Due Diligence Matters - March 2023 Bulletin
Our flexible Operational Due Diligence (“ODD”) work, and coverage, continues to grow rapidly.
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James Newman will be speaking at ‘The Institutional Investor and Asset Manager Consensus 2023 Roundtable’ and will also be attending GAIM Ops Cayman next month.
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Regional bank failures and counterparty risk
The events of the last week, most notably the failure of Silicon Valley Bank (SVB) have re-introduced the threat of banking failures, at least for those not categorised as systemically important. Whether this bodes ill for the banking system in general is impossible to determine at this stage, but it certainly raises levels of counterparty risk in the banking sector to a significantly higher level. For investment managers and investors, transparency will be vitally important to maintain confidence, specifically how counterparty risk is managed both at the fund level and at the underlying investment level, particularly in the tech sector and other start-ups where regional banks play an important role. Our ODD services can help bridge the information gap between the investment manager and the investor to maintain confidence and understanding in these uncertain times.
What do recent bank collapses mean for crypto hedge funds?
In the world of crypto, it is not JP Morgan, HSBC, Wells Fargo or any other familiar institutional bank that provides the essential bridge between fiat USD and crypto assets for hedge funds and other crypto intermediaries. Until very recently, this function was performed primarily by two banks: Silvergate and Signature. These were conventional banks in the traditional sense (federally regulated and FDIC-insured for USD) but were notably smaller niche lenders which had spotted the opportunities in providing traditional banking services to the crypto sector. While there are some other banks that service the crypto industry, Silvergate and Signature both had the advantage of payment networks that could move fiat cash to and from intermediaries, such as crypto exchanges, in real-time and 24/7. This made them the banking providers of choice for hedge funds and for key crypto market participants such as crypto exchanges and stablecoin issuers. We struggle to think of many fund reviews we have conducted that did not feature Signature or Silvergate as the main bank account provider.
Last week was the most challenging in the banking sector since the 2008 financial crisis. Following well-documented concerns about its financial health in the wake of the FTX implosion, Silvergate confirmed on 8 March that it was entering voluntary liquidation. The failure of the US’s 16th largest bank, Silicon Valley Bank, a provider to many crypto startups, as well as the USDC stablecoin, followed on 10 March albeit with all depositors fully backstopped through the Fed’s newly created Bank Term Funding Program (BTFP). Finally, news broke on 12 March that Signature Bank had been closed by the US banking regulators (again with all depositors fully backstopped). So, with both Silvergate and Signature banks having failed within the space of one week, crypto hedge funds are faced with the challenge of finding replacement fiat banking services. A key question for the crypto industry is whether other providers will be able and willing to fill the void. Will these be conventional banks, or crypto-native firms? Will these firms have strong enough balance sheets and good enough technology capabilities? From prior reviews we note that Sygnum Bank (Switzerland), Deltec (Bahamas) and Wintrust (US) have provided fiat banking services to crypto hedge funds, and that Sygnum Bank started seeing an increase in enquiries after Silvergate’s collapse.
In our crypto ODD reviews, we constantly probe and challenge managers on their counterparty and service provider relationships. The crypto banks provided an essential 24/7 service to match the 24/7 world of crypto. For ODDers, responses to these challenges will remain high on the agenda in the coming weeks and months.
ODD Report Solution Clients
Investment Managers and Service Providers with a perfORM ODD Report will be announced here from April onwards.
Regulatory compliance support?
Adam Palmer will be working along-side us, as an expert ‘on-demand’ compliance consultant leveraging off 20 years UK regulatory compliance experience.
Adam is the highly respected former Partner and UK Regulatory Compliance Business Unit Lead at ACA Group. In his career, Adam has held both in-house and consulting roles giving him a deep insight into both regulator and investor expectations across with a broad portfolio of investment / asset management firms including hedge, private equity, infrastructure, UCITs, Crypto and long only managers. Projects have included regulatory change management (for example SMCR, MiFID II, Consumer Duty), building and implementing compliance programmes, regulatory review / assurance and board advisory work.