Custom House Manager Workshop
Good afternoon Ladies & Gentlemen,
Let me first of all start off by thanking Karen Azlen, who organised this workshop. And I would also like to thank you for coming.
The program this afternoon is going to be quite comprehensive.
I will start off by giving you a brief introduction to Custom House and then follow up with an overview of the process of setting up an offshore fund and what we can do to help you in that area. I will then go on to give an overview of hedge fund administration.
Finally, my colleague, Mark Hedderman, who is the Manager of the Custom House Administration Department, will give you a brief demonstration of both our PAXUS fund accounting system and the CHARIOT web-reporting platform, which he will do after David Wentzell of McMillan Binch has spoken about certain Canadian tax issues.
So, first of all, Custom House.
I moved to Dublin in 1989 and set up the Custom House Group of Companies in April of that year, intending to take advantage of the newly emerging International Financial Services Center in Dublin, what is known as the IFSC.
Custom House was originally established to provide a fairly broad range of financial and corporate services to international high net worth and institutional clients.
However, by the end of 1993, I decided that the company should be more focused and that we should concentrate on the business of organising and administering offshore funds.
As a result, we have done this exclusively from the beginning of 1994.
At that time, I recall we were administering five funds that we had set up for clients. We now act for some 175 funds, for about 65 clients, with assets under administration close of US$8 billion. We currently employ 73 people of which some 50 or so are on the administration side.
We call ourselves The Specialist Fund Specialist and that is because we predominantly organise and act for alternative investment and hedge funds. We do not administer traditional mutual funds or unit trusts although we are quite capable of doing so.
By way of illustration, I can tell you that we have set up funds that have investment strategies that vary from a capital protected currency fund that complied with Islamic investment principles (Sharia Law), at one end of the spectrum (we couldnt call it a Guaranteed fund, because guaranteeing is something that only Allah can do).
At the other end of the spectrum, we once set up a fund that invested solely in arable farmland in Argentina.
Between that, we have set up and administer funds utilising a wide variety of strategies.
Our client base has always been very strongly biased towards emerging hedge fund managers and start-up funds, but we also act for institutions. For example, we set up a multi-manager currency fund for American Express Bank and a series of Capital Protected Multi-Manager CTA funds for Credit Suisse Asset Management. The core fund in that product had seventeen separate CTA managed accounts and we had to provide a daily valuation by 10:30 am Dublin time If I tell you that the fund was managed by CSAM, the money was raised by CS Private Banking, the clearing broker was CSFB in NY and the Capital Protection was structured by CS Special Products in London and that not one of these offices seemed capable of speaking, electronically, to another, you will understand what a remarkable achievement producing a daily valuation by 10:30am was.
Custom House also acts as administrator for a series of funds issued by a UK specialist fund management group investing in TEPs. Some of these funds also invest in real estate, which requires a different expertise. TEPs are UK Traded Endowment Policies. In the UK, an Endowment Policy is an investment linked life insurance policy, similar, I believe, to what is called in North America an annuity. These policies have a fixed term requiring monthly premium payments.
The average policy is small (circa UK13,000), therefore, you will understand that, as the total assets in these funds amounted to more than UK200 million/US$360 million, there were over 6,000 policies issued by several different insurance companies extant. This means we have to reconcile over 6,000 premium payments every month, before we can calculate and confirm the monthly NAV.
I would now like to discuss what is involved in setting up an offshore hedge fund.
I will start off by saying that, if you want to find out more about Custom House and what you must do if you want to set up a hedge fund or want us to take on the administration of a hedge fund that has already been set up, or is being set up elsewhere, I would invite you to visit our Website, which is www.customhousegroup.com. There, we publish full information on the services that we provide and I trust that you will find it to be a very clear and easily navigated Website. It has a considerable amount of information that I hope you will find useful.
We get most of our customers by introduction, by meeting them at conferences and networking and occasionally by seminars such as this. We also receive a surprising number of Feedback Forms from our Website from people who have searched the Web to find service companies like ours.
We respond to that information request by sending them a Questionnaire, which you will also find in your pack, together with a Memorandum entitled Some Factors To Be Considered When Establishing An Offshore Fund. The purpose of this Questionnaire is to try and find out what the prospective fund manager thinks he wants.
That sounds a little patronising, but it is not intended to be so.
We ask our clients, when they are completing the Questionnaire, to review the Memorandum at the same time, because many of the points in the Memorandum refer to specific questions and will go some way to explaining why we ask them. When the Questionnaire has been completed, it is sent to me and I revert with my own comments and by the time we have one or two further exchanges discussing the Questionnaire and the structure of the fund, we are usually ready to proceed.
