The FSA Issues A Consultation Paper On Hedge Funds

Investors Offshore, London

23 August 2002

Britain's Financial Services Authority launched a consultation exercise yesterday over the future for the marketing of hedge funds in the UK. In a Discussion Paper, 'Hedge Funds and the FSA', the FSA sets out how its regulatory regime bears on the UK activities of hedge funds. The paper asks for comments on:

• the current controls on the selling and marketing of hedge funds in the UK;
• the regulation of UK-based fund managers who manage off-shore hedge funds; and
• the FSA’s approach to monitoring the effects of hedge funds on UK markets.

Michael Folger, FSA’s Director of Conduct of Business Standards, said:

“The hedge fund market has grown significantly in recent years, as increasing numbers of wealthy investors and trusts have decided to place a proportion of their portfolio in ‘alternative’ investments. Just as some of our international counterparts have also done recently, we are therefore reviewing our regulatory regime in respect of hedge fund activities in the UK, particularly the sale and marketing of such funds.

“We come into this with an open mind. Hedge funds cannot readily market themselves direct to the UK public, and ordinary investors generally do not seem to have become involved. But financial advisers may recommend investors who understand the risks to put some money in them as part of a diversified portfolio. Is this the right balance, or is there scope to make hedge funds more accessible?”

The FSA is seeking views, from industry and consumer groups, on whether it should change the rules on the sale and marketing of hedge funds, to make them more readily accessible. This could potentially increase the product choice available to UK investors. But it also raises significant consumer protection and education issues, which would have to be addressed satisfactorily before any changes were made. In particular, there are legitimate concerns about the comprehensibility to retail investors of the information provided by hedge funds about their activities and risk profiles.

Michael Folger added:

“Although hedge funds are usually incorporated and governed in offshore jurisdictions, mainly for tax reasons, many employ fund managers onshore. The UK-based fund managers providing services to hedge funds are legally required to seek authorisation from the FSA. Our powers under the Financial Services and Markets Act cover the activities of such a firm and the services it has contracted to provide its clients.

“But, if a UK-authorised fund manager is engaged by an offshore hedge fund that brings no FSA oversight of the fund itself or its risk profile. Recognising that, we are explaining our approach to regulating UK-based hedge fund managers and invite comments. We also describe our approach to monitoring the effects of hedge fund activities on UK markets. We have regular dialogue with market participants so that we maintain up-to-date knowledge of the hedge fund sector. As users of the UK-based securities markets, they are of course subject to the same market standards as similar institutional investors.”

The FSA, which is reswponsible for regulating the whole UK financial services sector, points out that it is required to have regard in its activities to the desirability of facilitating innovation in the areas it regulates. Hedge funds cannot currently be marketed freely to the general public in the UK and the discussion paper asks for views on whether there is a case for liberalising this regime and explores a number of options for authorising or listing such funds.

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