There are over 1,000 people in the organisation working on Cayman funds, although not all of them are in Cayman. Around 60% of all the funds administered by State Street are domiciled in Cayman.

The presence actually in Cayman is tiny compared with staff levels elsewhere. The six people working in Cayman are what Sullivan terms high-level salespeople. “We felt we needed more contact on the island. It is import to be there,” he confirms. This is where he says the “influencers” are based, including law firms, consultants, accounts and important parts of the fund distribution channels. “Being there is important. We effectively pipe back into the global operational backbone serviced out of New York and Toronto.”

Sullivan admits State Street moved a lot of people out of offshore locations in order to “access appropriate labour pools for our business. It wasn’t cost. It was about access to the labour. What we try to do is access appropriate labour pools for our business.” With more standardised processes and other efficiencies through technology, Sullivan confirms fund administration needs a global ­presence.

Cayman’s staff are “very high-level, client-facing, market-facing people. They are not charged with clerical accounting functions.”

Sullivan confirms he is bullish on Cayman’s prospects. “It has proven to be resilient. The model is obviously well accepted by the marketplace with over 9,500 funds domiciled there. Frankly, what we see is it growing very substantially and although there is a lot of press about competition from Europe, Ireland and Luxembourg in particular, I see those two locations as complementary. They offer something different, distribution. It is a different environment. They are all strong and seeing growth.”

Like others he says State Street would only expand its presence in Cayman if it made sense within its global business strategy. “I think we could need more people. We would expand our footprint there relative to business and clients. That said we are not planning to run operations from Cayman,” he says, although if client servicing needs to expand it is likely to be there. “We just relocated one salesperson to Cayman and that went very smoothly.”

One of the largest employers of fund administration staff in Cayman is UBS Global Asset Management. Darren Stainrod, managing director of UBS Fund Services (Cayman), has also recently taken over as chairman of the Cayman Islands Fund Administrator’s Association (CIFAA). Established in January 1995, the association represents mutual fund administrators based in Cayman.

Stainrod is in optimistic mood. He points to the solid number of fund launches and registrations in Cayman. He reiterates that Cayman is clearly the hedge fund jurisdiction of choice for the industry as far as domicile.

With around 70% of its business with FoHFs, UBS has seen recovery take a bit longer as this sector was hit particularly hard, especially after the Madoff scandal. Stainrod says the dust is beginning to settle and AUA is beginning to increase, albeit much slower than in single hedge funds.

He also says FoHFs are adapting to a new environment and are being used much more as advisers and consultants. Stainrod also thinks the trend to provide more transparency and liquidity reporting is feeding into fund administration work.

UBS has built a substantial technology platform it believes will be able to give it an edge in helping clients meet the challenges of a world where investors want detailed risk and position reporting more frequently and faster. This is a trend he expects to continue.

While FoHFs are moving towards weekly reporting, single managers are keen on daily reconciliation. This, coupled with the move from self-administration to third-party service providers, Stainrod hopes will continue to help UBS pick up business.

Regulatory changes, he confirms, are on the radar but Stainrod does not think there is anything coming that the industry will not be able to cope with. From a jurisdictional point of view, he confirms what the majority in Cayman say: the alternative investment fund managers (AIFM) directive looks to be less of a concern than 12 months ago. How passporting rules evolve in the European Union and when or if they apply to Cayman is still an open question. He believes Cayman is in a strong position to meet any criteria the EU uses to judge non-member countries.

The big issue for all administrators, admits Stainrod, is Fatca, the US Foreign Account Tax Compliance Act, a comprehensive reporting and withholding regime: However, until the rules are clarified he is wary of saying what impact it might have on the industry, although he agrees that fund administrators will be the ones delegated by fund managers to cope with the new requirements.

Stainrod believes it is becoming more difficult for smaller single fund managers to operate in a more regulated climate that imposes compliance costs as well as expensive operational risk controls demanded by institutional investors and significant investment in technology.

He concludes Cayman is still competitive as a jurisdiction and “holds its own on standards” as well as being the default setting for fund domiciles. Stainrod is not worried about the European Ucits products which he sees as complementary rather than straight competition with the offshore vehicles Cayman offers. He also dismissed talk of mass re-domiciliations out of Cayman, saying there is no actual factual data to support claims by European jurisdictions on this front.

Like others Stainrod believes the open architecture the jurisdiction offers coupled with the concentration of expertise found in Cayman within the legal, administration, auditing and other service sectors will continue to keep the jurisdiction at the top for some time to come.

