Critical Issues for Hedge Funds
The State of Valuation | A Global Balancing Act | Hedge Funds Not Sold on Self-clearing | Capitalizing on the Demand for Valuation
A Global Balancing Act
June 4, 2007
Hedge funds are multiplying rapidly and can't just be swept under the carpet, said Pratip Kar, the former executive director of the Securities and Exchange Board of India who is dean of finance and corporate governance at Tata Group's management training center in Pune. "They are a reality, and people are still trying to figure out degrees of regulating them," said Kar.
Restrictions that regulators are considering include requiring hedge fund managers to register--an approach taken by the Securities and Exchange Commission in the U.S. before it was struck down in the courts last year--and allowing only professional investors to have access to the funds.
Assessing Risk
"There are three major
types of risk that regulators are concerned with as far as hedge
funds go," explained Steven Lofchie, head of the funds, regulation,
enforcement and derivatives practice at New York-based law firm
Cadwalader Wickersham & Taft. "One is systemic risk--that hedge
funds will fail and cause damage to the economy. Two is market
fraud, such as trading on the basis of inside information. And
three is ... the risk that hedge funds will defraud their
investors."
Though many countries have been content in the past to rely on self-regulation and natural checks and balances, some in Europe are beginning to agitate for tougher restrictions. Germany in particular has been driving the demand for closer regulation. Hedge funds in that country are structured as public partnerships and are required to enter into a commercial registration process. Single-manager funds cannot be marketed to retail investors, and funds of hedge funds have to register with the regulatory agency BaFin. For other private equity vehicles in Germany, however, regulation is negligible.
"Currently there is no regulation at all for private equities," said Christian von Sydow, a partner in the Munich office of McDermott Will & Emery. "We have regulations for banks and insurance companies and financial institutions. [But] the fund world is at a very low level, and this is currently under discussion by our government. They are considering creating a private equity act."
National Competition
Von Sydow believes that the solution that emerges from the current discussions will be relatively moderate. "There is tough competition between the countries, and so they will be very reluctant to be the forerunner on being very strict on regulation," he said. "Markets are transparent and the different regulatory environments are transparent. One country cannot afford to say, I'm the strictest regulator.' I think the slowest regulator or the loosest regulator will set the standard."
In the U.K., hedge funds are formed as independent companies, subjecting them to a different set of indirect regulations. "The concern in the U.K. is that hedge funds could borrow too much and then go bust," said Simon Firth, a corporate and finance partner in law firm Kaye Scholer's London office. The Financial Services Authority "keeps a close eye on the prime brokers and managers to ensure that market risk and systematic risk are contained," he added.
