The Regulation of Hedge Funds

Transcription

1 The Regulation of Hedge Funds Hedge Funds UZH IBF, HS 2016 Zurich, Prof. Dr. iur. Franca Contratto

2 Agenda I. Why regulate? 1. Hedge Funds: Culprits or Scapegoats? 2. Evidence from the Markets II. Regulation: Goals, Limits & Principles III. Regulatory Framework for Hedge Funds 1. International Standards 2. «Post-crisis» Regulatory Developments United States European Union Switzerland IV. Conclusion 2

3 Why regulate?

4 Hedge Funds: Culprits or easy scapegoats? «intransparent, opaque and too complex to understand» «prone to manipulation and other fraudulous activities» «a source of systemic risk» «create incentives for reckless behavior» 4

5 Evidence # 1: Long-Term Capital M gmt Elements of a catastrophe: trading strategy: convergence trades on US, JPN & RUS government bonds 1997: Asian Financial Crisis / 1998 Russian Financial Crisis widespread panic on the markets LTCM illiquid LTCM: strongly «entangled» with Wall Street (credit exposure, unsecured swap deals) Sept. 1998: loss of $ 4.6 bn US Federal Reserve: forced bailout financed by LTCMs major creditors ($ bn) Key problem? Danger of systemic event bailout 5

6 Evidence # 2: Amaranth Advisors LLC Multi-Strategy-SHF Founded 2000 in Greenwich (Ct.); AuM: $ 9 bn Main trading activities: energy sector (natural gas futures) Success largely dependant on «prodigy trader» B. Hunter Sept. 2006: loss of $5 bn Orderly liquidation; no bailout No knock-on effects Key problem? Price manipulation Lessons (partly) learned no bailout required! 6

7 Evidence # 3: Madoff Investment Securities Largest unregistered HF worldwide «Ponzi-Scheme» offered constant return of 10% p.a. huge attraction no investment activities; no transparency for clients investment scheme lasted for more than 15 yrs. 2008: System collapsed due to general downturn of markets damage: $ 40 bn; affected investors «flood of cases» worldwide Key problem? Oversight & enforcement failure 7

8 Evidence # 4: SAC Capital Advisors LP Group of HFs registered offshore (British West Indies) founded in 1992, 800 employees, $15bn AuM trading offices in NY, Connecticut, Stamford SEC investigation: Insider trading violations ( ) SAC Capital Advisors LP: Plea deal; penalty: $1.2bn; forced winding down of advisory business Individual employees: 8 employees found guilty (insider trading, conspiracy, securities fraud); penalties; jail sentences Steven A. Cohen: no criminal charges; but professional ban Key problem? Oversight & enforcement failure 8

9 Evidence # 5: HF Professionals Survey 28% estimate that the leaders of their firm would be unlikely to report misconducts (e.g., insider trading); 30% have witnessed misconduct in the workplace; 35% personally felt pressure to break the rules to get ahead; 46% believe their competitors engage in illegal activity, break the law or act unethically; 54% found the SEC was ineffective in detecting, investigating & prosecuting securities violations. 9

10 Agenda I. Why regulate? 1. Hedge Funds: Culprits or Scapegoats? 2. Evidence from the Markets II. Regulation: Goals, Limits & Principles III. Regulatory Framework for Hedge Funds 1. International Standards 2. «Post-crisis» Regulatory Developments United States European Union Switzerland IV. Conclusion 10

11 Regulatory Goals protection of individuals investors consumers additional, EU-specific goals: - regulatory harmonization - creation of a Single Financial Market fair, efficient & stable markets system soundness market integrity transparency liquidity competitiveness 11

12 Regulation: Principles & Limits Principle: Non-Intervention Exception: Regulatory intervention Justification: market failures negative externalities asymmetric information Limit: Proportionality 12

13 Vectors of Regulation disclosure authorization transparency organisational requirements risk management fund manager custodian liquidity requirements products investment vehicle administrator reporting distributor prime broker capital requirements code of conduct licensing 13

14 Agenda I. Why regulate? 1. Hedge Funds: Culprits or Scapegoats? 2. Evidence from the Markets II. Regulation: Goals, Limits & Principles III. Regulatory Framework for Hedge Funds 1. International Standards 2. «Post-crisis» Regulatory Developments United States European Union Switzerland IV. Conclusion 14

15 [ ] the recent financial crisis is not actually a hedge fund crisis. [ ] However, the activities of hedge funds may have amplified the consequences of the crisis. [ ] these risks arising from the role played by hedge funds in financial markets and other regulatory risks [ ] need to be appropriately addressed through global action IOSCO High Level Principles on HF Regulation

