Monday, June 15, 2009

Hedge funds crave regulation

Hedge fund regulation will be successful and in fact will benefit hedge fund firms if:

1. Managers can run both regulated and unregulated money (if one wants to manage her family money - assuming she has a wealthy family - for example, regulation for that pool of money just does not make sense).
2. The specific regulatory regime applies to a fund registered in the jurisdiction of regulation, not the fund manager (who can be anywhere).
3. The regulated product receives a clear stamp of approval from the regulatory body.
4. The regulated fund has sufficient flexibility to implement it's strategy (appropriate liquidity, leverage, and asset classes) while disclosure requirements do not jeopardise the strategy.
5. The regulated fund can be easily marketed within it's regulatory jurisdiction (without ambiguities on what can and can not be presented to potential clients).
6. The regulatory jurisdiction is large enough to make fund "registration" (application to operate as a regulated fund) worth while.
7. Regulatory requirements/compliance can not be cost prohibitive.

European regulators may be on to something (see comments from Paul Allen /Financial News). Ucits (the EU directive on undertakings for collective investments in transferable securities) III and IV structure seems flexible enough to appeal to a number of managers. Ucits may address all of the requirements above:

1. Ucits allows managers to run regulated and unregulated money as long as it's the regulated funds that are marketed in the Eurozone.
2. Ucits applies to a specific fund, not the manager.
3. Regulated funds will undergo a regulatory approval process that can be used as a "stamp of approval".
4. Liquid funds such as Brevan Howard (macro/fixed income) can comply with the Ucits requirements for certain strategies. Daily valuations, diversity requirements, Value at Risk based leverage limitations, etc. are achievable for these strategies.
5. Ucits compliant funds can be openly marketed in the Eurozone which is -
6. - certainly large enough to make registration/compliance worthwhile.
7. Ucits allows, in fact encourages outsourcing of activities to independent entities such as custodial banks, audited administrators, audit firms, valuation agents, risk measurement agents (Measurisk, Riskmetrics, etc.), technology/infrastructure firms. As long as these services are reasonably priced (and in this environment they better be), costs can be controlled.

Hedge fund firms will in fact create new product that will be Ucits compliant. The more success they have with this program the more hedge fund money will become regulated.

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