U.K. Standards Board Wants Hedge Funds To Open Up
July 1, 2009
London’s Hedge Fund Standards Board today recommended that hedge funds hire out their operational work to independent parties who would be responsible for custody of, recordkeeping on and valuation of assets.
The self-regulatory association of 56 large hedge fund managers also wants hedge fund managers to provide more disclosures on possible restrictions on redemptions. Comments on the HFSB’s best practices are due by August 21.
The HFSB is adding its voice to a growing chorus of trade groups on both sides of the Atlantic that are calling for the multitrillion dollar industry to improve its operational procedures after well-publicized scandals, involving, for instance, the feeding of funds into Bernard Madoff’s $65 billion Ponzi pyramid. The alternative, they argue, is increased regulation by securities enforcement agencies.
The HFSB has opposed the European Commission’s draft legislation issued earlier this year to require hedge funds and private equity funds in Europe to register and regularly give details on trading strategy, risk management, asset valuation and capital levels. While President Obama’s financial reform proposal released last month also calls for the registration of large hedge fund advisers and more detailed reporting it falls short of addressing the issue of independent recordkeeping.
Madoff’s Ponzi scheme highlighted the importance of independent oversight of a fund’s operations. Madoff, now facing a 150-year prison term, performed all of his operational work in-house. “A hedge fund should do what it reasonably can to enable and encourage the fund governing body to appoint a third party, independent of the manager in charge of administration to ensure the segregation of functions and the avoidance of conflicts of interest in relation to the calculation of the (net asset value) and the maintenance of the accounting records of the fund,” wrote the HFSB in its consultation paper.
The HFSB also said that the recent surge in hedge fund redemptions reflects a perverse scenario: long-term investors are being penalized for their loyalty because other short-sighted investors want to “rush to the exit” by redeeming. The direct and indirect costs of the liquidity cushion, which the hedge fund manager has created by selling off assets, are being carried by all investors equally. The trade group didn’t recommend that hedge fund managers follow any particular redemption policies. However, it does want them to disclose in their prospectuses gating levels; suspension of redemptions and side pocketing policies.
Gating refers to restrictions placed on hedge funds limiting the amount of withdrawals from the fund during a redemption period. Side-pocketing requires hedge fund managers to divide their funds between liquid and illiquid share classes. Redemptions can continue on the liquid part but redemptions are suspended on illiquid shares.
Chaired by Antonio Borges, former vice chairman of Goldman Sachs International in Europe, the HFSB was formed in January 2008. It replaces the Hedge Fund Working Group whose report on best practice standards was published that month.
