Hedge funds and Private Equity - PES

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Hedge funds have flourished in a deregulated environment. In recent years, there has been
increasing effort by regulators to try to, at least softly, regulate the industry nationally and – to a
limited extend – internationally. So far national or domestic regulation of hedge funds has taken
place at three levels: the level of the fund manager; the fund itself; and the distribution of funds.
Based on domicile, hedge funds can be registered in offshore and onshore locations.
Offshore hedge funds are registered in jurisdictions allowing investors to minimise their tax liabilities.
Thus, hedge funds often do not pay any fiscal charge on the financial returns at the fund
level. In addition, the jurisdictions are characterised by a deregulated environment where there
are short authorisation periods in connection with the establishment of funds and constraints
regarding investment policies are very limited. Offshore hedge funds are usually structured as
corporations although they may sometimes be limited partnerships. Generally the number of
investors is not restricted. Onshore hedge funds often set up a complementary offshore fund to
attract additional capital without exceeding limits on the number of investors.
According to HFR, as of 2005, 68% of single strategy products worldwide were domiciled offshore
and only 32% onshore. According to data elaborated by the ECB (European Central Bank), the
preferred off shore domicile was: Cayman Island 58%, BVI 20%, Bermuda 12% and Bahamas 4%.
Onshore or domestic hedge funds are investment companies registered in an onshore location.
Here the most popular locations are the US and – within the EU – the UK. Within the US and
UK investment managers are usually domiciled in the most important financial districts, mainly
New York and London.
Historically, hedge fund managers in the US have not been subject to regular SEC (Securities
and Exchange Commission) oversight. In October 2004, the SEC approved a rule change implemented
in February 2006, which requires hedge fund advisers with more than 14 clients and
$30 million in assets to register with the SEC as investment advisers under the Investment
Advisers Act. Nearly 1,000 hedge fund managers had registered before February 2006. The
measure, which requires hedge fund managers to disclose certain information about their operations,
aims to protect investors and stabilise securities markets.
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In most European countries, fund managers are generally allowed to manage hedge fund products
and both hedge fund and conventional fund managers operate under the same regulatory
regime. Nonetheless, there are variations in the regulatory approach of EU member states.
The UK is the most popular location in Europe for hedge funds, with an estimated European
market share of around 73% based on AUM (assets under management) and 62% based on
number of managers.
One of the key drivers behind the growth of the hedge fund sector in the UK is the Investment
Manager Exemption (IME). The IME essentially provides tax freedoms of funds based on a simple
set of rules: A fund manager, based in the UK, will not bring a fund onshore for tax purposes,
provided that overall policy and control of the fund rests outside the UK.
UK/London based fund managers provide services to hedge funds, including consulting services
such as advice on investment strategy and are therefore regulated by the Financial Services
Authority (FSA). The FSA specifies the restrictions on sales and marketing of hedge fund products.
Hedge fund products cannot be, for example, marketed to the general public but UK investors can
deal directly with offshore funds. Towards the end of 2005 the FSA created an internal team to
supervise the management of 25 so-called high impact hedge funds doing business within the UK.