Canada should embrace hedge fund HQs

Whether we like it or not, there are an estimated 8,000 hedge funds in the world today. According to reports, three-quarters of them are based in the Cayman Islands — a small island off Mexico that got rolling in 1962. They choose Cayman for tax reasons, which has served to create a cottage industry for professional services firms, and a bounty of directorships for every local Tom, Dick and Harry who wants a few (or more) lucrative board seats.

If Canada wanted to, she could make a couple of adjustments to the tax system and perhaps rule the hedge roost worldwide. It shouldn’t be lost on us that every few months, there’s an article somewhere about the frustration that global money managers have with the lack of transparency they find with the legal and organizational structure of hedge funds in the Cayman.

Here’s an excerpt from an FT piece from 2011:

Now, in the wake of the 2008 financial crisis, the Caymans’ fiduciary services boom is coming under pressure. Some of the world’s biggest investors in hedge funds – from UK pension schemes such as USS and Railpen, through to multibillion-dollar US funds of funds – are demanding transparency over exactly how many directorships individuals on the islands hold and whether they are genuinely acting in investors’ interests.

An investigation by the Financial Times can cast some light on to exactly how high the numbers can be: A document from one large international bank from 2006 reveals one Cayman individual on more than 560 boards, while analysis of current US regulatory filings shows another person with more than 250 directorships and several others holding more than 100.

Independent directors have already come in for criticism in two of the Cayman’s biggest hedge fund legal cases which dealt with the collapses of Beacon Hill and Bear Stearns High Grade Structured Credit.

“Before 2008 people could pretend it didn’t matter,” says Luke Ellis, who oversees $14bn of investments in hedge funds at Man Group, the world’s second-largest hedge fund manager by assets, from its London headquarters. “But it really mattered in 2008 and afterwards…the key was to have a board that stood up to a manager if it needed to.”

As much as the name “Cayman” sounds tropical and is equated with being a tax haven, Queen Elizabeth II appoints its Royal Governor and the island itself is a British Overseas Property. Greenwich, CT-based hedge funds domicile in Cayman purely for tax reasons.

For Canada, a short flight from New York, that makes no sense.

Canada has every reason to make the necessary tax changes to be able to attract the business of the world’s largest funds, with the support of their valued LP investors: a robust corporate governance system, very strict anti-money laundering controls, strong law and accounting practices, and a deep pool of experienced Board candidates.

I’m not saying it would be easy, since the Department of Finance would shutter at the thought. But here’s the thing: there is no tax currently being collected from international hedge funds by the Canadian treasury today. As such, if you set up the appropriate tax-free structure to attract them away from their Cayman or Isle of Man domiciles, Canada wouldn’t be any worse off. And it might grease the skids for Canada’s Common Securities Regulator (more on that in a moment).

And there’s precedent for onshore tax free zones. In 1989, the Hon. Mary Collins (then Assoc. Minister of National Defence and M.P. for Capilano-Howe Sound) decided that she was going to pick up the challenge of getting Finance to agree to designate Vancouver as an International Maritime Centre. I drafted letters to every relevant Cabinet Minister, and the argument was simple enough: there were no global shipping HQs in Canada, but many wanted to reflag here. The parent companies currently pay no worldwide tax as 3rd party goods travel between major international ports, but there are lots of high-paying white collar jobs at stake if you made the changes required to bring these shipping conglomerates to Canada, while preserving the tax-free status of the parent companies.

It took two years, and lots of presentations to people like Benoit Bouchard, Don Mazankowski and Mike Wilson, but working with the International Maritime Centre staff paid off. Vancouver is now a global centre for shipping headquarters, with 20 different operations; from zero in 1988. Canada didn’t lose a nickel of corporate tax, there was no leakage, and the dozens of foreign employees that moved to B.C. with their firms are all happy local taxpayers themselves. Helping to make Vancouver than much more of a global city.

The parallels to the opportunity with international hedge funds is eery. Rather than move ore between North America and Asia, funds move money. They currently pay no tax themselves anywhere, but their investors eventually do. The very sensible argument that attracted TeeKay Shipping (now a $2 billion revenue company headquartered in downtown Vancouver) should work for the U.S. hedge fund industry. And Canada already knows that this can be done without the sky falling in.

The bonus comes in the form of the carrot this would give Finance Minister Jim Flaherty with Canada’s much-needed common securities regulator. It would be easy to say that every province and territory that signs on to the National Regulator can also have its main business centre designated as an International Fund Management Centre, with tax free status available to each of the HQs of hedge firms that move to Canada from a tax haven abroad. Lawyers and Accountants from Vancouver, Calgary and Montreal who feared a loss of local business from the proposed National Securities Regulator might feel differently if they had 8,000 new corporate clients to market their services to. With one Cayman businessman being reported to have held 567 different hedge fund directorships himself, it seems to me there’s enough work for everyone.

The IMC worked for Vancouver, which was a natural location for the world’s shipping players. But Calgary, Toronto, Montreal, Winnipeg, Halifax, Saint John, etc. all have plenty of talent of a diferent sort. Our economy relies more on professional services jobs than ever. These are highly qualified, well-governed pros. It’s time we got more competitive as a Nation.

We share the same Queen as the Cayman Islands, after all, and a British Cabinet Minister is responsible for the outpost, so let’s not pretend our bureaucrats can’t figure this out. And fast.

MRM