In this guest post Thalius Hecksher, Global Director at Trident Fund Services, discusses the drivers behind the trend for bigger funds and fewer start-ups, and why Cayman remains the largest and most popular offshore fund domicile.
When it comes to the Cayman Islands, blue skies, beautiful beaches, scuba diving, and snorkeling are the norm, and have been for decades. But when it comes to offshore fund administration there are some interesting changes afoot in Cayman. In a pronounced sea change Cayman start-up funds are getting bigger, while on the flip side, small start-ups, while not quite an endangered species, are certainly rarer. With regulatory costs creeping up in recent years, partly as a result of the implementation of new initiatives such as FATCA, it looks like this trend is here to stay.
The new larger funds tend to be a lot more sophisticated and complex than they used to be, with much greater backing and infrastructure behind them from the get-go. But it’s not just the funds that are changing the start-up demographic in the Caymans. We are also seeing investors responding to the additional reporting requirements of today’s offshore market. In short, there’s a much greater level of sophistication for both buyers and sellers. And regulation is not solely to blame for this: standards, and therefore costs, around the entire due diligence process have also increased, as have the requirements around software compliance and back-office systems.
Opportunity Knocks Onshore
In an interesting dynamic, as the average size of start-up funds in Cayman is increasing, it’s going down in the US. For today’s start-ups, it is generally much harder to get big money together, and there is a definite trend for US funds to launch with $5 to $10 million behind them, build a track-record and then go back to the fund-raising table.
In the US, small start-ups with very modest assets and only a few limited partners don’t have to deal with federal regulations until they put on more muscle. A manager that hasn’t yet had to register with the Securities and Exchange Commission in the US might have to start dealing with some additional state regulations, but otherwise the regulatory hurdles are generally much lower than they would be in many offshore jurisdictions. So smaller start-ups in the US have not seen costs increase in the same way as they have in the Caymans.
With investor capital often currently flowing to established names, it is increasingly difficult for new fund managers to launch with any size. But there are opportunities. With a growing mandate to invest in emerging managers in the alternatives space, $25 million has become a viable threshold for some institutional investors to consider, down from the old $100 million mark. Once these managers get a small domestic vehicle up and running, it is usually the case that they will then head offshore and start something bigger that will also be attractive to overseas (non-US) investors.
But the Cayman 'Gold Standard' Reputation Remains
No one will dispute that Cayman remains the domicile of choice for funds going offshore to access a global investor base. However, although Cayman might be the 300lb gorilla in the offshore world, it isn’t blind to the fact that it’s got some challengers - smaller funds are definitely exploring other offshore alternatives. Notably, there is growing interest in the British Virgin Islands (BVI), which already has a leadership position in the global market for offshore companies. BVI is less expensive and is pushing its fund regime hard in the market. Cayman is definitely still number one, but BVI is in its rear view mirror.
Of course not all jurisdictions, or administrators for that matter, are alike and start-ups need to be wary of cutting costs while at the same time sacrificing resources and compromising their needs. With a long-standing and very well founded reputation for quality service and a dedication to staying on top of an increasingly sophisticated and punitive regulatory environment, Cayman is still the number one offshore jurisdiction. Money talks and the established investor base in the Caymans is impressive and includes: US pension plans, which are projected to increase allocations this year; tax-exempt US investors who prefer offshore vehicles; and investor funds from Latin America and other jurisdictions who are accelerating into the alternative fund space. Cayman will benefit from these trends even as other offshore jurisdictions join the party.
All the signs indicate that Cayman will remain the first choice on most fronts. The reality is that Cayman has many advantages as a mature and sophisticated jurisdiction with a fantastic infrastructure, international recognition, a highly experienced professional community and a sophisticated and well-respected court system — something that is often forgotten. With the experience to handle very large, complex funds, the higher costs associated with that level of service might be too rich for some smaller funds in the early stages of their development. But these costs have come about because higher regulatory standards have been set, something that will ultimately enhance Cayman’s reputation further for those who can afford it.
Thalius Hecksher is Global Director at Trident Fund Services, which provides high quality fund administration services to more than 400 hedge funds and private equity funds in 10 fund domiciles worldwide. Contact Thalius at email@example.com or follow us on Twitter and LinkedIn.