In this curated interview, our consultants Graham Blyth and Will Koutney seek to shed light on the current state of the Cayman Islands’ insolvency market. Contained herein, you’ll find key insights from leaders on both sides of the insolvency equation, both the Practitioner’s (IP) perspective as well as legal counsel.
As the state of play seems to be changing by the hour, our subjects have attempted to offer a valuable mix of historical perspective, current developments, and predictions of things to come.
Insolvency Industry Interviewees
Grant is a Director at Deloitte in the Financial Advisory practice in the Cayman Islands with over 12 years’ experience in public accounting. He has been based in the Cayman Islands for the past 10 years and specializes in cross-border insolvency and restructuring, financial investigations and asset recovery solutions. In addition to being a CPA, CIRA, and CFE, he is a Cayman Islands qualified insolvency practitioner (IP) and works on a variety of assignments, including liquidations, investment fund wind downs, corporate restructurings, and providing dispute resolution and other advisory services.
Peter is Senior Counsel in the Walkers Insolvency and Dispute Resolution team in the Cayman Islands with over 12 years’ of international restructuring experience. Since joining Walkers in July 2013 from the UK, he has worked on a wide variety of complex cross-border insolvencies and restructuring mandates, both contentious and non-contentious, for a range of institutional clients, licensed insolvency practitioners and international law firms. He frequently appears in the Grand Court of the Cayman Islands, as well as acting on matters in both the Cayman Islands Court of Appeal and the Privy Council.
What role do you play in the Cayman financial services industry?
Peter: As an attorney specialising in insolvency and dispute resolution matters, a large proportion of my mandates are focused on assisting IPs with the orderly wind down of a fund’s affairs, often in the context of a Court supervised official liquidation process. In these circumstances, I will work closely with IPs with a view to seeking to maximise value to the estate and protect stakeholders’ interests.
This role may also require me to advise on or pursue claims on behalf of an entity in respect of potential misconduct of management in the period leading up to the commencement of the liquidation, as well as advising liquidators generally in respect of their ongoing statutory or contractual duties to a particular fund.
In addition to formal insolvency work, I frequently advise investment managers, directors and investors in relation to their respective rights and obligations to a fund and its investors as a matter of Cayman Islands law and will assist with the implementation and maintenance of best practice procedures. Such matters will be a particular area of focus for clients during an economic downturn.
Grant: The role of an IP in the Cayman financial services industry are wide and varied. An IP will often serve as a liquidator or a receiver, and depending upon a company’s circumstances and what process would produce the best outcome for the stakeholders, the role and duties of an appointment can be very different.
We will help stakeholders in situations where companies are insolvent or facing challenges with their cash flows, and in other instances when there is a dispute between management and its investors. IPs may also be appointed as a result of regulatory actions being taken against a fund or its management.
An IP will take control of a company, deal with and run the business, investigate what went wrong, report to the stakeholders. There might be complex legal matters, assets to be realized which are oftentimes illiquid, or negotiations with debtors and creditors to find a suitable outcome for the stakeholders. Ultimately, the activities of an IP will be driven by what is best for the creditors, and investors if the entity is solvent.
What value does the part you play add to market efficiencies?
Grant: The Cayman Islands caters investment and financial solutions to private investors who take comfort in the quality of professionals, robust laws and regulations, and the ability of the courts to handle complicated and distressed matters in a way that is fair and consistent with the rights of stakeholders, while also maximizing value.
When circumstances do not go as planned for stakeholders, IPs play a vital role in remediating issues and preserving investor confidence in the jurisdiction. In a circumstance where a bad actor has acted in a manner that damages stakeholder interests contrary to local law and regulation, IPs in Cayman play a critical role investigating such conduct and where appropriate commencing proceedings to recover for wronged stakeholders.
In addition, IPs can also be appointed as controllers by the local regulator, CIMA, in circumstances where the regulators consider that an entity or its management are acting contrary to stakeholder interests in violation of applicable law. This work all adds significantly to market efficiencies in the Cayman Islands, as well as elsewhere in the world given the very international nature of much of the work we do.
