On 6^th October 2020, the European Union removed the Cayman Islands from its so-called blacklist of non-cooperative jurisdictions for tax purposes. This is good news for the offshore investment funds industry, but focus will now turn to demonstrating compliance with the various measures introduced by the Cayman Islands to ensure its removal from the list.

Reportedly one of the reasons for being placed on the blacklist in February 2020 was the delay to implementation of the Cayman Private Funds Law (CPFL). The CPFL reflected a clear directive by the EU to place closed ended private funds on a similar regulatory footing as open ended hedge funds which were already subject to the Cayman Mutual Funds Law.

Whilst the CPFL became law in February, existing funds were only required to comply from August.  Some 12,000 + funds registered by this deadline. The CPFL not only requires funds to register with the Cayman regulator, CIMA, but comply with a number of operating requirements, such as cash flow monitoring, record keeping, custody and asset ownership verification, which are heavily based on the depositary role under the EU Alternative Investment Fund Managers Directive (AIFMD).

There is a view that in the rush to meet the deadline to register funds with CIMA, not enough consideration has been given to the compliance with these operational requirements which private funds and their managers will now need to promptly address.

The registration of private funds will also shine a spotlight on those taking responsibility for compliance with the Cayman AML Regulations, with the identity of the AML officers of private funds being reported to CIMA for the first time since the revised AML Regulations came into Law in 2018.

At the same time, the Cayman Islands is under pressure to demonstrate its regulations are being complied with and commentators note that a greater level of enforcement is expected to result. In preparation, CIMA have updated their fines regime with significant fines for non-compliance with the CPFL, AML and other regulations.

We would be pleased to speak with firms that want to ensure that they are fully complying with the Cayman Private Funds Law and AML Regulations.  As a regulated AIFMD depositary, we are ideally placed to enable compliance with the CPFL operational requirements and our market leading CIMA AML officers service can immediately ensure compliance of this function without internal officers taking the personal risk.

By Jon Masters, Head of Business Development, INDOS Financial

INDOS Financial recently concluded a project to enable the Alternative Investment Management Association (AIMA) to become carbon neutral. It has been a pleasure to support AIMA through this process and help them achieve this important goal. As part of INDOS’ own focus on corporate social responsibility, we became a carbon neutral organisation in 2019. We have since assisted clients achieve the same status as part of our broader range of ESG oversight and assurance services for asset managers and their funds.

We would be delighted to assist other firms with their carbon neutral process. To find out how we can help please contact us at [email protected].

On 20^th September 2020, approximately 2,600 documents were made globally public, having been leaked from the Financial Crimes Enforcement Network (FinCEN) to BuzzFeed News and the International Consortium of Investigative Journalists (ICIJ). The FinCEN Files are primarily made up of records of the suspicious activity reports (SARs) submitted by Banks and Financial Institutions (FI) to FinCEN authorities between 2000 and 2017.

It should be noted that the filing of SARs is encouraged by Financial Regulators worldwide and is in line with international anti-money laundering standards in order to raise concerns of money laundering, terrorist and / or proliferation financing. FIs use SARs to report suspicious behaviour, but they are not proof of any wrongdoing or crime by the underlying client, just a suspicion that is more than fanciful. They do however offer the individuals and institutions a degree of protection against money laundering offences in the case of knowing/assisting an offence.

One of the key concerns raised from the leak is the continuation of business with clients for which an FI has submitted a SAR, and the purported lack of action from that FI and the authorities. Headline cases coming from the leak include big name banks that purportedly allowed fraudsters to move millions of dollars of stolen money around the world, even after being informed by  US investigators a  scheme was a scam, and another involving the movement of cash for a bank more than a decade after the client’s accounts had been used in funding terrorism.

In addition to the severity of the issues raised, the amount of money involved with the SARs leaked is staggering, as the estimated total transaction value tops USD2 Trillion. The number of different FIs involved in the leak also demonstrates the global nature of international money laundering through some of the world’s biggest banks.

The FinCEN Files have clearly shown that the system of reporting suspicious activity is well established, and this is certainly a good thing in combating money laundering. However the lack of action and capacity to address the SARs and stem the flow of money laundering has now been exposed and it will be interesting to see whether the FinCEN exposure leads to change.

By Matthew Queree, Head of AML, INDOS Financial 

The process of becoming carbon neutral has been around for over two decades. In recent years, the number of businesses including many in the asset management industry becoming carbon neutral has increased significantly. Obtaining carbon neutral status is an excellent way for asset managers to demonstrate to investors and other important stakeholders such as their employees they take environmental, social and governance (ESG) matters seriously. The carbon neutral process involves collecting data about a company’s carbon emissions which is then sent to an independent auditor to verify as a form of ESG oversight. Carbon credits can then be issued to the company, thereby offsetting the emissions.

Usually, the process for asset managers is straightforward: identify activities creating emissions such as the use of electricity (business premises) or business travel. However, in 2020 and the impact will be different. As a result of the Coronavirus,  many office-based employees are working from home, a  practice which is likely to become more widespread in future. Companies should therefore consider how to reflect this within their carbon footprint analysis.

