Regulations proposed for hedge funds

Hedge funds, long accused of a string of misdemeanours, from fuelling the 2008 global economic meltdown to being the investment vehicle of choice for fraudsters, are about to have their wings clipped in South Africa. National Treasury and the Financial Services Board (FSB) this week published a proposed regulatory framework for these funds.

Mainstream hedge funds aim to profit from both good and bad market conditions. They also use strategies that can be very high risk.

Until now there has been no regulation of South African hedge funds, apart from a requirement for hedge fund managers to be registered as financial services providers in terms of the Financial Advisory and Intermediary Services Act.

Hedge fund managers and consultants have been hard-selling their products to retirement funds since the easing of restrictions on alternative investments (contained in the prudential investment requirements of regulation 28 of the Pension Funds Act).

However, draft regulations have been published that will place a responsibility on retirement fund trustees to exercise special care before their funds invest, and once their funds have invested, in hedge funds.

The draft regulations released this week propose the creation of two categories of hedge funds, each with different levels of regulation. These are:

Restricted hedge funds will not be subject to strict regulation but will have to register with the FSB. The funds will have to submit annual returns to the FSB, mainly so that the regulator can assess their gearing (borrowing to invest, which can multiply returns, as well as losses).

It is proposed that retail hedge funds will be regulated more strictly than restricted funds by the addition of a section to the Collective Investment Schemes Control Act (Cisca), which regulates unit trust funds and mortgage participation schemes.

Cisca allows the investments of many investors to be pooled and managed by collective investment scheme management companies, subject to very tight regulation.

A key proposal is that an investor in a retail hedge fund cannot be liable for more than the amount invested in the fund. In other words, the most you can lose is all your capital. Any additional losses incurred as a result of gearing will be to the account of the fund manager.

Other special conditions proposed for retail hedge funds are: