| Hedge funds: many common characteristics, but still no legal definition |
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| 23/01/2005 | |
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This might be the last regulatory frontier for financial regulators. Under close monitoring throughout the world in 2004, hedge funds nevertheless still lack a legal definition. This is the case in the United States, where the Securities and Exchange Commission (SEC) officialised last month a decision obliging hedge funds with more than 15 US investors to register by 2006. "There is no legal definition of hedge funds. It is a generic reference to funds which have liquidities and that are private, that is, not registered", recalls David Goldstein, a hedge fund lawyer at the New York office of White & Case, a law firm. "People have to free themselves from the understanding that hedge funds are only about some particular strategies. They have to be understood as sharing these two characteristics. After all, even classic mutual funds use hedging strategies", he says. In the United States, hedge funds are included in the "private investments" category, which is characterised by the absence of regulation. In turn, these funds are only accessible to accredited and institutional investors. Stringent regulation Even the French regulator, the AMF, which framed one of the world's most exhaustive regulations for hedge funds in 2004, does not give any clear legal definition. One of the main reason for not clearly defining what is to be understood as a hedge fund is the constant transformation of the sophisticated strategies used by alternative manager. Giving hedge funds a clear-cut definition, explains the AMF, would be the same as putting a whole series of strategies into a box, potentially leaving many more outside. Nevertheless, the French regulator points out that the alternative strategies used by hedge fund managers generally seek a decorrelation with the markets as well as absolute returns. But if there is no way to know once and for all what is a hedge fund, where does the new French regulation apply? The answer is simple and circulatory at a time: to the extent that a fund is using one of the alternative vehicles created by the French financial authority, it can be described as a hedge fund. These vehicles enable the manager to use various strategies such as the shorting of assets, a lower dispersion ratio, as well a higher leverage effect than what is allowed in traditional vehicles. In turn, the fund can be marketed only to some predefined categories of investors, as in other jurisdictions. Catchall definition Elsewhere in Europe, where regulation is not as developed as in France, the issue of giving a definition to hedge funds face similar hurdles. For instance, here is what the Financial Services Authority (UK) has to say with regard to hedge fund: "[…] it would be difficult to define the term "hedge fund" to allow authorised "hedge funds" to become a category of authorised fund to sit alongside others. The term "hedge fund" has no generally accepted definition an attempts to devise one would include a wide range of presently unauthorised schemes." In Ireland, one of the main centres of the European hedge fund industry, the Irish Financial Services Authority (IFSA) stands along its counterparts in other countries, saying that there is not legal definition and even not one widely accepted definition for this type of fund. "There is no legal definition of "hedge fund" within the Irish regulatory regime for collective investment funds and such funds generally have no clear cut definition. The term "hedge fund" is commonly used to describe a variety of different types of investment vehicles that share some similar characteristics. In its broadest form it refers to investment funds which can engage in short selling techniques and utilise derivatives extensively. Also, many hedge funds use high levels of leverage", explains Marina Kelly, who works at the Financial Institutions and Funds Authorisation department of the IFSA. Oddly enough, it is in Germany, where only a buy-side regulation exists, that a somewhat stricter legal definition exists. Hedge funds are defined by the Bafin, the German regulator, as "institutional investors whose managers have a free choice of investment markets, instruments and strategies and may invest largely free of statutory restrictions". Julien Laplante |
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