Peter: As the world’s leading offshore hedge fund jurisdiction, we are fortunate to have a very sophisticated financial services market in the Cayman Islands, supported by, amongst others, experienced professional directors, fund administrators, accountants and insolvency practitioners. I frequently advise these professionals on a broad range of practical issues, including in relation to asset realisation strategies, matters pertaining to potential breaches of fiduciary duties, the pursuit and defence of claims and day to day issues related to the winding down of an entity’s affairs.
Many of these mandates are commercially sensitive and high value, with the execution of a particular strategy often required to be implemented within a short time frame. Given the international nature of our work, I will often be required to work with onshore counsel across a number of jurisdictions and to coordinate an agreed approach with regard to a broad range of commercial and legal issues.
From a dispute resolution perspective, the Financial Services Division of the Grand Court (the “FSD”) specialises in the resolution of complex disputes arising out of the financial sector and allows practitioners to effectively manage large scale international litigation proceedings under the supervision of experienced commercial judges. The ability of the Grand Court to deal with such large scale and complex disputes is key to allowing such matters to be resolved in an efficient and cost-effective manner in the Cayman Islands. The vast majority of my contentious work is conducted within the FSD.
How does an IP interact with a lawyer?
Peter: An attorney will work extremely closely with their instructing IPs, providing advice on any legal and commercial issues arising during the liquidation of a Cayman entity.
Examples of the matters that an attorney will frequently advise on include compliance with statutory reporting requirements such as formation of a liquidation committee, the preparation and issuance of update reports to stakeholders and the Cayman Court, the payment of liquidation distributions, dealing with the potential pursuit of claims against former officeholders or other third parties and considering strategies for the realisation of assets and/or related negotiations. In reality, an IP will seek ongoing advice from their attorneys on a range of matters and a strong IP/lawyer relationship is critical.
One of the aspects of my job that I enjoy most is building relationships with my clients and this is particularly so in the context of large restructuring and liquidation matters in respect of which I will often speak with an instructing IP on a day to day basis over a period of months or years.
Grant: In a variety of ways. From the onset of an appointment until the conclusion of the assignment, an IP will work alongside a lawyer when undertaking investigations, asset tracing and recovery, defending or pursuing litigation, selling assets, adjudicating claims, distributing assets, and assessing regulatory matters. There are many more scenarios, but you get the point, IPs and lawyers interact on a variety of matters and having a strong working relationship is very important.
How do you foresee changes over the next six months and beyond?
Peter: The pace of change caused by the COVID-19 pandemic has clearly taken many people by surprise and the economic fallout from this crisis will no doubt be severe. Whether the hitherto unseen levels of government stimulus being pumped into the economic system can relieve the turmoil over the next 12 to 18 months remains to be seen. However, there will clearly be some high-profile casualties along the way and, from a distressed funds’ perspective, many of the same issues that arose during the 2008 financial crisis will likely have to be grappled with again.
Whilst many fund managers will be focussing on liquidity issues in the short to medium term, the prospect of increased redemption requests may once again lead to many funds being wound down, whether by way of an orderly wind down conducted by existing management or, alternatively, via a Court supervised process.
At present, it feels that we are still in the preliminary stages of governments and large financial institutions seeking to react to this rapidly changing landscape and few people could have envisaged the market volatility that we are now seeing on a day to day basis, with interest rates and oil prices reaching record lows and state backed financial stimulus initiatives massively increasing the role of big government in most capitalist economies. Therefore, whilst there can be no doubt that we will see a significant increase in distressed situations during 2020, the scale of the crisis faced by the global economy may not become clear for some time.
It may also be the case that businesses in certain industries or sectors will survive in the short term by significantly stripping back their operations and working with financial institutions and lenders to seek to maintain cash flow. However, in the absence of a strong rebound in consumer confidence and consumption, my view is that we are likely to see various waves of corporate restructurings and insolvencies for some time to come.
Grant: The obvious answer is we are expecting an increase in pandemic caused restructurings and insolvencies. There is extreme volatility in capital markets and widespread concerns around the pricing of assets. Add to this the oil production and price wars, where low prices are expected to continue for some time due to the oversupply and decreased demand.
As the COVID-19 issues intensify, we are already starting to see a significant uptick in distress related enquiries. So while it is evident that work in the insolvency and restructuring space will increase, what is not clear is the timing and to what extent.