16 International Standards (1) 2009 IOSCO High Level Principles on HF Regulation 1. Mandatory registration for HF and/or HF managers 2. Ongoing regulatory requirements for HF managers: organisational and operational standards; conflicts of interest and other conduct of business rules disclosure to investors, and prudential regulation/supervision 3. Mandatory registration, regulation & supervision for prime brokers and banks which provide funding to HF implementation of appropriate risk management systems regular monitoring of counterparty credit risk exposures 16

17 International Standards (2) 4. Duty to provide information to the relevant regulator for systemic risk purposes by HF managers prime brokers 5. Industry good practices to be encouraged by regulators with a view to ensure: constant development, effective implementation, and growing international convergence 6. Information sharing by regulators in order to facilitate efficient/effective oversight in the international context 17

18 Regulatory Developments: US 2010 Private Fund Investment Advisers Act 2010 Dodd Frank Reform Act Scope: HFs with AuM > $ 150 Mio Regulatory mechanisms: enhanced transparency:registration duty for «Investment Advisors» Operational requirements technology implications: (1) system safeguards, (2) record keeping, (3) disaster recovery, (4) business continuity planning Enhancement of whistleblowing 18

19 Regulatory Developments: EU (1) Overview: HF relevant regulations MAR / MAD II Short Selling Regulation EMIR MiFID II/MiFIR Financial Transaction Tax (FTT) EU-AIFMD 19

20 Regulatory Developments: EU (2) EU-AIFMD: 2010 Directive on Alternative Investment Fund Managers Scope: EU-domiciled/marketed HF s with AuM > EUR 100 Mio. certain extraterritorial effects ( Swiss portfolio managers!) Regulatory mechanisms: licensing & supervision for HF managers (EU «passporting») transparency & reporting duties (investors & regulator) functional separation: risk mgmt/portfolio mgmt. requirements re. remuneration stringent rules on custodians (incl. liability) 20

21 Regulatory Developments: CH (1) 1. Domestic Regulation: Collective Investment Schemes Act «CISA» (2007 & 2012) Legal structures for HF: Contractual fund Limited Partnership for Collective Investments Liberal regime re. distribution: no restrictions for Swiss investors investing in a HF; certain products are only open to «qualified investors» risks must be explicitly adressed (prospectus / Key Investor Information Document, KIID) HFs domiciled in Switzerland need «local» key service providers (i.e. Swiss custodian and fund administrator) 21

22 Regulatory Developments: CH (2) 2. Impact of EU-AIFMD Swiss providers falling under AIFMD Scope: Swiss HF managers managing AIFs domiciled in the EU Swiss distributors offering AIFs to EU qualified investors Consequences: licensing requirements for HF managers/distributors (large expenses, long application process with FINMA) distribution of foreign HF rendered more difficult Recent development: ESMA recommends expansion of EU-passport on third countries (incl. Switzerland) 22

23 Agenda I. Why regulate? 1. Hedge Funds: Culprits or Scapegoats? 2. Evidence from the Markets II. Regulation: Goals, Limits & Principles III. Regulatory Framework for Hedge Funds 1. International Standards 2. «Post-crisis» Regulatory Developments United States European Union Switzerland IV. Conclusion 23

24 The uncertainty around the rules is making life difficult A Hedge Fund Manager 2012 KPMG/AIMA Global Hedge Fund Survey

25 Regulation and its impact on HF Business Source: KPMG international, Growing up: A new environment for hedge funds (2015) p %: regulation identified as the biggest threat to growth 48%: operating costs have increased; some market actors believe that regulatory costs will flatten out in the future 25

26 Challenges in a changing landscape Regulators view: Growing regulatory pressure increasing costs Operational risks cyber security HFs as SIFIs/Shadow Banking ongoing debate Industry view: Consolidation/concentration process in the HF industry lower industry-wide returns pressure on fees Investors view: institutionalization rising risk aversion changing investor base and new investor expectations 26

27 Have we done the right things right? Regulation is important Free enterprise operates best when there are clear rules! But: Growing regulatory burden and respective costs accelerate consolidation process in the HF industry reduced competition less effective markets? Rule-making process itself is far from being perfect Overwhelming majority of investors remain critical re. effectiveness of new regulatory requirements Regulation is only useful if it is actually enforced 27

28 Thank you! Prof. Dr. iur. Franca Contratto Assistant Professor of Financial Market Law University of Zurich Department of Law Rämistrasse 74/15 CH-8001 Zurich 28