Investors can be patient people, but a recent uptick in insolvency petitions in the Cayman Islands suggests many are running out of patience with fund managers struggling to realize illiquid portfolio assets.
According to Tony Heaver-Wren, a litigation and insolvency partner with Appleby in the Caymans and co-author of a paper on the subject, the increase in petitions in 2013 has its roots in the 2008 financial crisis.
“When the global financial crisis hit, it was in summer 2007 and early 2008,” Heaver-Wren told FINalternatives in a recent phone interview “but you'll see the petition statistics for the year 2008 were very modest...which in some ways is surprising because you'd think in the midst of that systemic global crisis that the petition filings would have been at a peak.”
The relatively muted petitions stats for 2008, he said, show that investors and fund managers alike were “shocked numb” by the sheer magnitude of the financial crisis. “[I]t took the whole of 2008 pretty much...for the dust to settle and people to take advice and consider what they were going to do...”
In 2009, people began to respond and the result was a spike in petitions calling for the appointment of official liquidators (including winding-up petitions and conversion of voluntary liquidations), which increased 410% relative to 2008.
“You see the spike in petitions because all of those these investors were inclined to say, 'I'm not prepared to wait; I'm not prepared to listen to the promises of investment managers given they were in control when it crashed,' these people all said, 'Formal process please,'” said Heaver-Wren.
The Appleby paper focuses on the two types of insolvency petitions mentioned above—winding-up and conversion of voluntary liquidations—as harbingers of investor sentiment.
Heaver-Wren defines a winding up petition as “an out and out application to wind up the company.” It comes in two flavors: the first is a petition filed on a debt basis “where the company is insolvent in the commonly understood sense of being unable to pay its debts.” The second “is where there are just and equitable grounds to wind up the company.”
Heaver-Wren said debt and insolvency petitions are filed by creditors while just-and-equitable petitions are generally instigated by shareholders.
The second type of petition, a conversion petition, is filed where “the liquidation starts its life as a voluntary liquidation but it gets converted to a court-supervised liquidation because the company can't continue liquidation on a solvent basis,” said Heaver-Wren. “It used to always be used where the parties wanted a voluntary liquidation but for one reason or another the directors couldn't swear a declaration of solvency and therefore the company had to go into the court-supervised [liquidation]."
“More recently, it's been used as a very streamlined entry into a court-supervised liquidation because if you take this route, all that is required is a special resolution of shareholders that the company be wound up...As soon as that resolution's passed and the liquidator's consented, the voluntary liquidator is appointed without any court involvement.”
Some of the investors who chose to wait in 2009, ran out of patience as early as 2010. That year, said Heaver-Wren, saw fewer insolvency petitions than 2009 but still far more than normal.
But 2011 and 2012 saw a further ebb in petitions as more investors opted for negotiated solutions, mandating investment managers to carry out soft wind-downs:
“A soft wind-down is somewhat analogous to a debtor in possession,” said Heaver-Wren, “where...the management team stay in place, the directors stay in place, however there's no formal court process, rather there's consent by the stakeholders to the arrangement where time is given to try and realize assets, without recourse to a formal liquidation process...”
“Investors who take this soft wind down alternative don't want a fire sale of the assets, they want to get the best return that they can and they accept that the realities of life as they currently exist are, essentially, that 'if we want to see anything of value, then it's going to take some time.'”
There were a lot more of these negotiated solutions in 2011 and 2012, he said, with “returns coming through those processes in varying degrees that were keeping people more or less happy.”
By 2013, however, six years out from the actual crisis, even the most stoic of investors were becoming restless and dissatisfied. Moreover, by 2013, as markets began to recover, those investors had other places to put their money.
Said Heaver-Wren, investors began to think: “'I'm just going to cut my losses and I'm not prepared to keep paying this manager...when...I don't feel we're achieving value.'”
That thinking led to the spike in Caymans insolvency petitions in 2013—up 33% over 2012—and Heaver-Wren thinks it could drive an even bigger spike in 2014.
“Investors are coming unstuck from their allegiance to these programs, increasingly, they are not happy to wait. There are more rumblings about veering away and doing their own thing with a formal process. And I think that's going to continue because there's still a lot of people that are locked up...I would be surprised if we don't at least have the same figures as 2013 and probably more.”
That said, he was quick to add that there are a lot of variables at play and market developments could make viable sale of assets that for long periods have been unsalable.
“If the markets become stronger, [there may not be] a huge increase in petitions—not because this analysis is wrong, but because that provides an alternative exit, it revives the hopes of an exit using a soft wind-down.”
Managers have come under a lot of criticism, said Heaver-Wren, but many are continuing to work very hard to return money to investors.
“Life has never been harder for managers than in the last few years,” he said.