We are in a preliminary stage of economic shock and companies are having to make difficult decisions. The situation remains fluid, and the global markets are unsettled and investors are very reactive to the evolving circumstances. As liquidity issues proliferate, we are seeing unprecedented relief being provided by governments, taking measures aimed at providing debtors the benefit of the doubt given the unforeseen economic forces that are out of their control.
But while these measures might maintain the economy on life support, they are not long-term solutions, and the global economy continues to shrink while in many countries the shock from the coronavirus has not peaked.
Only time will reveal the extent of the structural damage triggered by COVID-19 to elements of the economy and whether or not government intervention is simply delaying the inevitable for some companies.
We are all hopeful that the coronavirus crisis comes to an end quickly, but it is clear that companies on a global scale are in the midst of a very challenging time and significant damage has already been inflicted which will have to be remediated.
In your opinion, how well-positioned are funds to withstand economic turmoil? Any particular areas of strength or weakness?
Grant: There have been and will continue to be winners and losers in the fund industry. The coronavirus crisis will certainly evidence which managers can survive or even thrive on the ensuing volatility, and which cannot. The funds managed by those that cannot will be unlikely to survive in the medium term as investors seek to cut their losses and redeem their interests.
Early indicators show a wide spread in performance across the hedge fund industry and within strategies. The ability of a hedge fund to do well in these uncertain times will largely depend upon the steps taken by managers to protect funds from the instability in the market, as well as their ability to make investments that capitalize on market turmoil. Certain fund strategies will thrive in this environment and others might suffer.
For private equity, there are obvious industries that are expected to do well, such as healthcare, pharmaceuticals, and telecommunication. Utilities are better positioned then most industries as well, though they also may be exposed to decreased demand and delinquent customers. Then there are various industries that are suffering most, such as transportation, tourism, food and hospitality, manufacturing and construction, just to name a few. Funds that hold significant investments in these struggling industries are going to experience losses.
There are some hedge funds that are raising capital to try and capitalize on opportunities in the current market dislocation. And reports say there are also a number of private equity firms that have stockpiled cash due to the previously rising markets and the difficulties in finding good investment opportunities. Reports say this “dry powder” is at record levels, and these firms are no doubt looking to take advantage of investment opportunities resulting from the pullback on asset valuations.
Peter: Although commentators and analysts were increasingly forming the view that global stock markets were overvalued and that a market correction was likely to occur in 2020, the scale of market volatility seen in recent weeks is largely unprecedented and was unlikely to have been foreseen by many of even the most experienced fund managers.
However, whilst some sectors (for example, aviation, travel and retail) have undoubtedly been severely impacted by the closing of borders and increased social distancing measures being imposed on a global scale, other sectors (for example, pharmaceuticals and certain commodities) have undoubtedly fared better in the current climate.
Notwithstanding a fund’s exposure to certain sectors and geographic markets, a manager’s ability to maintain liquidity and to continue to meet the fund’s investment objectives will largely depend on the tools available to it for the purpose of controlling redemptions (whether via a gating mechanism, a suspension of redemptions or a side-pocketing of illiquid investments). In addition, it will be critical for fund managers to maintain an open dialogue with investors and to demonstrate a clear strategy for navigating the current volatility.
Some managers are considering restructuring funds or offering new classes of interests with different liquidity and other terms. Depending on the fund structure, there may be circumstances which require increased capital calls from investors.
There will also be a number of well capitalised funds who will see a wide range of opportunities and value in the market and who may seek to increase their positions in certain industries or sectors, whether through the primary or secondary markets. Much will depend on the particular trading strategies which are in place.
How does the current environment differ to the 2008-09 crisis?
Peter: This is undoubtedly the biggest challenge faced by the global economy since the 2008-09 crisis, however, both the scale and underlying causes of the present crisis are in many ways unique.
In particular, whilst the 2008-09 crisis was largely a consequence of the huge and unsustainable increase in personal indebtedness fuelled by the sub-prime mortgage crisis, the precipitous halt in global economic activity caused by COVID-19 is without parallel, causing states to close their borders and quarantine billions of people almost overnight, thereby preventing large sections of society from working and going about their daily lives in a manner that has never been seen before in peacetime.
Despite the scale of funding proposed by governments to seek to offset the economic and social disruption caused by COVID-19 already dwarfing the funding provided during the 2008-09 crisis, it is already unclear if the amounts pledged by governments will be sufficient to allow economies to avoid the most serious consequences of a deep recession.
