STATE STREET


chiefl y in the form of so-called ‘Newcits’ products, but also from the increase in alternative strategies available through Irish Qualifying Investor Funds (QIFs) or Luxembourg Specialised Investment Funds (SIFs). Both Ireland and Luxembourg have introduced specifi c legislation to facilitate redomiciliation from offshore locations, further driving growth in the sector.


While the European centres appear to be gaining from this expansion,


the Cayman Islands and its peers in the British Virgin Islands and Bermuda are expected to continue to thrive amid strong returning growth to the sector.


Hedge Fund Research found that hedge fund assets surpassed


the pre-crisis high of $1.9 trillion attained in the boom of 2007 with a new peak of more than $2 trillion at the end of the fi rst quarter of 2011. The Cayman Islands is the world’s premier domicile for hedge funds, accommodating an estimated 70 percent of global hedge fund registrations. Despite the number of Cayman-domiciled funds softening since its peak at the end of 2008, Cayman today hosts more than 9,400 registered, administered or licensed mutual funds. At the end of 2009, according to the latest available fi gures for assets under management, the 7,000 hedge funds that provided data to the Cayman Islands Monetary Authority’s (CIMA) annual Investments Statistical Digest had an aggregate year-end net asset value of almost $1.6 trillion—a sizeable proportion of the entire hedge fund industry.


Growth brings options The hedge fund sector is multiplying into a number of different


categories of products, differentiated by their chosen fund vehicle and the profi le of their target end-investor. Investors looking for increased liquidity and transparency—as well as the rigorous protection and reputation of the UCITS brand and other offshore vehicles—are driving growth in EU domiciles. For those investors that are unable or unwilling to buy into offshore-domiciled funds, EU domiciles provide an important means of access to alternative strategies. However, it is clear that offshore domiciles continue to be a popular option, as co-domiciliation becomes more common and managers create onshore clone funds to complement their existing Cayman or other offshore offerings.


While it is true that many hedge fund strategies can be replicated in


onshore vehicles, some of the fl exibility and innovation that is a core part of hedge funds’ DNA is achievable only in offshore locations. Many hedge funds invest in often-illiquid assets and use leverage with the goal of delivering returns that are superior to those of traditional funds and uncorrelated to the direction of markets. The UCITS III directive allowed funds to invest in fi nancial derivatives, making common hedge fund strategies such as long-short equity possible within the UCITS framework and spurring the trend for Newcits. However, UCITS funds are still subject to monthly liquidity and leverage restrictions.


Beliefs that restrictions inherent in onshore vehicles—including


rules governing liquidity, leverage and eligible investments—will dilute performance are infl uencing experienced hedge fund investors, who choose to remain invested with traditional offshore funds. Regardless, the hedge fund sector is offering a range of choices amid signifi cant change and polarisation in investor preferences and needs, emphasising the industry’s huge innovation and enterprise, as well as an ability to adapt and succeed in the post-crisis environment.


Keeping up with regulations The fi nancial crisis, and the new regulation it triggered, together


create an additional factor in the evolution of the hedge fund sector. Operational due diligence and compliance have become an increased priority, considering the unparalleled volume and pace of new regulatory action.


“The hedge fund sector is offering a range of choices amid signifi cant change and polarisation in investor preferences and needs, emphasising the industry’s huge innovation and enterprise.”


Europe’s Alternative Investment Fund Managers Directive (AIFMD) is


foremost among these regulatory initiatives. Cayman Islands fi nancial professionals watched the development of the AIFMD closely; it sets out new terms for the marketing of non-EU domiciled funds within the EU. Despite initial concerns, the approval of fi nal terms of the directive by the European parliament in November 2010 indicates that non-EU funds should be able to continue marketing to professional investors within the EU through both a private placement regime and a passport system, although issues such as taxation arrangements must also be considered.


Several factors can claim credit for this positive development,


including highly regarded supervisory cooperation agreements between EU regulators and their counterparts in the Cayman Islands. While offshore regulators will have to reach certain agreements with the EU member states so that their funds can be marketed, current expectations are that these conditions will be achievable.


Future diversity Hedge fund managers and domiciles are working hard to adapt to


changing regulations and investor preferences, and this is an exciting time for both the hedge fund industry and the diverse centres where they are based. The traditional offshore centres will remain unchallenged as hosts for ‘pure’ hedge funds, while European centres such as Dublin and Luxembourg will attract the rapidly growing regulated fund business. Meanwhile, the likes of Guernsey and Jersey will play to their strengths as private equity centres. Looking to the future, it seems that the world’s offshore centres will each develop according to their distinct offerings.


George Sullivan is executive vice president and global head of State Street’s Alternative Investment Solutions group.


The opinions expressed refl ect general perspectives and information and are not tailored to specifi c circumstances. The information we provide does not constitute legal or tax advice and it should not be relied on as such. There is no representation or warranty as to the current accuracy of, nor liability for, decisions based on such information.


George Sullivan is responsible for the strategic direction, global sales, product structuring and operations of State Street’s hedge, private equity, offshore and real estate fund administration businesses worldwide. Sullivan has more than 28 years of experience servicing fi nancial products.


CAYMAN FUNDS | 2012


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