The legal side of the Asian hedge fund industry

Kate Hodson, Ogier
Kate Hodson

Kate Hodson

Regulatory issues are frequently mentioned as a major issue for many of Asia’s hegde fund managers. HFC’s Stefan Nilsson wanted to find out more about the legal side of the Asian hedge fund industry and decided to have a chat with Ogier’s Kate Hodson. Hodson has been working in Ogier’s Hong Kong office since 2010 and has been promoted to partner in the firm from August. Kate advises a large number of sponsors and fund managers as well as their onshore counsel on the establishment and structuring of hedge funds, private equity funds and other closed ended and opened ended fund structures. She also advises managers, trustees, family offices, HNMWIs, administrators and other service providers on fund related issues and other corporate matters. Kate has particular experience in partnership and unit trust structures and advises an extensive number of Japanese clients, including some of the largest investment houses and prominent fund managers in Japan. She has an international client base with a particular focus on clients in Asia, including Hong Kong, Tokyo, China and Singapore.

 

What is your background and what brought you to Asia and the hedge fund industry?

Well Asia, in particular Hong Kong, is home. My English parents moved to Hong Kong in the late 70s. I was born and have lived in Hong Kong for over 20 years, and spent just under two years in Singapore. Whilst I trained as a lawyer in the UK, I always knew I’d be back to Asia. I started my career as a banking and finance lawyer in London with Allen & Overy, and it was the move to Hong Kong nearly six years ago and joining Ogier that got me into the hedge fund industry. I’ve not looked back since.

 

What do you see as the biggest legal challenges and issues for offshore fund managers operating in Asia today?

Fund managers around the globe have been thrown a few regulatory hurdles of late, with new requirements imposed on their businesses such as under FATCA and AIFMD. This has had major cost implications and for smaller and even larger managers looking to access capital in Europe, this can pose a significant barrier. Fund managers have had to deal with a surge of compliance requirements – requiring new people, processes and at times, technology. This will have impacted profit margins and restricted some managers from being able to build their infrastructure and grow – and there are also serious implications if they get it wrong.

 

Corporate governance is high up on the agenda in Asia, including the role of independent fund directors. In your opinion, what are the main issues?

I think the focus here has to be on identifying truly independent fund directors with the right skills, who will offer the checks and balances that this role demands. However, particularly as independent directors are under pressure to keep down their number of directorships, the costs of these appointments can be an issue for funds with small AUMs. To access bigger ticket investors, funds are going to need to be able to show that they have strong corporate governance in place. Appointing appropriately skilled and independent directors to the board is just one step towards achieving this.

 

Cayman Islands and other offshore financial centres have in recent years been more criticised and questioned than perhaps ever before. What impact does this have on the alternative investment industry and how it operates?

These offshore jurisdictions are often in the firing line for negative PR. However, this is not always deserved and has at times been allocated in a blanket manner. I think the majority of investors in Asia generally appreciate this or at least won’t let it scare them from investing into jurisdictions that they are familiar and comfortable with, and with managers that they trust. However, at the same time, it remains a cause for concern and ultimately it is down to the relevant jurisdictions to respond appropriately. Looking at the Cayman Islands in particular, it has done its fair share of co-operating with international regulators. It was one of the first offshore jurisdictions to sign up to an IGA with the US for FATCA and it has taken a number of proactive steps to adopt best practice international standards as well as strengthening its anti-money laundering regime. Whilst offshore jurisdictions have had to defend themselves against the criticisms, international pressure has most likely had a positive impact on the alternative investment industry, as jurisdictions such as the Cayman Islands, BVI, Guernsey, Jersey and others have updated their legislation and addressed transparency while looking to maintain their competitive edge. Some of these changes have added to the compliance burden on the industry, but looking at the Cayman Islands for instance, this doesn’t appear to have dented its attractiveness to Asian investors, and it remains one of the most popular and widely used jurisdictions for offshore transactions.

 

One of the issues in the Asian hedge fund industry is the relatively small size of assets managed by a typical Asian fund manager. A small AUM also means lower revenues and less likelihood of running a profitable business. Some managers cut corners by using second-tier, cheaper service providers. Is this a problem that investors should worry about?

There is a lot of comfort that comes with appointing a large financial institution as a service provider. However, in Asia there is also an appetite for accepting smaller boutique firms to do the job, especially given that a number of banks have started to withdraw from this area due to regulatory changes such as the Volcker Rule. In Hong Kong, this is such a competitive space that administrators have had to stay ahead of the game, and many have proven that going with a “tier 2” firm by no means leads to a drop in service. One outcome of the financial crisis has been renewed attention and a growing awareness of custodial risk. Yet, the larger financial institutions offering prime brokerage have been paring back their services to the smaller hedge funds and it is becoming harder for these managers to secure the support, technologies and services they require. The space is now more competitive with a new wave of players having entered the market and while these smaller sized firms will fall short of the levels of capitalisation of the big primes, they are at least driven to provide additional tools, functions and solutions to their client. The overall result is that there are now more options in the market for fund managers to choose from. Ultimately, the details of a fund’s service providers will be disclosed in the fund’s offering memorandum so that investors can make an informed choice about whom they are “getting into bed with,” so to speak.

 

We have seen a number of asset management-related frauds in Asia in recent years. Subsequently many investors are now spending more time on operational due diligence and scrutinising funds and their service providers. Has this had any impact on Ogier’s business in Asia? Do you check potential clients more thoroughly now?

Compliance is clearly a big area of focus for us as a leading offshore law firm. We can’t afford to get it wrong. It means we are constantly growing and reviewing our KYC processes – every client has to be analysed from a take on perspective and kept under review during the life of the relationship. We have a dedicated team working on this. Of course, clients do get frustrated with the amount of evidence and documentation they have to provide when all they want to do is get the deal done. But we have observed that they are getting used to these processes now, having come up against similar requests when opening bank accounts and appointing other service providers, so generally speaking we find the gathering of information a little smoother these days. The importance put on these procedures has undoubtedly strengthened of late and all lawyers in the firm are required to undergo training and to stay up to date on Ogier’s policies and procedures.

 

What do you think the future looks like for the hedge fund industry in Asia?

With regulatory improvements across the region, the ability to manage risk has developed and the industry has become more sophisticated. Added to this, a competitive environment and global regulatory pressures has meant that fund managers have had to adapt and to bring about product diversification and a broadening of investment strategies. The overall picture is that Asia is well set for growth, despite the ongoing challenges. But the industry certainly hasn’t gotten easier – it has actually become harder to navigate, but perhaps more professional as a result.

 

If you hadn’t been a lawyer, what would you have been doing for a living?

A complete pipe dream, but if I could have made a career out of sailing then I would have done it! As it is, I’m content for it to remain a weekend activity with an offshore race to the Philippines each year – a good way to unwind.

(Jul 2015)