Sarah Jane Leake | Bloomberg Law Revisions to the Hedge Fund Standards and Feedback on Consultation (CP3/2011) – Hedge Fund Standards Board Feedback Statement, 17 Feb. 2012 The Hedge Fund Standards Board (HFSB) has confirmed a number of changes designed to strengthen the Hedge Fund Standards (Standards) in the wake of the financial crisis, and to make them more international in nature so that they are more relevant and accessible to a wider international constituency. It is hoped that the changes, which have been agreed after a brief consultation with industry,1 will bring the HFSB increased support from overseas hedge fund managers, particularly those in the U.S. and Asia.
Internationalising the Standards— Fund Governance As revised, the Standards will be more appropriate for fund managers outside the EU who typically use a different governance structure. The key changes revolve around strengthening fund governance, in order to ensure that, where there is no independent fund governing body (FGB), shareholders are sufficiently placed to protect their own interests. Under the revised Standards, where no FGB exists, more specific rules will need to be set out in the fund documentation. To this end, a new Standard 21 will be introduced, providing that where there is no FGB, certain actions must be disclosed to investors, such as material adverse changes to the fees and expenses payable by the fund to the manager or the redemption rights available to investors. — Financial Services Authority's Principles Initially, the Standards were developed with the Financial Services Authority's (FSA) Principles for Businesses2 (Principles) in mind, which are applicable to all fund managers. In their current form, the Standards provide guidance on how the Principles can be interpreted and specifically applied to the hedge fund industry. In view of the growing international base of signatories to the Standards, as well as their investors, and to avoid the Standards being tied to any one national regime, all explicit references to the FSA's Principles will be removed. — Legal Wording At present, some of the Standards expressly state that, in some areas, compliance requires action on the part of the relevant FGB rather than its manager. However, the manager is required to "do what it reasonably can to enable and encourage" the FGB to achieve the outcome required by the Standard in question. The HFSB, however, thought that the inclusion of this wording makes the text of the Standards unwieldy and, moreover, unwittingly weakens the substance of the Standards. For the sake of simplicity, the Standards will be revised so that the wording of each relevant Standard will be put in the passive voice, stating the outcome to be achieved rather than the action the fund manager and/or the FGB is expected to take in order to achieve the stated outcome. By way of example, the phrase "[a] hedge fund manager should do what it reasonably can to enable and encourage the [FGB] to put in place valuation arrangements aimed at addressing and mitigating conflicts of interest in relation to asset valuation" will be reworded as "[v]aluation arrangements aimed at addressing and mitigating conflicts of interest in relation to asset valuation should be put in place." Many respondents to the HFSB's consultation, however, expressed concern that these changes may remove clarity as to who is in charge. To address this issue, the Standards will explicitly require the manager to explain any areas where it has encouraged the FGB to comply with an individual Standard but, despite its best efforts, the required outcome has not been achieved.
Strengthening Investor Disclosure— Investment Policy & Risk Disclosure A number of minor amendments will be made in relation to investment policy and risk disclosure. In particular, the revised Standards require better ex ante disclosure to investors (new Standard 1.1), clarify that material changes to a fund's investment policy require either investor consent and that investors should be given sufficient notice to enable redemption before such changes become effective (new Standard 1.3), establish periodic reporting in relation to investment strategy, the fund's risk profile, and the manager's business (new Standard 1.5), and ensure that investors are sufficiently informed about material litigation and formal regulatory proceedings against the fund manager (new Standard 1.6). New Standard 1.6 reflects the approach taken by the U.S. Commodity Futures Trading Commission, which requires disclosure of any material administrative, civil, or criminal action, pending or already concluded, against the manager, any principal, or its broker. Similarly, the U.S. Securities and Exchange Commission's (SEC) Form ADV requires such disclosures to be made by investment advisers when applying for registration with both the SEC and state securities authorities. Concern has been expressed by many stakeholders that such a provision may cause undue reputational risk. In their view, there is little benefit to investors in disclosing details of any investigations underway before any conclusion can be drawn by the investigating regulator. The HFSB, however, maintains that, from an investor perspective, it is important to disclose any material litigation brought against a manager, as it could end up drawing upon manager resources or highlighting certain issues that investors should be made aware of. The Standards do not, though, state any particular level of disclosure as the HFSB prefers to leave this up to the manger itself to determine. It must be remembered, however, that merely disclosing the fact that the manger is involved in material litigation or a formal regulatory enforcement proceeding will inevitably lead to requests by investors for further disclosure. — Commercial Terms A new Standard 2.2 is to be introduced to increase transparency on material fees, costs, and changes payable by the fund to the manager or parties related to the manager. Moreover, a new Standard 2.4 will require the disclosure of any parallel funds or accounts that may exist, in order that investors may assess their impact on investments in the fund. To maintain confidentiality, specific details of these funds or accounts need not be disclosed. The HFSB, however, clarifies that where differential liquidity of managed accounts vis-
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