24 February 2009
It has become increasingly clear that credit is the oxygen in the financial ecosystem.
Without it the system shuts down and exhibits symptoms of dysfunction. In the oxygen-enriched atmosphere of the boom years, where credit fuelled the aggressive expansion of the mature and emerging economies, the Cayman Islands vehicle has been an active participant in cross-border operations.
Cayman’s exempted companies and limited partnerships have been very familiar in the financial ecosystem, whether as special-purpose vehicles (SPVs), collateralised debt obligation (CDO) issuers, hedge funds or private equity funds. It will come as no surprise that, post-crunch, Cayman vehicles have continued to play an active role and have even introduced a degree of liquidity and credit.
From a Cayman perspective, since August 2007 there has been a noticeable and dramatic reduction in the volume of those commoditised debt finance transactions that used to pass through offshore jurisdictions and, in particular, Cayman. So-called ‘flow’ work has evaporated as risk-aversion has intensified, confidence in the rating agencies has perhaps for a while been lost and there has been a flight from complexity and a return to simplicity and transparency. To many, those sorts of finance transactions that characterised flow work served to introduce liquidity to the financial sector, enabling cheaper mortgages, generating more consumer credit options, facilitating the benefits of infrastructure projects sooner rather than later… and the list goes on. As appetite for such commoditised products decreased, liquidity dried up – and the effect of this on financial institutions in particular has been well documented since.
In the absence of the kick-start to the wholesale markets solicited in Chris Ricciardi’s open letter to Hank Paulson of September 2008, Cayman vehicles started to edge into slightly different roles than their staple, featuring in highly evolved, bespoke transactions of a structured nature, occurring both at a ‘macro’ level in the various global economies as well as at a ‘micro’ level.
Often, achieving liquidity was a core objective of those transactions for at least one of the participants.
In the latter half of 2008, there were the vast, bespoke, public transactions such as the Merrill Lynch-Lone Star deal, where a highly engineered Cayman SPV acquired from Merrill Lynch a $30.6bn (£21.17bn) CDO portfolio, financed to a significant extent by a Merrill Lynch entity. Another transaction involving the extension of relief to a stricken financial institution’s balance sheet was the $22bn (£15.22bn) Blackrock-UBS deal, again involving the acquisition of a large portfolio of so-called ‘toxic’ assets by a Cayman vehicle, this time a Cayman exempted limited partnership. There have been many other smaller transactions, where SPVs have, by taking assets off an entity’s balance sheet, assisted in easing the market tensions. Cayman SPVs have entered into repurchase transactions, have aggregated assets stuck in separate warehouse portfolios in transactions that could not go to market and have injected equity into deals that would otherwise have encumbered balance sheets and reduced the agility of the large global players. Investors in these structures have accepted illiquidity, but clearly in the expectation that returns will be theirs once the market stabilises and risk can be priced and valued accurately.
At a micro level, the Lehman administration has created illiquidity, leaving many hedge funds facing claims from withdrawing investors, but denying them access to assets trapped in Lehman brokerage and custodial accounts.
Innovative quasi-repackaging vehicles, generally Cayman exempted companies, have been worked into hedge fund structures, not for the purposes of monetising illiquid assets, but in order to unitise those assets and facilitate a distribution to shareholders of tradeable instruments whose value is ultimately referable to trapped assets. Against this background, Cayman has remained central to the business of asset finance, which has continued to prosper.
Across the spectrum of the financial markets, whether concerning equity or debt, Cayman vehicles have been involved in structures and transactions the purpose of which is to acquire positions, often involving illiquid or ‘toxic’ assets, and holding them within a structure that has a longer time horizon (or more aggressive risk profile). Cayman vehicles, whether in corporate form, as trusts or as limited partnerships, have proved themselves versatile and eminently suitable for accommodating the complex and varying appetites and risk profiles that may need to coexist within a single structure. Whether as producers of financial assets, consumers of financial assets or scavengers looking to pick up residual value in distressed assets, Cayman SPVs remain active participants in today’s financial ecosystems.
Philip Paschalides is a partner in the finance group at Walkers in Cayman