With COVID19 spreading in the Cayman Islands, MATTHEW FEARGRIEVE explains why R$200 billion of Brazilian offshore assets are at risk
1 APRIL 2020: the world’s largest offshore financial centre, the Cayman Islands, has reported 15 cases of COVID-19 and one death. The chief medical officer has confirmed that the Cayman Islands now have “community transmission” of the virus. The islands are in lockdown, with a nightly curfew and all flights cancelled. There are reports of the islands’ premier, Alden McLaughlin, allowing in one British Airways flight in the coming days, to enable out-of-work expats to leave.
In this article we will consider the potential devastating impact of the virus on the 4,000 financial services workers in the Cayman Islands who administer R$200 billion of Brazilian assets currently under management in Cayman investment vehicles. We start with an overview of Cayman’s investment industry.
Cayman Islands Financial Services
The news that the virus has arrived in the Cayman Islands and claimed its first casualty will only add to the woes of fund managers worldwide, in whose Cayman-domiciled investment vehicles an estimated US$7 trillion of assets are under management. This figure, the only official one currently available, is taken from the 2018 Investments Statistical Digest of the Cayman Islands Monetary Authority (CIMA), the jurisdiction’s financial regulator. This figure is likely now to be higher, given the long-running bull market that was only recently killed off by the pandemic.
Of this US$7 trillion, approximately US$40 billion (R$200 billion) is Brazilian investor money, and is held in Cayman Islands investment funds.
Brazilian investment in offshore investment structures
Brazil’s investment funds market is a regulated one. Open-ended investment funds require a daily NAV per share to be calculated, which has to be provided to the regulator on a daily basis. With the Brazilian Real being a non-deliverable currency, there is a regulatory requirement for Brazilian FX futures and options that are non-deliverable to be settled domestically. For Brazilian fund managers running liquid strategies with a hedge/FX overlay, an offshore vehicle is their only realistic structuring option. The Cayman Islands, with its memorandum of understanding (a sort of bilateral tax treaty) with Brazil, has historically been the jurisdiction of choice for Brazilian fund managers.
Post-2016, a number of US private equity managers have been investing in Brazilian real estate and hard assets, and Cayman investment vehicles have been in increasing use to establish JVs with Brazilian fund managers. The structure of choice for Brazilian fund managers in the illiquid space is a closed-ended master fund, with one Cayman-based feeder fund (set up as a Cayman limited partnership, mirroring the Brazilian Fundo de Investimento em Direitos Creditórios (FIDC)) together with a Delaware-based feeder fund to ensure segregation of US and Non-US-taxable investors. The Delaware feeder (LLC) effectively acts as a feeder back into the Brazilian fund that is responsible for opening the non-resident Brazilian bank account.
The net position as at Q2 2020 is that around R$200 billion of Brazilian investment is under management in Cayman Islands investment fund structures.
There are, however, some other numbers which take on a worrying significance in the wake of the arrival of coronavirus in the Cayman Islands.
Cayman Islands Population
The 2018 Compendium of Statistics, produced by the Economics and Statistics Office of the Cayman Islands (ESO), provides the most up-to-date official population and census figures in the three islands that comprise the Cayman Islands: Grand Cayman, whose largest centre George Town is home to the country’s financial services industry; Cayman Brac, and Little Cayman.
The ESO population figures for 2018 tell us that the Cayman Islands had a total population of some 65,000 people, of whom 4,425 were employed in the country’s financial services industry. Unsurprisingly for the 100 square-mile British Overseas Territory, financial services is the country’s biggest employer, with most offices being in George Town on Grand Cayman, the largest of the three islands with a population of some 34,000. These figures are for 2018, and are expected to be somewhat higher today.
But the ESO statistics make clear one salient fact: that the Cayman Islands’ US$7 trillion asset management industry is serviced by a group of people which in number would be easily contained on two or three floors of the average São Paulo office block. Nearly all of these 4,000-odd people live on an island that is 76 square miles in size. Nearly all of these people work in George Town; all 10 square miles of it.
Operational Risk to R$200 billion of Brazilian Assets
Indicative mortality rates provided by the World Health Organization are around 4%, but authorities acknowledge the potential for this to be considerably higher. Consider the number of workers currently in self-isolation or who have yet to manifest symptoms; there are not yet any official statistics for what proportion is represented here of the working population of each affected country. It has been reported that the number of cases of COVID-19 in the US is currently at around the 4,000 mark, which puts the US ahead of China in terms of infection.
It is easy to see the risk that a fast-spreading virus poses to a small, concentrated group of people living on an island of 76 square miles, with limited infrastructure and resources, and a restricted capacity for obtaining help from beyond its borders.
It remains to be seen how the virus will impact the workforce in the Cayman Islands, in terms of mortal and economic cost. But at present it has to be said that there is a serious operational risk to US$7 trillion of global assets managed in Cayman-domiciled investment vehicles. We know from the ESO figures that there are around 4,000 people who service these entities. Introduce COVID-19 into this population and in a short space of time there is not enough personnel to carry on the essential daily maintenance of them. As yet, there has been no indication from the islands’ financial services bodies or its government of any crisis management plan. Given the size of the islands, their extreme geographical isolation and their small population (with the skilled sector thereof being even smaller), it is difficult to see how the world’s largest centre of offshore assets could possibly carry on as normal were the virus to take hold.
Fund management companies (there are around 140 resident in the Cayman Islands, with real infrastructure and skilled personnel); cash and custodian services (there are some 200 banks and trust companies in the Cayman Islands, themselves holding around US$1.8 trillion, or 7% of global banking assets); unit issuance and NAV calculation (there are around 90 fund administrators in the Cayman Islands); oversight of the fund’s management by Cayman-resident directors; and provision of basic registered office functionality. The failure of these operational functions poses a substantial operational risk for Brazilian investors with R$200 billion invested in Cayman Islands investment fund structures.
MATTHEW FEARGRIEVE is an investment management consultant. You can read more of his blogs on how coronavirus will impact the asset management industry here: