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Regulators to Impose a Clamp Down on Hedge Fund Managers

Ian Allison

28 February 2006

The Financial Services Authority has confirmed that a consultation paper on the regulation of hedge funds will be released next month as managers face a clampdown in both the UK and the US. A spokesman for the FSA told WealthBriefing: “A consultation paper is about to follow the discussion paper issued in June last year. This consultation paper will appear at the end of March.” A special hedge-fund unit has been set up to be headed by Andrew Shrimpton. London’s hedge fund managers must now register with the Securities and Exchange Commission if the fund has 14 or more US investors and one hundred London managers have registered with the SEC so far. “The two sets of rules will be similar and legislation will be leveled up to the highest standard,” said the spokesman. For example, if the SEC requires records going back four years and the FSA has only stated three year’s worth then managers operating in London and the US will adopt the four year requirement. “We are not going to regulate hedge funds; we will regulate the hedge fund managers based in the UK. And we will not be pooling with regulators in the US, we will remain independent,” the spokesman added. There are concerns about confusion, the fact that firms will have two similar sets of rules to adhere to could mean duplication of workload for the compliance department. The FSA’s discussion paper entitled "Hedge funds: A Discussion of Risk and Regulatory Engagement” summarised key risks associated with hedge funds. The industry can expect: increased thematic reviews of hedge fund managers; the implementation of a regular "Hedge Funds as Counterparties" survey that gives the FSA insight into the hedge fund/prime broker relationship and regulatory dialogue involving the Financial Stability Forum and the Joint Forum. The FSA also wants to improve investor due diligence and hedge fund disclosure, and provide its own guidance on appropriate disclosure standards, in particular with respect to side letters or managed accounts. It will issue health warnings about the quality and independence of some hedge fund valuations and encourage improvements in hedge fund valuations. With regard to issues such as increased disclosure of contracts for difference positions, the Takeover Panel is proposing to put these and other derivatives on the same footing as shares in relation to disclosure during an offer scenario. This would, however, require legislative change which goes beyond the FSA's remit, and it awaits consideration of this issue by the UK Government in the context of its consultation on implementing the Transparency Directive. The Alternative Investment Managers Association acknowledges calls for the use of third party administration and price providers, as well as the issue of an independent board of directors and division of duties. Florence Lombard, executive director of AIMA said: “The global hedge fund industry is constantly seeking to review and improve its practices. This is clearly evidenced by the work being carried out by AIMA and its members in the areas of asset pricing and fund valuation.” Since 2000, the number of hedge funds in the US has doubled to more than 8,600 with total assets now $1.1 trillion, according to Hedge Fund Research of Chicago, hitting the same ball park as the mutual fund total. In addition many hedge funds have lowered their minimum investments from $1 million or more to $100,000 or even $25,000. Rules require fund managers to register with the SEC are designed to combat fiascos such as Bayou Management meltdown last year, which cost investors $450 million. These rules provide a modicum of transparency and allow SEC regulators to perform inspections of hedge funds. However, some funds are skirting the regulations by holding onto investors' money for a minimum of two years, making them exempt from the registration requirement. In addition the National Association of Securities Dealers is looking into whether its members market funds of funds to clients for whom they are not suitable.