At that point, we provide a Letter of Agreement confirming what we are going to do with regard to setting up the fund and the cost and we go from there.
I should make it clear that our costs, which I will come to later, are, we think, very reasonable for the turn-key package that we provide and are predicated on the assumption and, indeed, agreement that we are appointed as the Administrator, because that is, of course, our core business.
I know I may have sounded a little patronizing just now, but I was not meaning to. The fact is that many people who are setting up their first hedge fund, were formerly traders or money managers within big institutions, who have never been involved in setting up a fund before because they have been concentrating on what they do best making money. If they, or any of their clients wanted a fund they used to dial through to the legal department, or get onto a large firm of lawyers, who would then spend many thousands of Dollars of the clients money putting the fund together.
We offer a turnkey package at a fixed price - that price depends upon the selected jurisdiction of the fund, which leads us to the first question.
Where do you set up a fund
There are three main groups of jurisdictions where people set up offshore funds, starting with the Caribbean, which includes the Bahamas, British Virgin Islands and the Cayman Islands, of which the most popular currently is the Cayman Islands. The Caribbean was and, in some cases, still is considered to be under regulated and, indeed not many years ago, was generally unregulated. Thats the first group.
Then, as you move east across the Atlantic towards Europe, you come to what I call the mid-Atlantic group, in which I have lumped Bermuda, the Channel Islands and the Isle of Man. Here you generally have more regulation and higher costs.
Finally, moving further east, you reach Europe, represented by Dublin and Luxembourg and more recently, Malta.
It used to be that, as you moved further east across the Atlantic, you climbed not only the regulatory curve and the cost curve, but also the time curve, so to speak. Thus, a European fund used to cost at least double and, possibly, three times the cost of a Caribbean fund and could take three or four times as long to set up that was before Malta joined the European Union and before Jersey introduced the Expert Fund of which more later.
We can set up a fund, if pushed, in the Cayman Islands in two or three weeks, although I wouldnt recommend it, because when working under that sort of pressure, things can fall through the floorboards, but certainly we can set up a Cayman fund in four weeks.
Some Bermudan lawyers claim they can do the same and if you are a recognised manager of an existing Bermudan fund, that may be possible, although I would think it is more likely to take six to eight weeks and, certainly it would be at least six to eight weeks in the Channel Islands or the Isle of Man, perhaps more. Although the recent introduction of the Jersey Expert fund has made that jurisdiction very attractive and more efficient for hedge funds.
In Dublin and Luxembourg, you would be looking, at the very least, at three months and, recently, I have known it to take six to eight months, because the regulators in the two jurisdictions are overwhelmed with work.
Although Luxembourg has become more active in this area in the past year or so, I will concentrate on Ireland, for obvious reasons.
The main disadvantage of Ireland, apart from the cost and time that it takes to set up a fund, is the restrictions that the Irish Regulator IFSRA (Irish Financial Services Regulatory Authority) - imposes upon the prime broker with regard to the custodial relationship.
As you know, most hedge funds, when they open an account with a prime broker, leave all of the assets of the fund with that prime broker, who is then free to use them as they will. They are, therefore, able to hypothecate and/or lend those assets to other clients. If you have a first class, well capitalised prime broker, there is nothing wrong with this, but there is undoubtedly a counterparty risk.
The Irish regulations require that the prime broker may only use, for its own purposes, those assets that equate to the collateral required to meet any margin or financing of short positions that the fund may have.
This puts off a lot of Managers.
However, the Manager may decide to go for Dublin, either because that is a requirement of their client and, as we know, The Client is King or, indeed, because they want that extra protection with regard to the assets.
Thus, to repeat myself, the first thing that has got to be decided is the choice of jurisdiction and a lot of this comes down to perception both perception of the Manager and, indeed, the perception of his prospective investors. What is there to choose between the three groups of jurisdictions
Ultimately, the choice of jurisdiction is a compromise between the three elements I have already mentioned cost, regulation and time, together with perception of respectability. The clear choice up to this year was probably Cayman Islands or Bermuda, on the one hand, with Dublin and more recently, Luxembourg, on the other hand. However, as I have already hinted, in the past few months, we have seen two new potential domiciles emerge.
Firstly, Malta, which has a Cayman style of flexible regulation, but with the advantage of lower costs and and this could be very important, because since the 1st of May, Malta became a full member of the European Union.
