Hedge fund redemptions: a new ruling may help stabilize markets
There is no one single definition for a hedge fund: they represent a broad swath of investment fund types and a near-infinite number of investment strategies and tactics. There is little doubt, however, that they are very much in the news on a daily basis, as the global economy continues its downward trend and world financial markets experience extreme levels of volatility. Hedge funds are vehicles intended primarily for very high net-worth individual and institutional investors. The Mutual Fund Law of the Cayman Islands, which regulates more than 10,000 registered fund entities, stipulates a minimum investment amount of $100,000 to underscore this fact.
In fact, the Cayman Islands are home to an estimated 50 percent or so of the total global hedge fund industry. Data through the end of 2006 from the Cayman Islands Monetary Authority (CIMA), which regulates hedge funds, indicate total fund assets under management of approximately $1.38 trillion. It can therefore be said that hedge fund-related legal decisions taken in the Cayman Islands, a jurisdiction subject to the common law traditions of the United Kingdom, may be taken very seriously among participants in the global hedge fund world.
The hedge funds news most commonly encountered in the financial press today concerns the volume of attempted liquidations by panicked investors heading for the exits, hurriedly fleeing to quality – at this point, quality means U.S. Treasury securities and very little else. However, hedge funds generally are not among the riskiest asset classes from a portfolio management standpoint. Hedge fund measures like the HFRI and Credit Swiss Tremont indexes usually demonstrate average volatility levels (using a risk metric-like standard deviation) somewhere less than common equities and more than bonds. Where hedge funds differ from other investments, like U.S. SEC-registered mutual funds or NYSE-traded common stocks, for example, is that they are not freely tradable on organized securities exchanges, and investors who want to sell out of a hedge fund position must go through a specific process – generally called redemption – to do so.
On December 12, 2008, a landmark decision was issued by the Cayman Islands Court of Appeals that sets a definitive precedent, grounded in principles of U.K. common law, regarding investment fund redemptions. The ruling affirmed the right of an investment fund to suspend redemptions in times of extreme market volatility and uncertainty – a clause that is part and parcel of the Articles of Association of a vast majority of funds and often also set forth in the offering document. Anthony Akiwumi, Head of Litigation at Cayman-based law firm Stuarts Walker Hersant, who successfully argued on behalf of the investment fund, notes the importance of this ruling, “as it marks the first such ruling in favor of an investment fund to occur at the appellate level in a common law-tradition country.”
Akiwumi adds that the implications of the recent decision will not be lost on fund managers and investors following this development: Funds will be able to rely on their powers of suspension according to how these are set out in the legal documents of the fund. For investors, however, there are also potential avenues to pursue depending on how long the suspensions continue – it is far from certain that a fund can simply continue to invoke its suspension powers indefinitely.
One thing is clear however: “In the current market climate these issues and problems will come to the forefront,” says Akiwumi. That should keep specialist law firms like Stuarts Walker Hersant, with an extensive funds advisory practice and detailed familiarity with Cayman law, regulations and practices, burning the midnight oil for some time to come.