Clearly, the primary goal of any government must unquestionably be to minimise the human cost of the pandemic and save lives. However, with social distancing likely to be the norm for much of 2020, the ongoing economic cost of the crisis will grow exponentially as more and more businesses are forced to close or downsize and consumer demand remains subdued. How quickly governments can safely and effectively redeploy and reengage large sections of the workforce in order to get their economies moving again remains to be seen.
Whilst it is therefore difficult to predict with any certainty what the ultimate economic consequences of COVID-19 will be, it is apparent that a massive and coordinated global stimulus initiative will be required in the long term to allow economies to recover and limit the social turmoil arising from this crisis. How long such initiatives will take to bear fruit remains to be seen.
Grant: I think it is easy to look at the current environment and think it seems familiar to what was experienced in the financial markets during the 2008-09 financial crisis.
However, the triggers to these crises are very different, and it is therefore very difficult to draw parallels, or to use 2008-09 as a predictor of how the global economy will emerge from 2020.
The 2008-09 financial crisis caused a recession due to systematic failures in the financial markets. This was the result of years of missteps and festering issues, primarily stemming from the significant and reckless lending by banks to subprime borrowers.
What we are going through now was not caused by issues in the economy, it’s been triggered by a pandemic. This is more comparable to a downturn caused by a natural disaster than a financial disaster. Following a natural disaster, businesses and lenders are usually better positioned to bounce back and recover compared to the disruption caused by a financial disaster. However, there are some significant differences in the economic shock caused by a natural disaster compared to those being caused by the coronavirus. Primarily, the uncertainty in the amount of time it will take to overcome the coronavirus and for the global economy to stabilize. So, we do not know the extent of the shock or how the path towards recovery looks.
It is possible, however, that the proliferation of issues being caused by the coronavirus will reveal or accelerate further cracks in the financial markets and regulators and investors around the world must be ready to respond.
In your opinion, will there be any particular types of fund strategies that will be vulnerable to the global economic destabilization being given rise to by the COVID-19 pandemic?
Grant: COVID-19 is driving market volatility and, in many instances, material changes in asset valuation on a daily basis. This may change how some managers run their investment operations. Some managers will have considered how to reposition investment portfolios and will reassure investors that the firm is managing through the volatility.
I think the response to the economic turmoil is different depending upon the type of fund we are talking about, hedge funds or private equity funds.
The rule of thumb for most hedge funds is to make money despite volatility in the market and to protect investors’ capital in a downturn. That said, there will be some hedge funds that have used leverage to try and enhance returns but have not adequately applied hedging strategies, and declining asset values will amplify losses and create some real liquidity problems in trying to manage their margin and collateral requirements.
Reports from February showed that the hedge fund industry was successfully preserving investor capital, with the average hedge fund losing only 1.46% in February according to Hedge Fund Research. However, early indications are that March has been a more challenging month.
For private equity funds, the impact might be even more significant. There are funds that have been patiently waiting to deploy capital, and the current market will present plenty of opportunities to invest in undervalued or distressed assets. For other funds, the low cost of debt over the past decade has resulted in private equity funds holding positions in highly indebted companies due to the use of leveraged loans. As the economy contracts, asset values drop, which will translate to losses for many private equity funds. In the short term, governments and banks may provide access to credit and other financial relief, but if the coronavirus crisis continues for an extended period of time, valuations of companies may not recover quickly, certainly not in all sectors, and refinancing will become very challenging.
Late stage PE funds that were expecting to monetize investments in companies that have been hit hard by the disruption caused by the coronavirus will be considering their alternatives, such as extending the realization timeline of its investments. Then there will be the early stage PE funds that will have invested in assets whose values have dropped significantly, and it might take a long time to recoup these losses.
Peter: Funds with highly concentrated investment portfolios in certain sectors may be susceptible to large scale losses.
Similarly, investment managers and directors who have failed to invest in accordance with a fund’s stated investment objectives could potentially be subject to claims from dissatisfied investors (albeit that such investment objectives or mandates are typically very broad).
