Decomposing FoHF returns
Where and when funds of hedge funds add and lose value
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28/04/2010
Comment: Julian Korek
Following the credit crisis, people looked around for sections of the industry to blame. As is often the case, politicians and non-industry pundits looked for a scapegoat. Rather than tackling the real cause of many of the issues, European legislation and politicians alighted on the hedge fund industry.
Why? Well, maybe because the industry was seen as highly successful, therefore it must have done something wrong.
With a rising head of steam, a piece of legislation was hastily drafted over two months by the European Commission, at the request of Poul Nyrup Rasmussen, a Danish MEP and president of the Party of European Socialists. It was published on 30 April 2009 and entitled the Alternative Investment Fund Managers (AIFM) Directive. The rest is now, unfortunately, history.
The outcome of this early draft was not only to cause confusion, but to present a set of requirements that would make it more onerous to market a hedge fund than it would be to establish a retail-style Ucits fund product.
When the rotating EU presidency moved from the Czech Republic to Sweden on 1 July 2009 and the Swedish Presidency published a compromise proposal on 12 November 2009, there was some good work towards providing classification and simplification to elements of the draft Directive, including the romoval of the ‘approaches from investors’ clause from the anti-marketing stipulations.
However, when, at the last moment, the Swedes tagged another requirement into the Directive – namely that of adherence to the ‘banking pay’ proposals set out at the Pittsburgh meeting of the G20 – this added yet another complication to the ongoing saga.
When the EU presidency moved to Spain in January 2010 there were high hopes that lobbying by industry participants and trade bodies would result in a balanced outcome. However, hopes were dashed as the Spanish issued six compromise texts within weeks.
Around this time, it seemed that US industry participants began waking up to the fact that the intended legislation would likely prohibit US managers from marketing their funds into the EU, unless they completely restructured the way the funds were serviced by EU-domiciled service providers. ‘Passporting’ of funds would, to all intents and purposes, be impossible and, furthermore, the Directive sought to prevent ‘reverse marketing’ – US managers would not be permitted to accept advances from EU investors.
Along with this general confusion, Luxembourg and Dublin’s finance centres saw the opportunity to promote Ucits funds to hedge fund managers. The Irish funds industry went further, introducing new legislation in December 2009 to allow offshore funds to re-domicile to Dublin, while keeping the fund intact.
So where does this leave us? For one, there is the risk of a falling out with the Americans. The US Treasury Secretary, Tim Geithner, delivered a blunt warning to the European Commission ahead of the forthcoming G20 meeting, that its plans to regulate the hedge fund and private equity industries could cause a transatlantic rift.
The Economic and Monetary Affairs Committee (Econ), which is overseeing the AIFM Directive, has re-scheduled a vote to the beginning of next month, with G20 finance ministers having met in Washington just prior to this ballot.
While all this has been happening, the Investment Advisers Act has been making its way through US legislature, requiring all investment advisers (including hedge funds and private equity fund managers) to become regulated by the SEC – even where the manager is domiciled outside of the US, but the fund has US investors.
People looking into the industry might ask ‘why are we not taking the opportunity to introduce global regulations to manage what is truly a global function of the investment industry?’ Instead of framing legislation that will most likely lead to regulation arbitrage, Econ should build on the work that has already been done by the G7, Iosco, the President’s Working Group and the Hedge Funds Standards Board and consolidate them into a single set of global standards. I think this is unlikely to happen, given the fact that the people trying to push through the legislation are not familiar with the detail of how the industry is structured and operates. However, I am more than willing to be proved wrong.
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