IOSCO Issues Report On Hedge Fund Disclosure

by Robin Pilgrim, LawAndTax-News.com, London

18 March 2003

The International Organization of Securities Commissions, the 20-year old Madrid based advisory/umbrella body of securities regulators from 100 countries, has released a paper prepared by its investment management standing committee concluding that hedge funds marketed and sold directly to retail investors should be subject to the same disclosure requirements as other collective investment schemes, including, at minimum, annual and semi-annual disclosure of holdings.

Furthermore, the committee argues that all member regulatory agencies should study the management and internal-control processes of hedge funds. "The complexity of the risks, the investment strategies, the management of the administrative organization and the valuation of the assets can demand special skills." The report suggests that agencies should consider their current adequacy in those skills.

For the purpose of its international survey the standing committee defined hedge funds as those that exhibited at least some of six characteristics:

• The inapplicability of borrowing and leverage restrictions that would otherwise affect a collective investment scheme in the same jurisdiction,
• Significant performance fees (often in the form of a percentage of profits) in addition to an annual management fee,
• Periodical (i.e. quarterly or semi-annual) redemption of interests by investors,
• Significant 'own' funds invested by manager,
• Use of derivatives, often for speculative purposes, and the ability to sell securities short, and
• More diverse risks or complex underlying products than traditional funds.

The report acknowledges that hedge funds so defined can give rise to a number of regulatory issues that it does not specifically address, such as short selling, fee structures and "whether the use of derivatives by hedge funds could lead to a more relaxed regulation of use of derivatives by traditional funds." But these issues are not limited to the hedge fund or fund of funds markets, so they warrant consideration in broader contexts, says the report.

Recent IOSCO guidelines covering the statements accompanying financial results and information disclosed by hedge funds sold to retail investors are intended as benchmarks for national regulators. Sir Howard Davies, chairman of Britain's Financial Services Authority, has said that these IOSCO's principles "are likely to become the global standards". The UK's Financial Services Authority is expected to publish its own recommendations on retail hedge fund sales either later this month or in April.

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