Cayman Islands: FAR Out! – E-Reporting Now Reality For Cayman´s Hedge Funds Industry

Originally published in Cayman Financial Review

On 29 March 2007 the Cayman Islands Monetary Authority ("CIMA") confirmed full operation of Cayman's new electronic reporting system for the submission of annual returns for hedge funds licensed, registered and administered in the Cayman Islands heralding the start of a new modern and digital era of hedge fund regulation in the Cayman Islands.

Following several months of successful testing by CIMA's own e-reporting team, third party contractors and industry stakeholders in Cayman, CIMA has now released the electronic Fund Annual Return (FAR) on its website and has opened the internet portal through which local Cayman based auditors will submit both a hedge funds annual audited financial statements and the FAR to CIMA.

All hedge funds licensed, registered or administered in the Cayman Islands that have a financial year-end date after 27 December 2006 must now file a FAR and audited financial statements within 6 months of the hedge fund's financial year end.

CIMA and its e-reporting team are to be congratulated on a job really well done. The entire process of conception, design, testing and implementation of the new e-reporting system has been completed on schedule ready for all 2007 audit filings, which is perhaps just as well as 2006 proved to be another record year for hedge fund registrations in the Cayman Islands.

Total active hedge funds registered in Cayman passed the 8,000 mark in September 2006 and CIMA reported a 31 December 2006 year-end closing total of 8,134 active funds, an increase of 15% over 2005 and a 123% growth over the past 5 year period.

The growth trend is not letting up in 2007 with CIMA reporting that new hedge funds continue to register at a rate of 30 to 35 per week in the first 3 months of the year. 508 new hedge funds were registered in the first quarter of 2007 (compared with 457 in the corresponding quarter of 2006), and, taking into account terminations, an additional 388 net new hedge funds were registered with CIMA in the first quarter of 2007 bringing the quarter-end closing total of active hedge funds to 8,522.

At this stage CIMA estimate that calendar year 2007 will be substantially similar to 2006, producing a net increase of between 1,000 and 1,200 new hedge funds.

Although many funds registered with CIMA in the second half of 2006 will have elected a first financial year-end date of 31 December 2007, and will therefore not file audited financial returns until as late as June 2008, the vast majority of Cayman's hedge funds registered under the Mutual Funds Law will now all file for the first time under the new e-reporting system between now and the end of June 2007.

CIMA and the local audit firms confirm that the first filings for hedge funds have now been made successfully under the new e-reporting system. By the third week of April 2007 Cayman based auditors had filed annual audited financial statements and FAR's for the first 21 hedge funds required to report electronically under the new regime.

Historically, CIMA has received and managed manually the audited accounts of the hedge funds that it regulates – an overwhelming, labour intensive and inefficient process. E-Reporting will make the entire filing, review and supervision process more efficient, and it will provide scalability and save time and resources by avoiding increased staffing numbers and costs.

The industry will benefit from e-reporting with CIMA committed to passing on cost savings produced by e-reporting by holding annual registration fees at current levels for as long as possible.

It is perhaps too early to say exactly how preparation and handling of the FAR's will be handled by both the operators of the registered hedge funds (directors in the case of a corporate hedge fund, general partners for exempted limited partnership and trustee's for unit trusts) and their service providers. Impact on the hedge funds themselves and operators is expected to be negligible.

Although operators may delegate completion of FAR's to service providers (in practice, likely to be the funds attorneys, registered office or administrator), the operator remains legally responsible for the accurate completion, and on time filing, of the FAR with CIMA and, importantly, the hedge funds audited financial statements for a reporting period cannot be filed by the auditor without of the FAR.

For independence reasons, auditors will not take part in the process of completion of FAR's, although they are likely to be provide the underlying financial data for completion of the FAR. Auditors will receive the FAR in electronic form from the operator of the hedge fund (or the hedge funds service provider) in the electronic form (e.g. e-mail, on cd-rom) specified by the audit firm and, in practice, audit firms are likely to also require a manually signed copy of the FAR to verify approval and signature by the hedge fund operator.

The involvement by auditors in the submission of FAR's as part of the electronic filing process had initially raised potential independence issues for auditors under US Securities and Exchange Commission (SEC) independence rules, but lobbying by CIMA resulted in the SEC confirming in November 2006 that the submission of FAR's by auditors under the new e-reporting initiative will not violate SEC auditor independence rules.

For those filing FAR's for the first time in 2007 the FAR itself, and Guidance Notes and Directions To Completing the Fund Annual Return, which were prepared by CIMA with the input and assistance of local stakeholders, can be obtained from CIMA's website at – www.cimoney.com.ky/ereporting.

The interest of international regulators and local service providers in the e-reporting process was always more significant than industry savings and security for audit filings, and attention will now turn to how, and when, CIMA will interpret and report data obtained from the more than 8,500 hedge funds now covered by e-reporting.

It will certainly provide more accurate aggregation and dissemination of industry statistics. We know that, but what of the detail? Certainly aggregate numbers for the value of assets under management by Cayman Island hedge funds globally and by geographical region, trends in net asset value performance for Cayman hedge funds as a whole (but perhaps also by country, geographical region and even city), average subscriptions, redemptions into Cayman hedge funds in each reporting period, percentage allocation of assets by investment managers to key hedge fund investment strategies, application/success of particular investment strategies in various geographical regions, the use by hedge funds of stock exchange listing services and the choice of stock exchange, minimum investment restrictions, the percentage of hedge funds suspending redemptions or valuations, summary of management and performance fees (by country, geographical region and even city . There will no doubt be many more.

CIMA and Cayman service providers have made much of the benefits of Cayman's new e-reporting system, and it really is an advanced step in the direction of effective regulation of the growing number of regulated hedge funds in Cayman. Cayman is already the clear jurisdiction of choice for the institutional hedge fund market and the successful introduction of e-reporting and the meaningful flow of industry relevant information will continue to set Cayman apart and will certainly continue to enhance Cayman's well-deserved reputation.

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