The Financial Services Authority (FSA) is planning to consult on plans to allow retail investors to ...
The Financial Services Authority (FSA) is planning to consult on plans to allow retail investors to invest directly into hedge funds, says Callum McCarthy, chairman of the regulatory body.
McCarthy said, in a speech on hedge fund regulation, the FSA would look at the extent to which retail investors should be allowed to invest directly into hedge funds, compared to indirect investments via pension funds or asset managers.
He said: "It has long been accepted that high net worth individuals, who are expected to be able to look after their own interests, should be able to do so.
"And, under the amended Ucits Directive, it is now possible for authorised collective investment schemes to invest more freely than before in derivatives. In particular, it appears increasingly anomalous for UK investors to be prevented from investing in an authorised fund of unregulated schemes.
"However, UK taxation issues would need to be resolved to make this regime a reality."
McCarthy also said it would need to be decided how consumers would be protected if they invested in such vehicles.
He added: "This would be unlikely to involve any substantial constraint on the investment strategy of the underlying hedge funds.
"Instead it would need to look at the relationship between the manager of the fund and the custodian, or the pricing of the fund. There also needs to be established principles governing due diligence of the manager selecting the hedge funds."
Concerning a different hedge fund regulatory environment, McCarthy looked at the prospect of how a hedge fund blow-up could trigger a systemic risk to financial markets and hence to financial stability. He stressed the need to identify how a collapse would impact the large investors, such as prime brokers, as well as have the need for extra supervision for the largest funds.
He suggested ongoing supervision of major hedge fund managers and regular surveys of prime brokers' dealings in hedge funds could help guard against this risk.
Another concern of McCarthy's was market integrity. He warned about misuse of insider information, mis-valuation of complex instruments, or preference given to preferred clients by brokers.
He also called for greater transparency for hedge funds. They should be transparent in terms of fees, redemption policy and valuation procedures, he explained.
For example, he said fee structures have many complexities associated with their calculation, such as hurdle rates, allowable expenses, and equalisation structure. McCarthy believed hedge fund managers should disclose these clearly to potential investors.
Turning to redemption policies, McCarthy said it is important for investors to understand the terms of redemption, including any restrictions on redemptions. Additionally, if investors have any preferential redemption rights, this should be disclosed.
He also pointed out it was important that hedge fund managers should set out the basis on which their portfolios are valued.
Other areas McCarthy highlighted hedge fund managers needed to be transparent on included investment strategy, administration and result report-ing. For example, managers should set out for investors and prime brokers the investment strategies they intend to follow. key points
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