An upbeat affair

Despite the scaled back size from last year’s GAIM Ops Cayman conference with 250 attendees making up about half of last year’s turnout, the atmosphere was far from gloomy, writes Basia Pioro.

The three day event, held at The Ritz-Carlton offered up a full slate of hedge fund industry experts providing a smorgasbord of hindsight, analysis and predictions for the future.

Joel Press, newly-arrived managing director of Morgan Stanley Prime Brokerage, was an early presenter, whose energetic presentation set the tone for the conference, providing a jumping-off point for the issues discussed in further detail over the duration of the conference.

Expressing his optimism that the industry is not in fact in decline, he also predicted that the past year’s separation of the wheat from the chaff likely signifies that today’s top funds may soon be managing most industry assets. In other words, the days of the two-man basement shop appear to be over.

Press touched on some other issues that received repeated treatment over the sessions that followed, including the way fees may be structured (is it really fair to use high water marks?) along with supporting equal treatment of investors when it came to preferential treatment and redemptions.

With a number of panel discussions livening the mood for attendees, topics that followed included due diligence challenges, and its role in creating storm proof funds in light of such issues as financing and counterparty risk.

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, another conference theme explored by others. 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.

Other speakers included Virginia Reynolds Parker, who offered candid advice on ensuring a fund would survive, and gently proposing that certain precautionary measures and due diligence red flags may have been ignored rather than not present when things were
going wrong.

Parker illuminated a rarely-discussed aspect of fund operations: the human factors that have impacted the industry. That approach is in stark contrast to the common practice of blaming events, market conditions and other intangible villains for the financial meltdown and also the frauds like the Madoff scandal, 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 fund 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 has hedge funds assets reaching $2.6 trillion by the end of 2013.

Lewin also underscored the report’s findings, and the remarks of other speakers, 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 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.

In a related panel discussion, 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 saying that need for increased expertise would mean 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.

The panel agreed it would be unlikely that a law firm or fund manager would be the appropriate entity to ensure the operational diligence was being met as well as taking custody of information exchange. Tannenbaum advocated for a 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 assets being dispersed internationally and trying to get them back (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 LLP
Gary Linford, Founder of DMTC Group, Nigel Farr of Herbert Smith LLP and Lloyd Lipsett of Evergreen Investments

One theme which emerged was the different experiences of British and US firms with their regulators, as the British system appears far more conciliatory and constructive than the US experience, which Davis argued may be a result of increased pressure on the SEC to prove it was doing its job by finding any and all deficiencies, with Lippsett adding that given the SEC missed the Madoff scam it will be more defensive and aggressive.

Also discussed was the possibility the SEC will reach out to third parties including custodians, investors, and administrators, which may cause all sorts of problems. As Davis observed, calling an investor may lead to an inadvertent leak to the media that a fund is
under investigation.

The agreement was that reduced regulation from the EU or the US was not in the stars, but Linford brought up the point that under tougher regulations, US managers may depart for more accommodating pastures, actually reducing long-term tax revenues.

The general consensus was that the funds industry needs to adapt to a changing regulatory climate where the minimum will no longer suffice when it comes to compliance, and that the industry must step up its public relations skills.

A parting thought from Linford was cautiously optimistic, but still tinged with doom – that that the industry is at a crossroads and may face what happened with telecoms and airlines; that it could shrink, or be totally reshaped by Washington and the EU.

And yet, the members from the industry known for its innovation and adventurous tactics who were present were clearly not mourning its demise, showing that at least for the short term the funds industry remains a viable player in the financial field.

 

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