Investor-manager disagreement on governance reform, according to CIMA survey
Major discrepancies continue to exist between investors and managers over corporate governance standards, while 86% of investors want to be provided with details of the number of boards directors sit on, according to a survey commissioned by the Cayman Islands Monetary Authority (CIMA).
Fifty-four per-cent of hedge fund managers said corporate governance standards were “fit for purpose” compared with just 11% of investors. Not one investor rated hedge fund governance standards as “outstanding,” and 71% felt major improvements were required.
Fifty-three per-cent of respondents expressed concerns that directors did not devote sufficient attention to each fund board they sat on. A lack of transparency among directors about the number of board relationships they occupy has been an investor gripe since 2008. Half of investors told the CIMA study they did not receive information from directors about board numbers, which led to questions about independence, conflicts of interest and concerns over capacity.
CIMA is currently in the process of revamping corporate governance standards in a move that has been welcomed by institutional investors. However, the reforms are likely to be delayed following a judicial review against CIMA by DMS, a Cayman Islands-based professional services firm, in a bid to prevent the regulator from acting upon the findings of its survey. The judicial review has angered investors, which accuse DMS of delaying implementation of the proposals. The legal challenge is all the more strange given that CIMA has not even published its proposals yet.
One expert said he was surprised by CIMA’s decision to publish the survey findings, adding it would pile pressure on vested interests in the Cayman Islands. “CIMA has faced pressure from a number of institutional investors over the years, and some have been flying regularly to Cayman to discuss corporate governance issues with them,” said the expert, who did not want to be named.
While CIMA’s proposals have yet to be determined, the majority of experts, including Kevin Ryan, founder of HedgeDirector, an independent director platform, predict the regulator will create an online database listing directors either on a fund-by-fund basis, or provide a list of funds each Cayman-registered director sits on. The latter has been endorsed by institutional investors such as the USS and the Chicago-based fund of funds Mesirow Financial, which argue a database would help streamline the operational due diligence process.
A survey of operational due diligence professionals by Deutsche Bank’s prime brokerage business highlighted corporate governance was an area of interest, with 34% of investors acknowledging they would devote additional resources to this area over the coming year. Nearly a quarter of respondents to the Deutsche Bank survey said they had vetoed an investment due to a lack of independent governance.
A database could be a major challenge to DMS’s business model, which has faced criticism over the number of boards its directors sit on. Critics argue their directors are overstretched and could be found wanting in the event of another crisis, while others complain the firm is not transparent about making public the number of boards its directors sit on. However, DMS has repeatedly said its infrastructure is solid, and held strong during the recent financial crisis, adding it is open with investors about the number of relationships its directors have.
“Any online database that CIMA proposes must ensure that directors are searchable by name and provide a comprehensive list of all the hedge fund boards they sit on – otherwise the entire exercise is redundant. If the database simply is done on a fund-by-fund basis, it will offer nothing. Investors can already get this information from the hedge fund prospectus. Creating a comprehensive database will help investors with their operational due diligence,” said Ryan.
Others, including James Newman, head of operational due diligence at Barclays Wealth, argued a public database is inevitable. “If no public database is created by regulators, a third party will create one. However, I believe Cayman regulators are determined to make changes in corporate governance,” he said.
A more extreme approach by regulators would be to impose a hard and fast cap on the number of boards directors sit on. Seventy-five per-cent of investors told the CIMA study they would like to see directors sit on fewer than 25 boards, while 72% of managers said it was acceptable for directors to sit on up to 50 boards.
Even the most ardent proponents of governance reform argue a regulatory-enforced cap would be counterintuitive, and self-regulation will better serve investors, managers and directors alike. Any limitation on the number of boards an individual should occupy is bounded to have unexpected consequences, since no rule can take full account of the complexity of the industry. Sitting on the board of a straightforward European or American-focused long/short equity fund probably requires fewer man-hours than sitting on the board of a complex, esoteric hedge fund running a large number of bespoke swap transactions.
Opponents of caps point out a limit would increase hedge fund managers’ costs at a time when margins are incredibly thin, while it could add another barrier to entry for smaller firms. CIMA’s survey indicated that more than 39% of those opposing caps felt restrictions would facilitate an exodus of experienced directors, and half said it could lead to directors moving to less well regulated jurisdictions. Seventy-five per-cent said it might result in under-qualified directors entering the space.
“I do not subscribe to the argument that changing the rules will lead to under-qualified people becoming directors. If anything, it will lead to better qualified directors, as industry experts with a diverse range of skillsets become involved, as opposed to individuals with just fund administration and custody backgrounds,” commented Ryan.
The survey, which was sent out in winter 2013, was completed by 57 hedge fund managers, 28 investors, 32 fund directors and 62 service providers.