UK - Investors await regulators line on hedge funds

Investors await regulator’s line on hedge funds
By Kate Burgess and Sundeep Tucker

Published: June 10 2005 21:23 | Last updated: June 10 2005 21:23

FSAPrivate investors looking for ways to earn double-digit returns will watch closely the Financial Services Authority's action to open up the hedge funds debate.

Once seen as dangerous, high-risk and exotic investments, hedge funds are becoming mainstream.

Increasing numbers of retail investors want to invest in these funds – unregulated investment schemes that have the freedom to switch between asset classes and are able to make money in falling markets.

This, and the fact that assets in hedge funds are increasing to more than $1,000bn worldwide, has changed perceptions. The FSA’s discussion paper, expected this month, marks this sea change.

In March 2003, the financial regulator concluded there was no need to relax its restrictions on hedge funds. These kept hedge funds offshore; hampered retail investors from buying them; and prevented on-shore funds from using hedge-fund investment strategies, such as high levels of debt or shorting.

If private investors wanted to put their money into hedge funds they could buy offshore, said the FSA. Or they could buy shares in several funds of hedge funds available as investment trusts listed on the London Stock Exchange. At the time, the FSA said, there was little evidence of demand from retail investors.

Within a year, however, the regulator was forced to reconsider as demand escalated. In early 2004 it signalled a more liberal stance when it rewrote the rule book on onshore unit trusts and open-ended investment schemes and launched “qualified investor schemes”. For the first time, professional investors and sophisticated retail clients were allowed access to funds that use hedge fund techniques – including gearing up, taking on high levels of debt, going short and using derivatives. The industry applauded.

But now the industry is urging the financial services regulator to go further, arguing that the relaxation of the UK's mutual fund regime should be extended. They say that while private investors have become more knowledgeable and are demanding more access to hedge funds, they remain wary of offshore products, which have tax disadvantages and suffer from poor consumer protection. Quoted investment trusts have not performed well, either.

“Investors prefer regulated onshore open-ended funds and managers are willing to deliver them,” said Timothy Spangler, partner in the investment funds group at Berwin Leighton Paisner.

The UK's fund management industry is also keen to protect its position as one of the leading international fund management centres. About 70 per cent of European single-manager hedge funds are managed from London, but this pre-
eminence is under threat.

Many other EU financial centres, including Germany and France, have changed their stance on hedge funds in an attempt to draw the lucrative and fast-growing hedge fund industry into the EU. This week Germany stepped back from imposing restrictions on hedge funds.

When the FSA first asked the industry in 2003 whether it should reform its rules on hedge funds, the response was muted. That has changed dramatically. Now it is clear that asset management firms will welcome any change that allows private investors easier access to them. But consumer groups will watch developments closely. They are wary of products that may put investors at risk.

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