Cayman government initiatives coupled with the approach taken by the regulator, Cayman Islands Monetary Authority (Cima), he believes is a winning combination. The jurisdiction continues for him to produce effective but manageable legislation with attractive products. Consultation with industry before implement changes to regulations is a strong point as well as Cima’s openness to new product ideas that could attract even more business to the islands.

Gordon Mattison, managing director at SGGG Fund Services (Cayman), echoes these sentiments.

While better known in Canada as a fund administrator, SGGG is keen to maintain and possibly grow its Cayman operation. He is seeing a pick-up in business flow and although SGGG tends to cater for smaller funds, he is confident of the future. He believes the company can take advantage of its lower cost structure to win business. With the vast majority of its operations in Toronto, Mattison nevertheless says Cayman is an important place for SGGG to be.

At Maples Fund Services, Karen Watson, senior vice president and the global head of the data management group and head of fund accounting in the Cayman Islands, is also positive about future prospects. With fund administration capabilities in Montreal, Dublin, Luxembourg and Dubai, she believes MaplesFS offers a good service to clients. Its links to the Maples and Calder law firm also helps provide it with a steady stream of business although it is privately owned and independently managed.

Most of the staff in Cayman came out of existing fund administrators present in Cayman (Fortis, Citco, UBS), providing MaplesFS with a solid base of ­experienced professionals.

Watson says MaplesFS sees itself as an independent administrator emphasising best practice. She believes the technology platform the company uses is best of breed and offers a good service across a range of fund structures, including managed accounts.

Like others she believes increased transparency, liquidity needs and operational risk controls are helping fund administrators to offer more services to a growing client base.

Overall, the mood remains positive within the fund administration community. The introduction of a third category of fund administration licence by Cima should help bring in some new blood as the sector continues to take a global perspective on ­operations.

With continued support from the government and other local service providers, as well as talent willing and able to relocate to Cayman, the industry could be set to see some growth, albeit modest, over the next few years.

Fatca concerns mount for hedge fund administrators

The Foreign Account Tax Compliance Act (Fatca) is aimed at US tax evaders worldwide and was enacted following revelations that some banks had helped US clients evade taxes.

The US Congress estimates the country loses nearly $100 billion each year to offshore tax abuses, according to KPMG. The joint committee on taxation estimates Fatca will prevent the evasion of $8.7 billion in tax over the next 10 years.

The rules, to be implemented in 2012 will affect US payments after 2013. Several details of Fatca, however, remain unclear. The idea behind the act is to compel foreign financial institutions and others, including hedge funds, to disclose information about their US accountholders or investors.

Fatca could be costly from an operational and investor standpoint for investment managers.

Although the law does not come into force until January 1, 2013, it is likely to affect every part of the financial industry. It will require foreign financial institutions (FFIs) to sign a contract with the US Internal Revenue Service (IRS) if they want to provide services to US persons and if US securities are part of their portfolio.

These institutions will be required to provide information on any US accounts held in order for the IRS to identify cases of tax evasion.

Institutions that do not sign the contract will be subject to a 30% withholding tax on all their revenues. For an asset manager that would mean a custodian holding back 30% of performance-based profits and investors losing the same amount.

A hedge fund with only direct investors should be able to identify its US investors. However, funds distributed by a network of distributors would have more problems. It was currently unclear whether or not distributors would be required to register as FFIs.

It was also unclear whether funds investing in US securities but without US investors would be caught by the legislation.

This reporting and withholding regime presents significant challenges for hedge funds in identifying US accounts and subsequently identifying and evaluating relevant payments for compliance. Most expect hedge funds to outsource this compliance requirement to fund administrators.

However, the administrators are still trying to discover how the rules will be implemented and how they can find out the information and keep it up to date in a cost-efficient manner. Few expect the costs of the operation to be minimal but most are uncertain as to how to pass on this extra cost to clients or just simply absorb it.

According to KPMG, non-compliance will be expensive. Fatca is relevant to foreign entities that derive investment income, including gross proceeds from sales, from US sources.

The requirements will be based in part on existing anti-money laundering and know your customer controls. But hedge funds through their administrators are expected to need to undertake large and complex remediation exercises to show they have identified all US shareholders.

This could also prove difficult if shareholders are not forthcoming in information or if the final holder of the shares is not clear.

KPMG estimates that it could take up to 18 months for companies to be undertake this exercise. This is all the more difficult as fund administrators have still not been given details of what and how to collect information.

The US Treasury says chief compliance officers, tax reporting heads and other key players within an organisation will need to evaluate the potential impact of the regulations and develop a plan for managing any potential risk associated with Fatca non-compliance well before the January 2013 deadline.

By the end of 2011 the actual proposed Fatca regulations are expected to be released with the final regulations only published at the end of 2012.