14/06/2011 Author: Will Wainewright

Transparency flows

As the reporting requirements of hedge fund investors increase, regulatory changes currently underway will also bring a new focus to information disclosure by funds’ end investors. Though burdensome, the developments offer the chance of a fuller dialogue between funds and their investors

A guide released recently by the Alternative Investment Management Association’s (Aima) steering committee and a host of big-name institutional investors, aiming to educate fund managers on their expectations and preferences, hit on a familiar theme. It was the latest indication that these big-ticket.

investors are as serious as ever about high standards of governance and operational infrastructure in hedge funds. The onus, as ever, is on the fund manager to outline their compliance and risk procedures to placate
investors demanding ever-greater levels of detail.

It is interesting to note, however, that regulatory changes could lead to this process occurring in reverse. While investors ramp up their due diligence surveys, the implications of various legislation in Europe and the US could lead to questionnaires from hedge funds landing on the investor’s doormat for a change.

Private Placement Regimes
“In the future we may see increasing focus on collecting data from investors,” says Martin Cornish, partner and hedge fund specialist at law firm K&L Gates. He sees the introduction of passports in Europe, brought in by the AIFM Directive, as one possible cause through its knock-on effect on Private Placement Regimes (PPR). He points out there is nothing to prevent countries changing their PPR terms and believes some may want to align them more closely with the Directive.

“The advent of the AIFM Directive may well cause lawmakers to look at their Private Placement Regimes,” he says. Imposing stringent information requirements on fund managers without a passport could be a way of encouraging them into the new regime. He continues: “They might ask: ‘If we are closing onshore, regulated funds in Dublin or Luxembourg to all but professional investors, why are we allowing funds from the Cayman Islands or other unregulated domiciles to be marketed more?’”

Phillip Chapple, executive director at offshore fund consulting firm KB Associates, agrees that PPRs could be manipulated in this way. “Countries are not under any obligation to leave their current private placement regimes unchanged. Such rules may be amended to push funds onshore.” However, Chapple believes this could be part of a healthy process leading to increased communication between hedge funds and their investors. “To keep investors, you need to know your investors and talk to them to know what they want. The more communication the better.”

Fatca
A legislative change in the US may also lead to more information disclosures by investors. Signed into law last year, the Foreign Account Tax Compliance Act (Fatca) will require foreign institutions holding US securities to reveal full investor details to the US Internal Revenue Service or suffer a 30% withholding tax. Matt Haddow, consultant at Kinetic Partners, says that although the final details have yet to be finalised, hedge funds are yet to realise the extent to which it could impact them. “A lot of the finer detail is still waiting to be clarified but it is highly unlikely that hedge funds will be exempted,” he says. “The IRS will be looking for information on all US account holders, including name, address and taxpayer identification number, account number and account balance, and gross receipts and gross withdrawals from that account.”

Obtaining this information will add a heavy compliance burden to funds, and there are questions over who will bear the brunt. “It is likely that it will be the administrators who will have to undertake the compliance exercise,” says Haddow, adding that even foreign financial institutions with no US investors may need to enter into an agreement  to avoid suffering withholding tax on US income. “I cannot believe that this burden was the intention at the start. Funds need to start planning for Fatca now.”

Are they doing so? “It is early as many of the details are yet to be finalised, but it will certainly have an impact,” says Hitesh Bharkhda, of Culross Global Management. “We are trying to keep up with how it develops and are certainly alert to the possible implications. What we would welcome most, as well as clarification on the details, is some guidance.”

Lawyers in the US point to other legislation such as the 5131 ‘New Issue’ Rule as a further development leading to increased demands for information. However these changes play out, the trend towards requiring more information from investors seems clear. Funds that remain unclear about their own investors need to prepare to create structures to obtain more information if required. But, as the Aima guide indicates, more communication between hedge funds and investors is no bad thing, and the changes, though in theory a further compliance burden, may actually help the partnership between the two.