Cayman Islands

Cayman is the first offshore jurisdiction to offer digital hedge fund regulation. Mark Lewis reports on the many benefits of e-reporting

The Cayman Islands have long been recognised as a leading jurisdiction for offshore hedge funds. In March 2007 Cayman introduced another innovation to the hedge fund industry.

The Cayman Islands Monetary Authority (Cima) went live with its new electronic Fund Annual Return (FAR) and an internet portal through which Cayman-based auditors can now submit encrypted digital versions of a hedge fund’s annual audited financial statements to Cima. This program makes Cayman the first offshore jurisdiction to offer digital hedge fund regulation.

Cima and the local audit firms confirm that the first filings for hedge funds have been made successfully under the new e-reporting system. By the second week of June 2007, Cayman-based auditors had filed annual audited financial statements and FARs for more than 500 hedge funds.

The majority of Cayman’s 8,522 registered hedge funds will file electronic audits and electronic reports for the first time by the end of June. Only new funds established in late 2006, with longer first financial year-end reporting periods, will avoid immediate filing, delaying the inevitable until as late as June 2008.

Since 2006 proved to be a record year for hedge fund registrations in Cayman, the timing for the entire process of conception, design, testing and implementation of the new e-reporting system was fortunate. Everything was completed on schedule and ready for the 2007 audit filings.

Reporting data
With the foundations established for e-reporting, Cima is now turning its attention to how it will interpret and report data obtained. Having the hedge fund information in an electronic format will make it much easier to compile, access and review countless permutations. The possibility of knowing hedge fund information quickly was viewed by international regulators and local service providers as a more significant benefit than either the financial savings for the industry or the improved security for audit filings that the electronic system offers.

Cima’s e-reporting group, comprised of Cima staff, third-party contractors and industry stakeholders, including attorneys and auditors, is working to determine exactly how the data will be presented. This is the same team that oversaw theintroduction of the new electronic reporting system.

It is expected that Cima will aggregate numbers for the value of assets under management by Cayman hedge funds globally and by geographical region. Other likely views include trends in net asset value performance for Cayman hedge funds as a whole (but perhaps also by country, geographical region and even city), average subscriptions, redemptions into Cayman hedge funds in each reporting period, percentage allocation of assets by investment managers to key hedge fund investment strategies, and application/success of particular investment strategies in various geographical regions.

Other possible presentations include information on hedge funds’ use of stock exchange listing services and the choice of stock exchange, minimum investment restrictions, the percentage of hedge funds suspending redemptions or valuations and a summary of management and performance fees (by country, geographical region and even city). There will no doubt be many more possibilities on how the data can be interpreted.

This aggregate information (fund or manager-specific information will not be made available to the public) will provide the most complete view yet of hedge fund performance. Unlike other databases that are compiled from self-reported figures, the information from Cima will be gathered from actual audit reports.

In addition to reporting on assets under management, hedge funds will be required to provide information on redemptions and on how assets are being allocated to specific strategies, providing more data for fund managers and investors.

Booming market
It is important to note that Cima has taken great care to ensure that e-reporting does not increase the scope of Cayman’s regulation. No new information is requested and all data required can be sourced from any set of financial statements, or as an update to information generally found in a fund’s offering memorandum or registration documents.

One of the key factors in implementing the e-reporting system was the growth in the hedge fund industry. Total active hedge funds registered in Cayman passed the 8,000 mark in September 2006 and Cima reported a 31 December 2006 year-end closing total of 8,134 active funds, an increase of 15 per cent over 2005 and a 123 per cent growth over the past five-year period.

Growth trends remain firm in 2007, with registrations continuing at a rate of 30-35 per week in the first three months of the year. In the first quarter of 2007, 508 new hedge funds were registered, compared with 457 in the corresponding quarter of 2006.

Taking into account terminations, an additional 388 new hedge funds were registered with Cima in the first quarter of 2007, bringing the quarter-end closing total of active hedge funds to 8,522. Cima estimates that this year will be substantially similar to 2006, with a net increase of between 1,000 and 1,200 new hedge funds for the calendar year 2007.

Prior to adopting e-reporting, Cima had received and managed the audited accounts of the hedge funds that it regulates manually – an overwhelming, labour-intensive and inefficient process. E-reporting will revolutionise the entire filing, review and supervision process, making it more efficient and scalable. The industry will benefit from this, since Cima has committed to passing on cost savings produced by e-reporting by holding annual registration fees at current levels for as long as possible.

In practice, funds attorneys, registered offices or administrators are usually delegated the task of completing the FARs. However, the operator (directors in the case of a corporate hedge fund, general partners for exempted limited partnerships and trustees for unit trusts) remains legally responsible for the accurate completion and on-time filing of the FAR with Cima. In addition, the hedge funds’ audited financial statements for a reporting period cannot be filed by the auditor without the FAR.

To maintain independence, auditors do not play a role in completing FAR’s. However, they are likely to provide the underlying financial data necessary for the return. Auditors will receive the FAR in an electronic format from the operator of the hedge fund or the fund’s service provider. Audit firms are likely to also require a manually-signed copy of the FAR to verify approval and signature by the hedge fund operator.

Initially, auditors’ involvement in the submission of FAR’s as part of the electronic filing process had raised potential independence issues for auditors under US Securities and Exchange Commission (SEC) regulations. However, in November 2006 the SEC confirmed that the submission of FAR’s by auditors under the new e-reporting initiative does not violate auditor independence rules.

CIMA and Cayman service providers have made much of the benefits of Cayman’s new e-reporting system. It is an advanced step in the direction of effective regulation of the growing number of registered hedge funds in Cayman.

Mark Lewis is a partner at Walkers