Retail investors will have greater access to hedge funds under new proposals from the Financial Services Authority. The FSA's latest consultation paper sets out recommendations which will allow UK consumers to invest in funds of hedge funds and other alternative vehicles.
The FSA argued that retail investors were already exposed to hedge funds and other alternative products, including structured vehicles, in a variety of ways. It believes that the time is right to allow the development of retail-oriented funds of alternative investment funds within its regulatory regime. The regulator said this would bring substantial structural and operational safeguards, including the requirement to have an independent depositary, strict rules on independent valuation of underlying assets and timely redemption of investments.
Dan Waters, the FSA's director retail policy and asset management sector leader, said: "Asset management is a dynamic and innovative industry and we believe it is important that consumers can get access to the latest techniques to manage their own savings and investments. We think the time is right to permit access to a wider range of innovative strategies through authorised onshore vehicles. This will allow investors more choice and a better opportunity for risk diversification, while maintaining investor protection through our rules on the operation of the product."
Uneven protection
A spokesman at the FSA added that consumers who invest in quoted companies subject to listings rules did not receive the same level of protections as they would from FSA-authorised firms. "Being listed and not authorised provides fewer protections, it's not the same as being authorised by us," he said.
The spokesman explained why the FSA had made its proposals:
· The offer and sale of wider-range products to retail consumers is subject to differing regulatory requirements. This means that retail consumers may be confronted with those products in a variety of circumstances, and subject to differing conditions. The FSA is concerned that consumers neither understand the nature of these products nor the different regimes that apply to them.
· Recent revisions to the Undertakings for Collective Investments in Transferable Securities Directive have meant that providers are now able to make use of more "advanced" portfolio management techniques. What have typically been seen in the past as "hedge fund" investment techniques have rapidly entered the mainstream market.
· Growing international interest by regulatory authorities in hedge funds. Many other EU jurisdictions, notably Ireland, Luxembourg, Spain, Germany and Italy, have developed their own regimes to allow funds of alternative funds, specifically funds of hedge funds, to retail consumers. As noted in DP05/3, the E-Commerce Directive has prevented the FSA from prohibiting the sale of such funds from other EEA member states via electronic means to UK consumers.
The FSA highlighted that a vital element in its approach is the expectation that the fund manager would operate with "due diligence". It said that this requirement was set out in a more principles-based way, while it would propose fund manager guidance on maintaining significant investments into unregulated schemes.
The FSA has also accompanied the consultation paper with a case study illustrating the respective responsibilities of providers and distributors of these products. It has asked for feedback on the study as well as the consultation.
The FSA proposals aim to:
· introduce retail-oriented FAIFs into the existing FSA regulatory regime for non-UCITS retail schemes
· lift the existing 20 per cent investment restriction into unregulated collective investment schemes for NURSs, thereby allowing the development of FAIFs
· apply due diligence guidance for fund managers producing FAIFs, to guide them on the matters to consider in making their initial and on-going investment decisions
· leave the current rules unchanged for existing NURSs, although a few consequential amendments would be necessary to ensure overall consistency in the regime
· ensure the regime for qualified investor schemes is in line with the FSA's revised approach for NURSs
The consultation closes on June 27 2007. The FSA will then finalise the draft rules in light of the responses. A policy statement is expected at the end of 2007 to set out the rule changes and the date on which they will come into effect.
Industry approval
The Investment Management Association welcomed the proposed inclusion of funds of alternative investment funds in the existing NURS regime. It announced its support for the safeguards that the FSA has suggested to ensure that investors understood the nature of FAIFs and their associated risks.
The IMA noted, however, that the tax treatment of such vehicles was crucial. The offshore funds regime has a direct impact on the tax treatment of such funds, given that they will be potentially investing in non-UK funds, it said. The association added that, following the Government's decision to review the OSFR, it would urge Her Majesty's Revenue & Customs to consider the development of FAIFs, or any innovation would be in vain.
Sheila Nicoll, deputy chief executive of the IMA, said: "The FSA is showing a clear commitment to product innovation. This is good news for investors who will benefit from this innovation and also greater competition and choice. The one remaining obstacle is the tax treatment of FAIFs — this needs to be addressed in order for retail investors to find them an attractive proposition."
Guy Rainbird, of the Association of Investment Companies, welcomed the proposals but highlighted that AIC members already offered alternative asset classes. He referred to recent work on opening up private equity funds to retail shareholders in which it had published a paper which looked at facilitating retail access.
Rainbird told Complinet: "They don't have to go through the current handles of pretty hurdles of putting up hundreds of thousands of pounds, they can access at low cost. Today retail investors will be thinking about not just buying shares, but the other asset classes they can be involved with.
"The interesting thing is that again, [the FSA] is talking about the need for independent oversight aspects, independent evaluation, independent depositaries. Of course, the key governance structure we are talking about is the independent board that provides that sort of oversight on behalf of shareholders, retail or otherwise."
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