In March 2020, some of the UK’s prominent property funds froze around £11 billion of assets as a result of the anticipated economic impact of the COVID-19 pandemic. The vast majority of these funds are domiciled offshore, to take advantage of the low taxation regime. Freezing the funds was a protective measure by fund managers as a result of an unprecedented level of requests for redemptions by investors.
A year later and several funds are still suspended. As a result, investors are becoming increasingly frustrated at their inability to recover their investments. We, and offshore law firms with whom we work closely, are now seeing complaints and claims against offshore fund managers, directors and corporate service providers. This will no doubt be of concern for insurers who write insurance in the offshore sector.
Fund suspensions
Funds can be suspended when the fund faces large numbers of redemption requests and, at the same time, cannot sell assets quickly enough to meet the demand. Typically, fund managers are therefore forced to control liquidity by suspending withdrawals. Fund suspensions are particularly common where the underlying asset class within the fund is illiquid - such as property assets - and cannot be sold promptly.
Whilst temporary fund suspensions are not uncommon, and are often used as a mechanism to ensure that the value of the fund is preserved during a period of particular volatility, if the suspension continues for an extended period, investors can become restless and seek to recover their investment from the professionals involved in managing the funds. This can be exacerbated where the suspension itself leads to loss of confidence in the manager and a reduction in fund values; there is a risk of an unchecked downward spiral taking effect.
Due to market volatility during the COVID-19 pandemic, a number of funds have either been suspended for a long period, or been subject to regular temporary suspensions over the last year. As a result we are starting to see professionals involved with funds being subject to particular scrutiny.
Offshore regulators are also particularly interested when funds housed in their jurisdiction become suspended. They are keen to act in a robust manner to protect the reputation of their jurisdiction as a location in which investors can safely keep their assets.
As insurers who write business in the offshore sector will be all too familiar, if a fund remains illiquid, it can result in the fund’s insolvency even if its fundamental asset base is sound - with a liquidator being appointed to secure a recovery for creditors. The appointed liquidator of the fund has an obligation to examine the reasons why the fund became insolvent which usually involves reviewing the acts of the directors responsible for running the fund and the other professionals’ accountability for the fund’s performance.
Concern for insurers?
If there is a shortfall in investor redemptions, due to the fund being suspended or worse, becoming insolvent, this can lead to claims against the offshore professionals involved with the funds. Any rise in claims will have an impact on the underwriters who provide insurance to the offshore sector.
Typically offshore professionals will look to their D&O and Professional Indemnity polices for payment of, at a minimum, defence costs, should they face civil claims or regulatory interest.If insurers receive a notification arising out of a fund suspension, a key consideration will be which is the appropriate insurance programme to respond. This can be particularly important as the D&O policy is likely to have a limited retention whereas other policies may have significant self-insured excesses. Insurers will also need to ensure that issues of other insurance are adequately considered. This is particularly the case in circumstances where a corporate service provider may have its own insurance programme as well as protection from the fund’s insurance arrangements.
Defence costs can be significant when dealing with claims in offshore jurisdictions. We are often engaged by insurers to monitor these claims and work with local firms to manage defence spend and ensure that a strategy is devised to resolve the claim as efficiently as possible.
Within this coverage and monitoring role we are increasingly being engaged by London Market Insurers to draft litigation guidelines to ensure that the parameters under which local lawyers incur fees are clear from the outset of the case. This is an important tool in ensuring that adequate reserving provisions can be made by insurers.
Offshore jurisdictions have typically been seen as benign claims environments but, with the impact of COVID-19 still being felt, this may be set to change.
DAC Beachcroft currently work with almost all the law firms in the major offshore jurisdictions and we can assist in drafting litigation guidelines and managing defence spend as may be needed.
