South African investors can count themselves lucky. If recent newspaper reports are anything to by, the Financial Services Board will soon publish for comment new laws which will regulate hedge funds.
The initiatives for regulation are borne out by the financial conundrum that the world markets have found themselves in for the past two years. After the spectacular worldwide burst of the financial markets bubble, Governments around the world called for increased regulation of the financial sector. Lawmakers responded with vigour and not many days go by without some country somewhere in the world introducing some or other regulatory reform.
Compared to many Pan-European countries, South Africa is streets ahead. A draft directive of the European Union has recently been leaked before its official publication date dealing with proposals for the regulation of alternative investment fund managers on a pan-European basis. The draft directive applies only to managers of alternative investments funds (hedge funds and private equity funds not already regulated under the UCITS Directive). While it is proposed that the directive should only apply to managers exercising control over assets of significant value, it is quite surprising to read simple inclusions in that directive, such as the requirement for managers to obtain necessary authorisations from their home state to market and manage a fund from and in the European Union and to show suitable qualifications and expertise in the management of the identified assets and instruments of the funds. Investors in South Africa would have taken these requirements for granted.
In South Africa hedge fund managers are regulated under the Financial Advisory and Intermediary Services Act. This Act regulates then rendering of advice and intermediary services in relation to certain financial products to clients in South Africa. Those who render advice and intermediary services to South Africans must be registered with the Financial Services Board and must meet certain fit and proper requirements. Hedge fund managers are also required to have appropriate qualifications and to demonstrate to the Financial Services Board that they have a suitable track record in relation to the management of particular hedge fund strategies. The existing requirements extend to demonstrating knowledge, skills and competency in managing the instruments making up the fund portfolio.
There are now moves afoot to increase the ambit of industry regulation to the hedge funds themselves. The feeling among industry insiders and regulators is that if effective regulation can be accommodated under existing legislation, in particular the Collective Investments Schemes Control Act, 2002 then this would be the preferred regulatory route. If this is achieved in the next while, South Africa will be the first country in the world to have adopted laws regulating this industry, specifically the hedge funds themselves. There are a number of options available to regulators under the collective investments schemes legislation, the most likely of which is to create a new separate category of collective investment scheme relating to hedge funds in much the same way that collective investments schemes in property, participation bonds and securities have been dealt with.
Regulation under the Collective Investments Schemes Act or other legislation would give investors welcome comfort. If hedge funds are brought under the collective investments schemes legislation, certain prudential requirements would be imposed on the hedge funds themselves and the hedge fund managers. Reporting requirements would be regularised and it is likely that additional disclosure obligations would be imposed on managers and funds using highly risky and highly leveraged investment strategies impacting on liquidity of hedge funds.
By Deborah Carmichael, Director at Deneys Reitz