This year’s GAIM Ops Cayman conference may have been scaled back in size with 250 attendees making up about half of last year’s turnout, but the more intimate setting did not succeed in reflecting a mood of austerity – quite the opposite. In fact the three-day conference, dedicated to the operational issues facing the hedge fund industry, and held at the Ritz-Carlton beginning on 27 April, was decidedly upbeat.
While the conference kicked off with a reception on Sunday, from then on it was (nearly) all business with a full slate of presenters chock full of hindsight, analysis and predictions for the future. Among the first of the many speakers to hit the podium was Joel Press, newly-arrived managing director of Morgan Stanley Prime Brokerage, who provided the audience with an entertaining take on the current state of affairs within the funds sector, along with the many challenges it faces. His talk provided a perfect jumping-off point for the rest of the conference, where many of the issues he raised were addressed in more detail.
Press expressed his optimism that the industry is not in fact in decline and that he believed a good deal of hedge funds would be starting up in due course. But he also predicted that the past year’s separation of the wheat from the chaff likely signifies that the top 100 funds may soon be managing up to 85 per cent of industry assets.
As another presenter, lawyer Harry Davis of Schulte Roth & Zabel LLP observed later, the hedge fund industry days of the two guys in a basement appear to be over.
With a number of panel discussions enlivening the mood for attendees, topics that followed included due diligence challenges and creating storm proof funds.
Speaker Jeff Green of Deloitte and Touche’s financial services regulatory and capital markets consulting division pointed out the dangers revealed from investors not knowing where their assets were held. The concept alluded to a term new to at least a few of the audience members known as rehypothecation, the pledging of securities in customer margin accounts as collateral for a brokerage’s bank loan.
Green noted the majority of holdings of securitized credit did not lie with investors but rather with banks, adding that the industry could not be regulated out of this crisis, pointing out that all this had taken place under Basel 1. He underscored the importance of treating activity that was bank like as if it were being done by banks.
Other speakers included Virginia Reynolds Parker, who offered candid advice on ensuring a fund’s survival. Looking back on the financial crisis, she gently proposed certain precautionary measures and due diligence red flags may have been ignored, rather than merely absent, when things were going wrong.
She urged the audience to invest in people and not in numbers, a point that was well received.
In doing so Parker illuminated a rarely-discussed aspect of fund operations: the human factors that have impacted the industry, in stark contrast to the common practice of blaming scams, events, market conditions and other intangible villains for the financial meltdown.
She urged attendees to consider that in all likelihood, the more complicated the strategy the bigger the blow-up would be one day, and warned of overly arrogant managers who decline to focus on what might go wrong, or hide behind a veil of secrecy. Over all, her message for investors was to enter into an arrangement only if comfortable with the risk, and called for stronger leadership from managers to create a more dependable industry.
Speaker Marina Lewin, co-author of a recently released report from Casey Quirk and the Bank of New York Mellon presented its predictions that, despite all the recent hits it has taken, the funds industry is far from dead.
Using data gathered from over 150 stakeholders in the industry, the much talked about report found that a base prediction (falling between a worst-case and best-case scenario) has hedge funds assets reaching $2.6 trillion by the end of 2013.
Lewin also underscored that lockups, gates and high water marks may soon become a thing of the past, while funds of hedge funds will rise to prominence in the sector.
At least one notable conclusion in the report that was well-received and reiterated to varying degrees by other speakers, was the urgent need to correct the poor long-term alignment between investors, firms and investment teams.
A panel discussion then followed on relationships between funds and prime brokers, administrators, auditors and other service providers.
Lawyer Michael Tannenbaum remarked that clients and managers should expect more value from their legal advisors, saying that in some cases the billable hour may not be appropriate, but also the need for increased expertise would require more senior level lawyers entering the picture on complex deals, raising the barrier to entering the business.
Fellow panellist Jack McDonald of Conifer Securities advocated for administrators taking on the mantle of information clearing house, to assume a more middle office role.
Tannenbaum advocated for new “must have,” executive councils composed of representatives from all third parties that would meet at least annually. He also foresaw registration of managers and registration of fund entities in the industry’s future. He berated the industry for not doing enough to lobby for their cause with legislators to ensure any regulation that arose would be as favourable as possible.
Subsequent panels went into greater detail on topics such as the relationships between funds and counterparties, managing through a new level of business risk, and the problems that can arise from internationally dispersed assets (lesson: you should know where your assets are, and you should ensure your assets are yours, not to be doled out by the manager unless specifically permitted).
The conference concluded with an animated panel on the future of hedge fund regulation featuring Harry Davis of Schulte Roth & Zabel LLPGary Linford, Founder of DMTC Group, Nigel Farr of Herbert Smith LLP and Lloyd Lipsett of Evergreen Investments
One theme that emerged was the different experiences of British and US firms with their regulators.
Farr commented the atmosphere in the UK was far from adversarial, as visits are done only after a risk assessment.
In contrast, Davis said US firms find themselves in a more defensive position, blaming the negative atmosphere on increased pressure on the SEC to prove it is doing a good job.
Davis also argued the requests being made of hedge fund managers are absurd and out of proportion to the risk, arguing against regulation in favour of a case by case approach.
Lipsett agreed that given that the SEC missed the Madoff scam (among others), it will likely be more defensive and aggressive in the future.
Lipsett also mentioned a letter sent out in March stating the SEC will reach out to third parties including custodians, investors and administrators.
“You do wonder what will happen as far as relationships with investors, because it can open a can of worms, for example unintended consequences if investors mention the SEC interest in that fund to the media,” he said.
Davis further noted that if, for example, the SEC calls an investor in a fund and the parties are in litigation, it may lead to some damaging consequences.
The panel also discussed that sentiment that the SEC just doesn’t have the resources and sufficiently experienced staff to conduct fair investigations, along with possible outcomes of the Levin bill, which would require any fund manager in the US no matter where domiciled to be subject to US tax.
Linford expressed his opinion that from the Cayman perspective, US managers will debark to UK, Hong Kong or elsewhere, while international investors looking to invest in the US will turn to other avenues.
"Levin thinks people who use tax havens are tax cheats but in fact his actions will result in fewer taxes for the US,” he opined.
Among the ensuing discussion, the panellists further noted the presence of a political will in the EU to pass regulation of investment fund managers, and discussed the challenges fund managers may face when domicile comes into question.
The panel concluded with thoughts on how Cayman will have to attack the issues it faces as an offshore jurisdiction.
A closing theme emerged that the funds sector needs to adapt to a changing world, and faces hostile attitudes from Europe in particular..
Linford’s observation that the industry is at a critical crossroads did not seem to inspire much fear, and despite the final panel’s gloomy predictions, the balanced presentations throughout the day meant the conference successfully concluded on a positive note, with attendees maintaining a resolute outlook on the sector’s future.