Hedge Funds May Desert The US If Regulation Bites Hard

by Carla Johnson, Investors Offshore, London

03 October 2002

In an article yesterday, the Financial Times speculates that the regulatory pressures threatening hedge funds in the US may drive some of them offshore - which is where many of their investments are in any case.

Apart from the SEC's ongoing study of the hedge fund sector, which is widely expected to lead to a more extensive program of registration than the current voluntary system, the Treasury last week issued a proposed rule requiring investment companies not registered with the Securities and Exchange Commission to establish an anti-money laundering program as specified under section 352 of the Patriot Act.

The unregistered investment companies covered by the proposed rule include hedge funds, commodity pools, and investment companies investing in real estate. Under the rule, these non-registered investment companies must establish an anti-money laundering program that includes, at a minimum, (i) the development of internal policies, procedures, and controls; (ii) the designation of a compliance officer; (iii) an ongoing employee training program; and (iv) an independent audit function to test programs.

Section 352(c) of the Act directs the Secretary to prescribe regulations for anti-money laundering programs that are "commensurate with the size, location, and activities" of the financial institutions to which such regulations apply. The Treasury Department deferred this rulemaking in April of this year.

There are already significant concentrations of hedge fund activity and expertise in various offshore jurisdictions, with Hong Kong being a leading example. The problem for a US hedge fund manager however is that a move offshore will quite probably increase the tax difficulties of his US clients, not to mention worsening his own tax position (if he is a US national).

So here is perhaps another case, hypothesises the FT, in which over-ambitious US legislation may drive a whole business sector away, as happened in the 1960s when attempts to tax the capital markets simply handed a massive present to the City of London and the Luxembourgers, who went gaily ahead to develop the Euromarkets with minimal participation for the US.

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