Hedge funds and Private Equity - PES

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3.3 Transparency and supervision in practice
One of the reasons given by EU and national regulators (eg. the FSA) for not introducing more
robust regulation is the risk of a greater number of hedge fund managers relocating offshore. To
counter this, an incentive structure through the regulatory system and enhanced disclosure
needs to be created.
And once more: we must not forget that the European Single Market is the world’s biggest
economy – an enormous attraction for international hedge funds and private equity.
If regulators refuse to harmonise regulations to a higher level because of the fear of relocation
then it will be necessary to distinguish between ‘onshore’ regulated schemes and offshore unregulated
schemes so that market forces reward hedge fund operators and managers that reside
within jurisdictions with enhanced regulatory standards.
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As a point of departure, our view is to fully harmonise European hedge funds (either single
strategy, or FOHFs) in order to create a unitary category of onshore funds with a common
minimum investment threshold, which could be lower in the case of FOHFs. By definition, it will
never be possible to prohibit offshore funds at a worldwide level. So it seems more realistic to
develop an onshore regime able to compete with offshore funds: it would obviously not prevent
some investors keeping their activities secret in offshore funds but it would offer an alternative
choice for the rest of investors, through a higher level of safety, a guaranteed level of professionalism
of fund managers, an overseeing by regulators. Thus, such EU regulated products will
be offered as a complement to offshore funds. And the features of such onshore products will
reduce the size of the offshore market as compared to the onshore one. This EU regulated
regime would not forbid Member States from keeping nationally regulated regimes. It should be
mainly designed around the needs for regulation of the professionals involved in the ‘value chain’:
the management company, and depositary/prime broker. It would focus on: registration of these
professionals in the EU, requiring that they are ‘fit and proper persons’, minimum capital requirements
and minimum rules on valuation of assets. However, contrary to UCITS, the features of
any alternative investment product itself should not be covered by the EU regime.
The key issue here relates to the legal and governance arrangements of hedge funds as investment
vehicles and the risks posed to retail investors. Most hedge fund managers located within
the EU are subject to some kind of authorisation and supervision regime. However, for tax
reasons most hedge funds or products are domiciled in offshore jurisdictions – as at the end of
2004, 64% of total hedge funds assets were registered offshore.
The offshore domicile for tax reasons raises concerns about the legal protection and redress
available to consumers in the event of the failure of alternative investment funds. The EC should
ensure that any alternative investment fund managers selling products to retail investors are part
of a suitable compensation scheme.
A recurring problem linked with policymaking at EU level is the absence of pan-EU studies that
compare and contrast regulatory approaches to managing those key risks within different
member states. Therefore, it is not possible to assess the risk of regulatory arbitrage (where firms
will seek to locate in jurisdictions which offer the lowest level of regulatory protection). This has
been an issue in financial services policymaking generally but has a particular relevance for policymaking
in complex areas such as hedge funds.