Hedge Fund Working Group Standards
An influential group of hedge fund managers in the UK calling themselves the Hedge Fund Working Group have published a Consultation Paper that seeks to establish a set of best practice standards for hedge funds. If they are deemed appropriate for the UK, do we need such standards in Australia?
The UK group was Chaired by former Bank of England Monetary Policy Committee member, Sir Andrew Large and supported by 14 hedge fund managers mostly UK-based. Interested the work was commissioned outside the auspices of industry associations such as AIMA, MFA and the CFA Institute which would normally be associated with developments of this nature.
While the standards were set against the backdrop of the UK's Financial Services Authority, the group anticipate the standards will have global relevance and are seeking feedback, including from the Australian hedge fund industry before final publication.
There is a clear defensive purpose to the establishment of the standards; to address what is perceived as unwarranted criticism of hedge funds, to acknowledge responsibilities of hedge fund managers and to prevent poorly thought regulation. However, at the heart of the standards is the importance of transparency particularly where funds and managers are dealing with illiquid and complex instruments. This is commendable.
The group also acknowedges the systemic risks that are often levelled against hedge funds associated with the concentration of holdings in particular strategies/positions and accepts the importance of on-going dialogue with regulators responsible for financial stability. The concerns of the Reserve Bank of Australia on this matter have been addressed in an earlier story on this blog titled "Reserve Bank of Australia's Stevens Flags Australian Hedge Fund Risk", September 2006.
The standards adopt a conform or explain approach and there is an expectation that conformity with the standards would be expected to be posted on a firm's website. To ensure on-going relevance the group expect that ownership of the standards will vest in a Board of Trustees. The group acknowledges the likely role of AIMA in supporting the evolution of the standards by the Trustees.
If Australian hedge fund managers are to adopt the standards there will need to be an acknowledgement of some important differences between the environment in Australia and that of the UK.
The group describes hedge funds generally as "investor access is regulated, but the product itself is lightly regulated". This is very different to the situation in Australia (and the UK), where investor access is not regulated, but the product itself is regulated in the same way as all other managed fund offerings to the retail investing public. Given the almost impossible task of separately defining a hedge fund (acknowledged to some degree by the group), and given the differences relate more to how instruments are used, not the instruments themselves, the approach of the Australian regulator, ASIC, is both sensible and sustainable.
The areas of concern covered by the group are; disclosure, valuation, risk, fund governance and activism. Within these, important sections relate to valuation of illiquid assets, handling of conflict of interest and investor activism. For the most part disclosure and risk is well acknowledged and dealt with in Australian product disclosure statements. The importance of segregating valuation from portfolio management functions has been highlighted including in recent AIMA publications.
Its not clear whether the standards provide any additional "protection" to investors in Australian managed funds. Neverthless, the spirit of the draft is fair and reasonable. Australian hedge fund managers are encouraged to read the detail of the draft standards and provide comments to the group, particularly where they make the standards more globally applicable. If there are matters that could be applied to improving existing industry association guidelines, such as those provided by the Australian chapter of AIMA, offer documents and hedge fund reporting then they should be considered for adoption.
by Rick Steele
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