| Hedge fund regulation: a new breeding ground for regulatory activities |
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| 21/11/2004 | |
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For the first time, hedge fund managers throughout the world face the development of national regulations. This new face of the industry comes alongside the credibility loss suffered by the traditional offshore hedge fund management centres after a string of scandals, as well as the widening of the industry's investor base. This is not a detail to be overlooked given that the industry has thrived on the absence of regulation. In fact, major hedge fund centres have bloomed where legal exemptions made the financial acrobatics possible thanks to advantageous disclosure and activity rules as well as a weak taxation. In turn, places such as Ireland, Luxembourg, and the Carribean, have all become hedge fund administrative centres. On their side, alternative investment companies, in a bid to be closer to their wealthy clients, have generally remained onshore, with London and New York as the two most important hedge fund powerhouse. Tightening rules But a wind of change is now blowing. Among one of the strongest signals, the new focus on regulation by various financial authorities, which seek to increase the transparency of the industry while making it accessible to both regulated institutions and retail investors. In this spirit, the Securities and Exchange Commission adopted on October 26th a rule making registration mandatory for most hedge funds in the US, where alternative funds have traditionally enjoyed a total freedom from any sort of regulation. Currently, about half of the US hedge funds are registered with the SEC. According to SEI, an US-based investment manager, hedge funds with a least 15 US clients will have to comply with most regulations that pertain to traditional registered investment funds, minus for prudential rules, which are left untouched. That is, while managers will continue to enjoy full liberty in the design of their investment strategy, they will have to keep detailed written records of all actions and fully document all performance claims going forward, monitor more intensively the possibility of conflict of interest, determine the allocation of trades in advance, and adhere strictly to deadlines for personal trade reports. Those measures are mainly designed to increase the level of transparency of the industry, and sanctions from the SEC can be expected for those not abiding by the new rule, that should come into force in February 2005. "For better or for worse, a regulatory revolution has occurred, and you have to take it seriously", said David Tittsworth, Executive Director of the Investment Counsel Association of America, who took part in a seminar organised by SEI investment. "You can either view it as a total burden, or decide to make it a business opportunity by saying: We're going to make compliance integral to our firm and what differentiates us from our competitors", he said. Degrees of regulation If the American approach to regulation will not directly affect the management of hedge funds since it doesn't address strategic issues, other regulators are adopting a heavier-handed stance by setting prudential rules for onshore hedge funds. This is the case of the French regulator, which has just created new investment vehicles designed to boost the national hedge fund industry. On the contrary to the SEC, the French regulator has taken the step to set a maximum leverage of 4 times the invested assets of a fund. "This maximum leverage gives a sufficient leeway to most hedge fund managers", explains to Pauline Leclerc-Glorieux, the deputy director of the saving products and provider service of the French financial regulator. Countries such as Switzerland, France, Germany, and Italy, now all have incipient regulatory framework, either for hedge funds or funds of hedge funds that usually says which category of investor can buy alternative products, usually by setting a minimum initial subscription. Germany allows the private placement of hedge funds only via registered financial advisors, while Italy permits the public distribution of funds of hedge funds. The trend seems to be for most jurisdictions to stick to a gatekeeper role by accrediting investors willing to subscribe to hedge funds, while leaving the managements of those funds unregulated. At this time, only Luxembourg, Switzerland, the Netherlands, and France – where the first local hedge funds should appear by the end of 2004, authorise the marketing of local and foreign hedge funds to their citizens. But only France and Ireland have an actual regulatory framework for the creation of regulated local hedge funds. In the UK hedge funds are totally unregulated – and consequently off-limit to retail investors - but are nevertheless obliged to register with the FSA, which has led British alternative managers to strongly oppose the mandatory registration with the SEC. Going forward, the Committee of Economic and Monetary Affairs of the European Parliament even produced a report in which it envisioned a EU-wide regulatory regime for "sophisticated alternative investment vehicles", which would include hedge funds. The time might still not be ripe for the harmonisation, but hedge fund regulations are now definitely popping up throughout Europe. Julien Laplante |
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