The Netherlands Authority for the Financial Markets has published a report calling attention to the lack of transparency of hedge funds, and intends to carry out a follow-up investigation, but does not see any need for additional regulation.
The Authority (Autoriteit Financiele Markten) has been responsible for supervising the operation of the financial markets since 1 March 2002, supervising the conduct of the entire financial market sector: savings, investment, insurance and loans.
AFM is the successor of the STE (Securities Board of the Netherlands / Stichting Toezicht Effectenverkeer), which supervised all of the participants in the securities trade. The establishment of AFM is a result of the policy document 'Review of the supervision of the financial market sector' ('Herziening van het toezicht op de financiële marktsector') of the Ministry of Finance. Accordingly, sector-based supervision has been replaced by function-based supervision, which is divided into prudential supervision and supervision of market conduct.
The AFM considers the lack of transparency of hedge funds to be a cause for concern. In its report, published this week, the AFM identifies a number of risks attached to the rapid rise of hedge funds. Although the AFM sees no pressing need for more regulation or tighter supervision, a follow-up investigation is to be carried out at a number of institutions, in order to obtain more information about Dutch market practices.
Says the Authority:
" 'Hedge fund' is an umbrella term for various types of collective investment schemes that are aimed at achieving the highest possible absolute returns, as opposed to more 'traditional' collective investment schemes that target a relative performance by exceeding a previously determined benchmark. Another important characteristic of hedge funds is that the returns generally depend little on the general performance of the financial markets. In addition, hedge funds often use different instruments and investment techniques. For example, hedge funds might decide to go short (i.e. to sell securities without actually owning them) and to use 'leverage' by borrowing capital. Hedge funds also often use derivates, such as options and forward contracts. There are many types of hedge funds, with different styles, objectives and risk profiles.
"The rapid rise of hedge funds, combined with the trend towards 'retailisation' of hedge fund products, led the AFM to carry out its survey. Until a few years ago, hedge funds were almost exclusively the domain of very wealthy private investors. Because of the lowering of the investment thresholds and the rise of funds that offer a selection of hedge funds as a single product - the so-called fund-of-hedge funds - less affluent retail investors can now also participate in hedge funds. As a consequence, the risks associated with these products are becoming relevant to a growing and more vulnerable part of the investor population.
"Based on the survey, the AFM identifies the hedge funds' lack of transparency as a key area of regulatory concern. In addition, the AFM calls into question whether fund managers themselves always have sufficient understanding of the investment policies and the risk profile of the hedge funds in which they invest. This might put at risk investors' interests. The AFM is carrying out a follow-up investigation to examine, amongst other things, possibilities for improving the transparency of hedge funds.
"According to the AFM, there is currently no compelling case to introduce measures specifically targeted against hedge funds. Only a small number of hedge funds are authorised on the Dutch market: five single manager hedge funds and some forty-five fund-of-hedge funds. In contrast with many other countries, where hedge funds are only partially supervised, if at all, the funds on the Dutch market are subject to the same supervisory requirements as all other collective investment schemes. Hedge funds are exempt from supervision in the Netherlands if they are offered exclusively to professional parties, to less than 100 persons or if the value of the participations on offer is greater than 50,000 Euro.
"Besides the risks attached to hedge funds, the AFM also points at the positive effects of hedge funds. For example, the activities of hedge funds can contribute significantly to improving the efficiency of the market, e.g. by providing liquidity."
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