Rules likely to trim array of hedge funds
New regulations will make entry harder and more expensive
THE number of hedge fund managers in South Africa is expected to drop when the continent’s most advanced economy becomes the only country in the world to regulate hedge funds.
From April next year, the Financial Services Board will start regulating funds following years of delaying the implementation of new rules for the industry.
The regulations would make it more costly for new companies to start, said Philippa Owen, chief operating officer at Tower Capital. In fact, she expects consolidation among the existing players due to the regulations.
All hedge funds would have to be registered as collective investment schemes and these schemes will be required to be run by a management company — similar to the way units trusts are managed.
Registering a management company is quite tough, which is why Owen believes that barriers to entry for new hedge fund managers will be raised. “Only established players will be allowed to have a management company licence.”
Her views are echoed by Mark Preston, chief operating officer at Laurium Capital, who expects bigger traditional investment houses to buy into smaller boutique fund managers rather than launching their own hedge funds from scratch. This would be a winwin for smaller players as the costs of complying with regulations may be hefty and capital adequacy levels may be too high for smaller fund managers.
South Africa has more than 113 hedge funds, which had inflows of about R6-billion last year.
Simon Peile, manager of Sygnia fund of hedge funds, said the new regulations would make running the business more onerous as managers would have more hoops to jump through. However, “from an investment parameter point of view, very little will change”, he added.
Like most hedge fund managers, Peile welcomed the regulation of funds as it removes the dark cloud that has been hanging over them for years. The FSB had previously toyed with the idea of “banning” hedge funds.
Regulation of the R57-billion industry would allow it to move into a mature stage, said Peile, who believes the hedge fund industry suffered greatly from a generally poor understanding of what it really does. He said regulation would help the industry to shed its “pariah status”.
Warren Buffett, chairman of Berkshire Hathaway, famously described hedge fund instruments, such as derivatives and credit default swaps, as “weapons of mass destruction”.
Paul Theron, CEO of Vestact Asset Management, still views them in a “dim light, with [their] high fees and patchy performance”.
Hedge funds are known to be aggressive financial instruments that have the ability to disrupt financial markets and cause systemic risk. Due to this fear, the regulator and the National Treasury have preferred to have a handle on what is taking place in this sector.
Peile said the FSB’s fears about hedge funds were purely theoretical, but it was not wrong to try to regulate the sector.
Under the new regulations, qualified hedge funds, which are mainly limited to investment by institutions such as pension funds and high-networth individuals, will not be vigorously regulated.
However, fund managers will have to prove that they have a clear understanding of the complexities and risks of running a hedge fund. The minimum investment amount required in these funds is R1million.
But retail hedge funds, which are open to ordinary investors, will be tightly regulated and their risk appetite will be limited to protect investors. The minimum investment that will be required for a retail hedge fund is R50 000.
Retail funds would be required to publish key investor information documents in plain language and to offer 14-day liquidity, meaning the funds should be able to sell their investments within two weeks.
Other regulation requirements are that investors’ losses are limited to their actual investment and a hedge fund manager covers the excess; and that derivatives trading would be supported by a risk management programme and experienced traders, among others.
The verdict is still out on whether regulators will successfully police the funds. So far, the industry has been a selfregulating sector.