The Regulation of Hedge Funds

The Regulation of Hedge Funds: A Global Perspective Date: 9th of May Presented by: Dr. Ana Maria Fagetan (University La Sapienza of Rome) Overview Of The Presentation - The rationales for the regulation of hedge funds; - The regulation of hedge funds in Europe: The AIFM Directive: the purposes, authorization process, criticism; - Conclusions The Rationales Of Hedge Funds Regulations  There are three objectives that provide the rationale for financial regulation in general and for hedge fund regulation in particular. These objectives are: 1. Protection of investors 2. Promotion of market integrity 3. Preservation of financial stability.  Investors protection concerns the strand of regulatory attention directed toward making sure that investors' interests are conducted against market failure or unfavorable behavior within institutions possessing investors funds.  There are some factors that turned the protection of investors into one of the most visible objectives pursued by financial market supervisors and lawmakers worldwide.  Among the most important factors of the protection of the investors, it is essential to mention: the noneconomic, paternal basis of many of the current financial market regulatory frameworks, the public desire for outer (governmental) regulation, together with the supervision of private self- regulation (mainly in times of crisis), the prejudicial economic results emerging from the "loss of investor confidence in the aftermath of market failures", but also from the high amount of empirical proof or researches stating that there is a casual connection between tighter investor protection regulation and financial market increase.  Lately, the focus has been on increasing investor protection in direct relation improving hedge fund valuation, particularly because an accurate valuation appears as critical on several grounds. Thus, on the one hand, measuring and reporting the performance of hedge funds to investors is done according to the changes over time of the fair value of their assets.  Nowadays, investors carefully track a fund's performance in order to make accurate decisions of whether keeping or not their capital with the fund, meanwhile when investing in a new fund, they also analyze its past performance before making a decision of investing or not with the fund.  The protection of market integrity represents the second aspect of regulatory interest in the field of financial investments. This occurs as one major determinant concerning each investor's capability to transact the business he/she manages in a transparent, fair background, and in the absence of discrimination, manipulative market conduct, secret agreements, and different abusive conducts.  The solution of market integrity problems raised by hedge fund market activities should be searched in: the effective implementation of the existing rules rather than in the introduction of new ones, devised with hedge funds and their operations in mind and the investors' accomplishment of the regular due diligence checklist suggested by sound investing procedures and constant precaution  A long time after the financial crisis, the long shadow it has cast has started to fade. Most post-crisis prudential policies have already been decided, financial stability being one major issue in this respect. Thus, the protection of the financial system stability, by means of ongoing systemic risk mitigation represents the third major motivation concerning financial market regulation and its primary objective.  Some aspects were considered very important in terms of financial stability: recurring financial crises during the last two decades, in association with the progressive liberalization (deregulation) and increasing integration and interdependence of global capital markets. These have progressively shifted the focus of the contemporary regulatory policy debate from micro-prudential (investor-related) to macroprudential (systemic stability-related) issues. The Regulation Of Hedge Funds In EU and AIFM Directive - The Alternative Investment Funds Managers Directive (AIFM) implements harmonized requirements for financial intermediaries involved in the management of alternative investment funds (AIF) in the EU. - The Directive defines an alternative investment fund (AIF) as any collective investment scheme that requires no authorization in compliance with the UCITS Directive. This extended definition was meant to include institutional vehicles which previously did not fit the perimeter of the EU financial regulation, among which one can mention "hedge funds, absolute return' funds, private, private equity funds, collective investment schemes, real estate funds, fixed property funds" and other types of investment funds. - AIFS management and administration experience certain limited exceptions, especially for the EU-domiciled AIFMs authorized as per the Directive. Purpose of the AIFM Directive  The purpose of the AIFM Directive is to regulate all major risk sources in th alternative investment value chain by guaranteeing that alternative investment fund managers (AIFMs) are authorized and undergo periodical and continuous governing and that robust regulatory standards govern key service providers, including depositaries and administrators.  The Directive seeks to attain also the improvement of the transparency of the AIFMs and their managed funds in front of supervisors, investors and other key stakeholders.  In addition, the Directive needs to guarantee that all governed bodies comply with the appropriate governance standards and benefit of robust systems for the risk, liquidity and conflicts of interest management.  The Directive also intends to enable AIFMs to market funds to professional investors throughout the EU, subjected to compliance with imperative standards. Authorization Process  The authorization received from the responsible authorities in its EU home Member State is compulsory to every alternative investment fund manager (AIFM) intending to manage or market an alternative investment fund (AIF), according to the provisions of the Directive.  The Directive contains a de minimums exemption for managers who directly or indirect manage AIF portfolios holding minimum EUR 100 million integral assets. This threshold is raised to EUR 500 million for managers who: 1. Only manage AIFs without employing any leverage, and; 2. Do not assure investors the right to redemption for minimum five years from the day of a fund's inception.  One of the preconditions of authorization is that an alternative investment fund manager (AIFM) should provide all officials in charge, detailed information observing, inter alia, ownerships details, features of the alternative investment funds the company intends to trade, all adjustments for the delegation of management functions and the appraisal, as well as safekeeping of portfolio assets.  More broadly, the AIFM has to assure the competent authorities that it is able to observe all the basic requests of the Directive.  After receiving the authorization, the alternative investment fund manager (AIFM) is enabled to provide management activities to alternative investment funds (AIFs) settled in any Member States, but also to market the securities of the AIFS managed to professional investors within the EU. In the short term, this passport it is only accessible to EU-domiciled AIFs and AIFMs. However, it was carefully considered and granted the extension of the passport to non-EU domiciled managers and funds in 2013. The passport of the AIFS who are operating in the UK will be discussed further on.  Once an AIFM received authorization under the Directive, it must provide full compliance with substantive requirements observing, inter alia: 1. Conduct of business, governance and risk management; 2. Third party appraisal and safekeeping, but also 3. Open, periodical as well as event-driven disclosure to investors, competent official bodies and also to some third parties stakeholders. Criticism Of The Directive - The Directive causes controversy at various levels. The uniform regime that th Directive intends to enforce on a wide range of distinct AIFS is one of the controversial issues. This implies purely national funds without any evident systemic security relevance. Many of these are regulated at national level by now. However, credit institutions or insurance companies are excluded. This occurs despite the implementation of an EU-wide fund risk monitoring regime, other than the legal one, only for certain funds. - Another major source of concern is the similarity of the AIFM directive and other previous EU Directives. Thus, an example could be the Prospectus, the Transparency, as well as the Market Abuse Directives. - The MiFID already regulates open-ended and listed, closed-ended investment funds. In addition, the assertion of the necessity to require a double license on management firms operating simultaneously UCITS and non-UCITS funds, the directive brings forth arguable issues in the regulation of such sectors where clearness is an essential element.