Originally published in the HFM Week Guernsey Report, 2009, distributed May 2009
Christopher Gambrell of Praxis talks to HFMWeek about the future of the hedge fund industry and how Guernsey can become the domicile of choice for fund managers
Governments and financial regulatory authorities are making changes which will impact on the way hedge funds are administered, following the recent financial crisis and the Madoff affair.
In light of recent events, HFMWeek spoke to Christopher Gambrell, managing director at Praxis, one of the leading independently owned financial services groups in Guernsey, about the new challenges and opportunities increased regulation will bring and how it will affect investor confidence, investment strategies and the future of the hedge fund industry.
HFMWeek (HFM): How do you see the state of the hedge fund industry in light of the recent economic crisis?
Christopher Gambrell (CG): The hedge fund industry is obviously going through a period of unprecedented change that has resulted from the economic crisis. Further change may be dictated by changes by national governmental and regulatory authorities, as they strive to tighten controls to prevent some of the issues that precipitated the crisis to occur again.
The real losers in the current economic crisis have been investors who have suffered disappointing returns after having been exposed to potentially greater than anticipated risk. Many have or are in the process of re-assessing the investment strategies they deploy and the managers they select. Those managers who have performed consistently or satisfactorily during these testing times will be the winners, as they will attract the lion's share of new inflows of monies. The losers on the other hand are likely to suffer significant outflows, as investors will seek to penalise those managers who have failed to perform at a consistent or satisfactorily level. Ultimately, natural selection will see the emergence of new managers out of the fragmented remnants of the current industry and this development will also see the development of innovative funds structures.
HFM: How have hedge funds been affected by the crisis and what effect has this had on the administration services provided to funds and the expectations of a fund administrator?
CG: The general perception is that hedge funds have experienced more problems than other fund asset classes. This perception has been created to some extent by the media reporting of the Madoff affair and the problems and losses suffered by other high profile hedge fund managers. This media exposure had added to the gloom and despondence surrounding hedge funds and assisted in the negative attitude that has been generated at hedge funds in general. In reality, a significant number of hedge fund managers have either performed as predicted or exceeded predictions, but even with such performance many managers have suffered from the 'rush for liquidity'. Despite this, and to their credit, many hedge funds have not imposed any redemption restrictions and have in fact retained investor liquidity.
This has provided administrators with some interesting challenges, particularly in the area of increased redemption levels. More significantly, there have been a number of cases where hedge funds have imposed redemption restrictions, and even fund suspensions or terminations. This in turn has seen a considerable increase in board meetings, as the directors of the fund are being required to meet more frequently to resolve a whole plethora of issues created by the current economic crisis.
While such events have provided a challenging environment, the combined experience of the senior management team within Praxis has enabled us to deal with each issue in a professional and competent manner in spite of the sheer quantity of those issues.
HFM: How can an independent service provider help provide comfort and safety to a fund manager during economic instability?
CG: The appointment of an independent fund administrator will provide investors with the knowledge that the net asset value of the fund is being calculated independently from the fund manager, since it is important to remember that a fund manager will always be conflicted if they perform the calculation and publish the net asset value. An independent fund administrator will ensure that asset values are not inflated in any way and that liabilities are properly calculated.
Most fund managers normally perform some degree of shadow pricing so they can validate the independent price calculated by the fund administrator. Under normal circumstances the conflict may be manageable, however, in a crisis the conflict leads to compromise and ultimately the fund manager's interests may override those of investors. These conflicts encompass performance fees, contingencies, adherence to investment policy and investment restrictions among others. It is extremely likely that future investors will regard the appointment of independent service providers as key criteria when considering an investment in a particular fund. In addition, a fund manager may struggle to raise investor monies if service providers are not independent of the manager.
HFM: In terms of corporate governance or regulation what changes have you seen?
CG: The respective fund boards have become more conscious that they need to be fully appraised and provided with the relevant information so they are able to make meaningful decisions. Part of this process is the provision by the administrator of comprehensive board information and packs combined with well-organised meetings and agendas. In view of the economic crisis, the number of funds undertaking 'exceptional' activities has increased significantly and this has resulted in an increase in board meetings.
This combination of heightened emphasis on corporate governance, together with recent events, has significantly increased the demands on corporate secretarial services and in my opinion the standards being adhered to now are unlikely to reverse. In fact, I anticipate standards will continue to increase and this will mean that corporate secretarial services will be the fastest growing sector in the fund administration industry. This trend is borne out by the number of fund beauty parades that we have participated in, where this specific service has been one of the most significant issues discussed.
HFM: What challenges do you see occurring in the coming year and how well is Guernsey positioned to take advantage of this heightened demand for outsourcing?
CG: The challenges in the forthcoming year will be driven by the length and depth of the economic crisis. It is widely anticipated that some of the issues that contributed to the crisis will be subject to increased regulation and there have been rumours that the hedge fund industry could bear the brunt of increased regulation.
However, regulation for regulation's sake does not necessarily provide investors with increased security. Any new regulation must not be implemented simply as a knee-jerk reaction to the events that have unravelled in the past 12 months. However, any new regulation will inevitably increase the workload of the administrator. For example, I wonder whether we will be completing a number of new international statistical returns in addition to our own jurisdictional return? I also believe that administrators will increasingly be visited by underlying fund investors, so that they can scrutinise controls, general service levels and the monitoring performed by the administrator. Another trend likely to emerge will be greater reporting on liquidity and maturity of assets, to ensure that liabilities can be met as they fall due. Not all managers will welcome this reporting, but it will provide investors with more transparency, particularly in relation to redemption proceeds.
HFM: What opportunities do you expect to see over the coming year?
CG: At Praxis, we believe that 'change brings opportunity'. This is certainly true of the recent economic crisis. I suspect that industry professionals will look to well-regulated jurisdictions in order to domicile funds in the future. In this context, Guernsey has weathered the storm in good shape. A jurisdiction's regulatory framework must have demonstrated, both through international scrutiny as well as through practical fund operation that investors have been uppermost in people's minds, that suitable structures worked and independent service providers met the challenges that arose. Guernsey certainly ticks these boxes. Most noteworthy is that Guernsey has complied with its international obligations in terms of anti-money laundering and the signing of tax exchange agreements and has been noted positively by the OECD following the recent G20 meeting in London.
Guernsey continues to be an offshore centre that offers innovation and high quality regulation, which allows it to be able to service the ever changing needs of fund managers and other service providers, particularly administrators in Guernsey. The majority of administrators in Guernsey are independent of fund managers and the adoption by the administrators in Guernsey's best industry practice will provide the opportunity for Guernsey to become domicile of choice for fund managers, who will regard it as a 'blue chip' jurisdiction which will also provide comfort not only to fund investors, but increasingly to their own home regulatory authority. Consequently, I believe that Guernsey will continue to increase its market share in the fund arena and specifically I see more hedge funds and fund of hedge funds choosing to use Guernsey as their domicile.
For more information about Guernsey's finance industry please visit www.guernseyfinance.com.
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