While working from home as a trend existed before Coronavirus because of factors like access to faster broadband, the pandemic has accelerated this trend exponentially with over 45% of workers now reported to be working at home till at least the end of the year. This has exposed issues with the current system for counting emissions since from the standpoint of the measurement standard used, work from home (WFH)  emissions form part of a company’s “Scope 3” emissions which place them in the same category as the emissions from the products a traditional company sells. Placing WFH emissions within this category makes it optional to report whereas the inclusion of “Scope 1” office emissions are mandatory.

There have been reports that working from home is more beneficial for the environment as commuting travel has decreased. These savings are quite large, as much as 5% of a staff member’s footprint. This is likely a seasonal benefit due to the mild summers where emissions are lower. In the winter behaviour shifts as heating is needed and emissions from natural gas from boilers increases. For a typical flat, the emissions can lead to an additional 0.3-0.8 tonnes of CO2 over a year. For  companies with a lot of staff, this will start to represent a sizable amount of their emissions. Under the current measurement standard companies would under-report emissions as reporting WFH emissions, being a scope 3 emission, is optional and usually excluded.

From a broader asset management perspective, firms often do not fully understand the scale of scope 3 emissions as a whole. Ian Stannard, a Data Strategist at Urgentem commented: “it’s not just the magnitude of the impact that can surprise portfolio managers and asset owners, but also the distribution of the impact across sectors within a portfolio”. What the “new normal” in terms of work from home practices becomes is unknown. However, with work from home expected to increase significantly scope 3 emissions, already the largest category of emissions, is set to grow. Encouraging measurement and full disclosure of these emissions will be beneficial for transparency and enable effective ESG oversight within the asset management industry.

Robust fund governance and proper oversight play an integral role in safeguarding the fiduciary interests of investors. Shortfalls in fund governance standards were well-documented during the 2008 financial crisis – and while there have been material improvements, events at the Woodford Equity Income Fund and H20 Asset Management illustrate there is still more work to be done. Nonetheless, a combination of intense global regulatory and institutional investor pressure is prompting more asset managers to further enhance their internal operational processes and fund governance practices.

Regulators turn the screws on fund governance

Across the world, regulators are pursuing a fiercely proactive crusade against substandard corporate governance. The EU is widely seen as being the bellwether on governance reform, having introduced the Alternative Investment Fund Managers Directive (AIFMD) in 2014, which imposed heightened risk management and oversight provisions on EU asset managers. Among the AIFMD’s requirements included an obligation that funds appoint a depositary to oversee their operations. In recent years, some depositaries have been recognised for providing pertinent information and views to fund boards enabling them to fulfil their fiduciary duties. On a local level, EU member states have also legislated on governance. For example, the Central Bank of Ireland (CBI) pushed through the CP86 framework, which insists that managers appoint at least two, independent resident directors to their boards.

Elsewhere, the UK’s Senior Managers & Certification Regime (SMCR) imposes strict accountability requirements on financial institutions including asset managers and their boards. It is not just the EU that is focussed on weak governance practices.. The US Securities and Exchange Commission’s (SEC) Office of Compliance Inspections and Examinations (OCIE) regularly issues risk alerts outlining its concerns following routine examinations of investment advisers.  Its most recent alert warned about the conflicts of interests at private funds, identifying examples of preferential client treatment and erroneous fee and expense practices. This blunt OCIE briefing should serve as a reminder to private funds that improvements are needed in their governance and compliance processes. Similarly, offshore fund centres are also taking meaningful action on the issue of fund governance. The Cayman Islands Private Funds Law – introduced in August 2020 – subjects private equity firms to added regulatory registration requirements and depositary provisions largely mirroring the AIFMD.

Investors prioritise governance

Having initially remained on the side-lines in the early stages of the  COVID-19 pandemic, institutional investors are once again beginning to allocate capital into alternative funds. While inflows have picked up since the nadir of the crisis, institutions are being highly selective when making their investment decisions. Simply having a solid performance track record is not enough to win mandates. Investors want assurances that fund houses have best of breed operational and compliance processes in place, including strong governance, especially in light of the issues at Woodford and H20. In this competitive market, asset managers are at risk of missing out on mandates if they cannot demonstrate that their governance and oversight measures are robust.

An external, independent provider makes the difference

Even though the appointment of a depositary is a legal requirement under the AIFMD and best practice under the Cayman Islands Private Funds Law, it could potentially become more ubiquitous even in jurisdictions where it is not mandated, especially if investors – having observed the benefits depositary confers – start asking for it.

Historically, depositary has been seen by many managers as a routine tick the box exercise, but these attitudes are gradually beginning to shift. The best asset managers are those that take a smarter approach to regulatory compliance and think holistically about governance and compliance across their businesses and address multiple regulatory requirements. They view functions such as depositary as something that should add value to their business and clients, thereby creating efficiencies and enabling them to better manage compliance and regulatory risk.

Moreover, asset managers need to take a more thoughtful approach when appointing a depositary. While a one stop shop provider (i.e. a service provider offering custody, fund administration, depositary, and other services) is often seen as a cost-effective and simple solution, it also has significant weaknesses. Not only does the bundled model create heightened counterparty risk, but there are inherent conflicts of interest and a lack of independent oversight and challenge.  There is no guarantee, for instance, that a depositary affiliated to a fund administrator will flag operational issues as readily relative to an independent provider. As a result, the affiliated model is not always in the best interests of investors to whom managers and fund boards have a fiduciary duty to protect.

By Bill Prew, CEO, INDOS Financial