A review of Cayman Islands hedge fund corporate governance and best practice, including in times of distress
It may be business as usual for hedge funds as they seek to weather the market storm caused by Covid-19. However, the true economic effects are perhaps yet to be seen.
This five-part series considers some of the guiding principles that apply to corporate governance in a Cayman Islands hedge fund context and some of the best practices that boards of directors should be implementing as a matter of course, which may need to be re-visited and adapted in times of distress.
To access part 1, please click here.
Part 2: Launch / Business as Usual
While there is no 'one size fits all' solution as to how boards of directors should regulate their business and conduct their meetings, directors must pay regard to applicable law, the fund's memorandum and articles of association and the principles set out in Cayman Islands Monetary Authority's ("CIMA") Statement of Guidance for Regulated Mutual Funds - Corporate Governance and, of course, act at all times in accordance with their duties as directors, including fiduciary duties1. How these principles/duties translate as a matter of practice will be a question for the board of directors, in consultation with the fund's professional advisors, including legal counsel.
In practice and in a 'business as usual' environment for a hedge fund, say, pursuing a long/short equity strategy with monthly liquidity, it would be typical for a board of directors to meet quarterly (bearing in mind that CIMA's minimum expectation is at least two meetings a year). However, the size, nature and complexity of a fund may require more regular meetings to enable effective oversight, including with respect to risk. In the early stages of operation and when assets under management quickly increase (or decrease), more regular meetings may be appropriate until operations regularise.
In advance of each board meeting, an agenda should be circulated with a board pack containing any reports to be discussed at the meeting that have been prepared by the fund's service providers, e.g. legal counsel, the investment manager, the administrator and compliance officer and, after the financial year end, the auditor. The directors should familiarise themselves with such documents and identify any issues that ought to be discussed and addressed at the meeting. It is important to recall that directors have, both collectively and individually, a continuing duty to acquire and maintain sufficient knowledge and understanding of a fund's business to enable them to properly discharge their duties as directors.
At the meeting itself, there is no substitute for active engagement by the directors: the directors should be proactive and prepared to ask questions of and, if required, challenge the fund's service providers. The board of directors must be satisfied that the fund is conducting its affairs in line with all applicable laws, regulations and other rules (including, but not limited to, CIMA's Rules on Segregation of Assets and Calculation of Net Asset Values), and consistently with all representations to investors, while satisfying itself that its service providers are doing the same with respect to all delegated functions. Accordingly, appropriate legal advice should be taken and then information should be requested from service providers and/or professional advisors, so that the board of directors can satisfy itself that such compliance is being achieved.
In addition, the directors should:
- regularly assess the suitability and capability of the fund's service providers, e.g. do the systems and processes of the administrator address the obligations of the fund as regards delegated Cayman Islands regulatory obligations2?
- regularly monitor whether the investment manager is performing in accordance with the defined investment criteria, investment strategy and restrictions; and
- as necessary and at all material times, inform themselves of the investment activities of the fund, as well as performance and the financial position, including material risks (which should be discussed and addressed, where necessary).
If required, the directors should make further enquiries, obtain advice from legal counsel, and give directions to rectify non-compliance, with all relevant action points being actively followed-up in an appropriate and timely manner until resolved to the satisfaction of the board of directors.
Accurate minutes of the meeting, including the matters considered and decisions made, and the information requested from, and provided by, service providers and advisors, should then be prepared for the review and sign-off by the directors3.
Part 3 will consider corporate governance in a period of market turbulence and in times of potential distress.
1 For further reading on the duties of a director, please see the Walkers Client Memo: Cayman Islands - Duties and Liabilities of Directors.
2 Regulation in the Cayman Islands is focused on the management of systemic risk, the prevention of money-laundering and the promotion of regulatory and financial transparency. In the context of a Cayman Islands investment fund, regulatory obligations include, but are not limited to: anti-money laundering, sanctions and the combating of terrorist financing; automatic exchange of investor information in connection with international tax cooperation arrangements (namely, FATCA and the Common Reporting Standard); and data protection. Walkers was the first offshore law firm to establish a dedicated Regulatory and Risk Advisory Team. For further information on or advice relating to a Cayman Islands investment fund's regulatory obligations, please contact Cayman Islands partner Lucy Frew.
3 It is worth noting that while the SOG does provide that full, accurate and clear records should be kept of all meetings, in the event of any doubt, or if there are matters discussed with legal counsel that could give rise to legal advice privilege considerations, specific Cayman Islands legal advice should be taken.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.