Fund investors happy to pay for independence, oversight

Author: Zoe Thomas | Published: 19 Nov 2013
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  • Corporate governance structures for offshore funds display improved oversight and independence, in spite of additional costs;
  • International regulators’ focus on transparency and conflicts on interest follows a trend set by investors;
  • Investors are requiring more independence between directors and a greater amount of expertise and experience;
  • Start-ups with high initial levels of risk are adding independent investors as they grow and can afford to do so.

Offshore investors are favouring fund structures with greater independence and oversight, in spite of their increased costs.

A string of corporate scandals and the effects of the global financial crisis have spurred offshore funds to consult advisory boards, appoint more independent directors, and on greater transparency. Institutional investors are also asking more of directors, demanding more experience and attention to their fund.

While each of these has increased the funds’ costs, investors have been willing to absorb these amounts.

"This has to be a cost benefit analysis by the manager and investors," said Melissa Lim, a partner at Walkers Global in the Cayman Islands. "From the fund manager's perspective, such costs of strong governance measures will create a performance drag on the fund and impact on the performance fees of the fund."

Further reading

Private investment funds’ new Fatca considerations

Cayman SPVs: making a good product better

How fundraising models will bifurcate PE market

Investor driven

The greatest push for changes is coming from investors themselves, their main concern hinging on a perceived lack of oversight at the general partner (GP) level.

Most feeder funds are corporates with their own boards’ of directors. In contrast, the master fund operates as a partnership with a GP who is affiliated with the fund manager. By installing an external advisory board to the GP, investors are seeking to add a level of both independence and oversight not provided in the original structures.

This concern has manifested itself at the offshore feeder level too, where investors have also started to add advisory boards.

"This may sound excessive, but it is happening because people want it," said Lim. "It’s all driven by investors’ demand. Fund managers would not come up with these additional oversight measures if they weren’t wanted by their investor base."

Regulators push for conflict disclosures

Regulators too are making advances in these areas, looking to increase transparency amid global scrutiny.

Following in the footsteps of the US Securities and Exchange Commission (SEC), the Cayman Island Monetary Authority (CIMA) is pushing for greater conflicts of interest disclosures, requiring a thoroughly laid out section in the fund registrations.

CIMA is also behind an initiative to create a database disclosing which funds different directors work on, to help investors make wiser choices about the amount of time and conflicts that potential directors might have. This too follows on from an investor trend.

Expert directors

According to Darren Stainrod, from investment services provider HighWater, investors are pushing for more engaged directors with fewer relationships, which means prices are going to go up.

"Certainly if you have director shops that work like a production line and take on many more funds it will cost less, but investors are pushing funds towards directors who are more engaged," he said.

In addition to more engaged directors, investors are becoming more willing to pay for experienced directors with specific expertise, including former lawyers or accountants, and insisting that directors have independence from each other as well as the manager.

This type of board makeup can help improve the fund’s credibility. Under the old model, directors were traditionally associated with the manager, or if there was more than one, came from the same shop.

Too much?

There is some concern that the trend may be beginning to go too far.

In January, the fund Bridgewater hired Northern Trust became a shadow adviser to the administrative work handled by BYN Mellon. The possibility of others adding shadow advisory boards or administrators has been discussed by some, and while it does add an even further layer of oversight, it significantly increases cost by requiring the fund to pay twice for the same service.

"Around the world most jurisdictions have independent boards and push for quality in those boards; it has been prevalent in Europe for years, is a growing trend in the USA and it is catching on in Asia," said Stainrod.

"There isn’t a lot further you can go with corporate governance, but the institutional investors will continue to push anywhere they see necessity," he added.

Start-ups

Start-up funds are not falling under the same pressure. The risk associated with this sector is enough to balance out the push for more security and oversight, until a fund reaches a certain amount of assets under management (AUM).

"This changes the way start-ups have to progress," explained Lim. "This won’t stop start-ups, but investors will want to have independents when the start-ups reach a sufficient AUM or wish to attract institutional investors."

"Investors understand that such costs are prohibitive on start-ups and are generally willing to forgo such governance protections for start-ups given the inherent riskier nature of investing in start-ups," she added. "If the start-up does grow they will have the fees and scalability to add the independent directors."

Cost-benefit analyses will continue to be an essential part of managers and investors’ considerations when adding corporate governance. Both sides will likely have to keep in mind the benefits of oversight and restraint of cost moving forward.

Further reading

Private investment funds’ new Fatca considerations

Cayman SPVs: making a good product better

How fundraising models will bifurcate PE market