Secondly, the Jersey Expert Fund, which is also a much less restrictive product than most Jersey funds, aimed at Professional or Expert investors. The main advantage of Jersey is the perception of respectability, rather than cost. For example, a Jersey fund can be authorized or regulated in Switzerland, which is not possible for a Cayman Fund.
Because of time constraints, I cant really cover all of the things that need to be considered in a presentation like this one that could take the whole day and anyway, most of the points that need consideration are identified by the questions in the Questionnaire and discussed and, I hope, explained in the Memorandum Some Factors To Be Considered When Establishing An Offshore Fund both of which are in your packs. The main factors include, in no particular order:
Investment Restrictions
Capital Structure
Sub-Funds Umbrella Structure
Subsidiary Trading Companies
Master Feeder Funds
Irish Stock Exchange Listing
Redemption Notice
Early Redemption Fee
Share Certificate
Management Structure
Custodial Arrangements
Cash Management
Subscription Procedures
Early Investment of New Subscriptions in Funds of Funds
Auditor
Directors
Sales Commission
Other Fees
Equalisation
Anti-Money Laundering; and of course,
Taxation
Once we have discussed all those topics and got all the information we need to set up the fund, we can proceed. You will find our terms in the Questionnaire but, in summary, the cost of the turnkey package, for a monthly dealing fund will vary between approximately 20,000 and 30,000, depending on jurisdiction, plus the usual out of pocket expenses and disbursements.
A Subsidiary Trading Companies will cost between US$2,000 and US$4,000, also depending on jurisdiction, which need not be the same jurisdiction as the fund. We set up a lot in Anguilla because of the cost savings.
This turnkey package fee includes: the production of the Offering document, obviously with your help; and incorporating the company. It also includes retaining and paying a local attorney, who will be briefed to ensure that the OM and the Mem & Arts comply with the local Company and Mutual Fund laws and that the fund is registered with the local regulatory authorities, as requested. Our fee also includes preparation of other service providers agreements, liaising with the Auditor and other service providers and opening the various bank and broker accounts. Again, all this is described in detail on our Website.
It does not include:
i. Printing any documentation, which will be provided to word processor finish;
ii. Translation of documentation into any other language English rules; or
iii. Any legal fees other than those have already been mentioned.
Red Herring OptionOne last point that I would like to make with regard to setting up and organizing a fund relates to what we call our Red Herring Option.
Quite often we find that Managers are uncertain as to how the market will react to a particular aspect of their fund, such as the fee structure, investment restrictions, minimum holding periods, levels of leverage all the sort of things that some investors may not feel entirely comfortable with. This can cause problems, if you have finalized the fund and issued an Offering Memorandum, because, obviously, there is both expense and hassle and also, often, some embarrassment in having to change the documents after the event.
With the Red Herring Option, we will prepare a Draft Offering Memorandum, but we do not either incorporate the company itself, nor incur any legal fees, pending the decision of the Manager to proceed with the incorporation of the fund. This Draft Offering Memorandum, which is of course covered in caveats on the front about it being for discussion purposes only etc, can then be used as a pre-marketing tool by the Manager. This means that you can go and see your various investors and, if you meet one investor who is prepared to give you a nice chunk of money, but only if you put in a hurdle rate, let us say, then you could consider whether it is worth making the change and amend the document accordingly or not.
Alternatively, of course, you may find that you have interest from two groups of investors with different views as to fees, or leverage, or whatever, in which case you can restructure the fund to have two classes of shares and thereby accommodate both.
The Red Herring Option is offered to give you greater flexibility whilst exploring the market.
One last point on this subject the cost of the Red Herring Option will be offset against the cost of setting up the fund, if you proceed with that.
That is all I want to say on the setup of funds but I will, of course, answer any questions you may have either at the end of my presentation or after this seminar.
I would now like to move onto Administration.
What is Hedge Fund Administration How Does it Differ From Traditional Funds
Administration, in the context of Alternative Investment and Hedge Funds, (which I will refer to collectively as Hedge Funds in this presentation), means, in effect, the management of the Fund in virtually all aspects of the day-to-day operations of the Fund, except the actual investment of the assets, which is the responsibility of the Investment Manager. In this role, the Administrator is always answerable to the Board of Directors and does not have any actual management control.
In simple terms, an Administrator is responsible for ensuring the efficient operation of a fund, whilst at the same time relieving the Investment Manager from having to do all the boring stuff, such as:
Calculating the NAV and the NAV per share or unit, as often as may be required by the Fund or its Board. Keeping the accounts and financial records;
Preparing the annual audit file and liaising with the Auditor;