Friday, August 27, 2010

Hong Kong Securities Regulator Calls for Internationally Harmonized Hedge Fund Regulation

A senior official of the Hong Kong Securities and Futures Commission emphasized that the regulation of hedge funds must be globally harmonized in order to prevent regulatory arbitrage and protectionist entry barriers. In remarks at a seminar, SFC Executive Director Alexa Lam said that large financial firms are internationally active, operating through affiliates in many countries, and financial markets themselves are increasingly linked. Thus, regulators must minimize scope for arbitrage between different regulatory requirements and ensure that data is able to be analyzed at the appropriate level when assessing matters such as systemic risk.

The challenges are numerous. Once regulatory gaps are identified and measures are being considered to address them, said the Executive Director, regulators must weigh the cost or regulatory burden against the benefit sought, and determine the best way to achieve the main objective. Regulators will have to take into account not just universal but local and regional needs or market characteristics, she continued, and also the time-sensitivity of a given matter at issue. And there will be issues and measures that have implications at a global level and others that by their nature have a more localized effect. With hedge funds and other alternative investment funds, the international issues involve requirements for registration and operations, reporting, and other transparency measures. Some of the measures being proposed target hedge funds in particular.

Hedge fund managers carrying on business in Hong Kong are subject to the Commission’s regulatory regime and are required to be licensed. Once licensed, they are subject to SFC supervision. To improve the transparency of Hong Kong’s hedge fund industry, the Commission has conducted surveys of Hong Kong-licensed hedge fund managers in recent years. Together with other IOSCO members, the SFC is also participating in the collection of information from hedge funds pursuant to the framework developed by IOSCO to facilitate assessment of systemic risk.

The Executive Director noted that the SFC has been carrying out joint inspections with the SEC both in the US and in Hong Kong of hedge fund managers who are both licensed in Hong Kong and registered with the SEC. Thus, while other jurisdictions are putting in place a licensing and supervision regime covering hedge fund managers, the SFC has regulatory supervision over those hedge fund managers who operate in Hong Kong. One of the areas of focus of the G-20 and the Financial Stability Board is on systemically important non-banks, such as hedge funds. The SFC official pledged to follow the global regulatory developments in the alternative investment fund area closely to ensure that the SFC regime continues to meet international standards.

The SFC is particularly concerned with the proposed EU Alternative Investment Fund Managers Directive relating to the marketing in the EU, or sale to EU investors, of hedge funds managed by non-EU managers or located in non-EU countries. Much has already been said about this aspect of the draft Directive, and its terms are still being debated, but the SFC fears that it has the potential to restrict substantially the universe of these types of funds available to EU investors. In the Executive Director’s view, this could be detrimental not just to the managers and the funds concerned but also to the EU investor base.

One version of the Directive, which is currently moving towards legislative enactment, would sharply limit the access of European professional and institutional investors to legitimate investment opportunities from non-EU hedge funds. In an earlier letter to EU finance ministers, Treasury Secretary Tim Geithner called on the European Union to participate in a globally coordinated approach toward financial regulatory reform and resist protectionist-driven initiatives in the proposed Alternative Investment Fund Manager Directive. Specifically, he asked that EU legislation regulating hedge funds not discriminate against US and other third country hedge funds not based in the EU.

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