In addition, funds that are unable to impose restrictions or limitations on substantial outflows of capital in the short term will likely experience liquidity issues, particularly if the fund’s underlying investments are comprised of largely illiquid assets with no easily ascertainable market value. Fund managers and directors should therefore be taking a pro-active approach to preserving a fund’s value and engaging with investors in a transparent manner when developing a strategy to respond to the current turbulence in the markets.
Do you foresee debt holders looking to restructure/swap for now-cheapened equity?
Peter: Debt for equity swaps are one of the numerous strategies that will be considered by debt holders in a distressed situation and will likely depend on the parties’ respective bargaining positions.
As noted, there are a number of well capitalised funds whose investment profiles will lend themselves to taking a long-term equity position in entities which now appear under-valued. Such strategies may also be adopted by large institutional investors seeking to exert control over an entity by building an equity stake and leveraging that position to exert control over the future strategic direction of the target entity.
Conversely, companies seeking to restructure their affairs may seek to vary or cram down existing debtholders by implementing a scheme of arrangement, the practical effect of which could be to convert an existing creditor’s rights to equity.
At a macro level, a direct consequence of increased government bailouts may be the nationalisation (whether in whole or part) of certain strategic sectors (for example airlines). As was the case following the 2008-09 crisis, the taxpayer may therefore end up owning an ever increasing and broad range of state backed assets, with little prospect of such assets being realised in the short to medium term.
Grant: A debt to equity swap is a restructuring alternative to eliminate the liabilities of a company and improve its liquidity. So if a company is distressed, a debt to equity swap might be attractive to a lender instead of forcing a company into insolvency. This might be a particularly attractive approach when a company is undervalued or is expanding but facing liquidity issues, as it will allow the company to continue as a going concern and the former lender will participate in the future growth of the company.
However, there is currently a lot of highly indebted companies due to the excessive use of leveraged loans over the past decade. Further, the global economic outlook does not look positive, the markets are volatile, and there is no clear timeline of when the coronavirus will be under control. So some lenders may be reluctant to swap their preferred debt position for equity with the uncertain future. Of course there may be circumstances where a low priority lender has no better alternative, and no doubt there will be a multitude of approaches explored to help companies survive in the current environment.
Do you see any larger implications for the macro economy?
Grant: The coronavirus pandemic is negatively impacting large sectors of the macroeconomic environment at an alarming pace. While this is true for the global economy, as matters progress I do think the economic disruption and impact of the coronavirus will vary across geographies. The financial measures and the policy innovation of some governments will be more successful than others, and we must also factor in the different degrees of medical infrastructure and the effectiveness of a government’s response to the coronavirus from country-to-country. So I think the economies of certain countries will be more resilient than others.
Regardless of where we are headed, much damage has already been inflicted, and the economic impact of the current crisis and its aftermath will take months, if not years to play out. One thing that is certain is insolvency and restructuring practitioners around the world will play a vital role in the eventual recovery.
Peter: The pace of change to previously established behavioural norms and working practices over the past four to six weeks has been unprecedented. Industry change had already begun in legal services, for example, namely in terms of technology and automation, but COVID-19 will accelerate the pace of transformation. There is no doubt that such changes will have a profound impact on the legal services industry as well as the macro economy for a considerable time to come.
The widespread adoption of social distancing, the abrupt halt in both domestic and international business and leisure travel, the decline in business confidence and investment and the potentially long-term social impact caused by mass unemployment and ongoing health concerns have already caused, and will continue to cause, a significant shift in global economic activity.
Whether the increased role of national governments in seeking to stimulate the global economy will lead to long term shifts in the manner in which traditionally free market economies have functioned remains to be seen. However, there is no doubt that many of the initiatives now being implemented at the request of the financial sector – such as the bailing out and nationalisation of key sectors, and the provision of guaranteed levels of income to large swathes of the population – would have been unthinkable even a few months ago.
There is now a growing consensus that all of the world’s major economies are entering a deep and potentially prolonged recession. This will lead to an increased amount of restructuring and insolvency mandates for IPs globally and the fallout from the present crisis will likely take a number of years to work through.
However, we have seen that markets have bounced back from previous crises, and that previous recoveries have been quicker and stronger than anticipated. Clearly, the challenge for governments going forward is to implement a response to COVID-19 that will allow consumer confidence, and economic activity to recover as quickly as possible, without reintroducing undue risk to populations.