The Regulation of Hedge Funds

A Global Perspective

Ana Maria Fagetan

• Publisher: Palgrave Macmillan
• Year: 2020
• ISBN:
  9783030637064
• Topic: Law
• Subtopic: Financial Law
• Index: Law

This book analyses elements of international finance, comparing the regulation of hedge funds in United States, Europe, the UK, and off-shore jurisdictions in the aftermath of the financial crisis. It critically compares the Dodd- Frank Act in US with the Alternative Investment Funds Managers Directive in Europe. Moreover, it goes further by analyzing the implementation of the AIFM Directive in seven jurisdictions in Europe famous for the incorporation of hedge funds: the United Kingdom, Italy, France, Ireland, Malta, Luxembourg, and Switzerland. The book also analyses the effect of Brexit on the legislation in the UK regarding the application of the directive and the distribution of financial products in Continental Europe, and will be of particular interest to researchers, academics, and students of international finance and financial regulation.

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2021

A. M. FagetanThe Regulation of Hedge Fundshttps://doi.org/10.1007/978-3-030-63706-4_1

Begin Abstract

1. The Rationales of Hedge Fund Regulation

Ana Maria Fagetan¹

(1)

Sapienza University of Rome, Rome, Italy

Keywords

Hedge fundsInvestors protectionFinancial stabilityMarket integrityMarket manipulationRegulatory arbitrage

End Abstract

1.1 Introduction to Hedge Funds

In the last decennium, there have been many changes in the asset management industry, the last year representing a critical point for the hedge fund industry. Thus, important hedge funds shut down,¹ meanwhile other managers decided in favor of mergers.² There were also managers who acquired other firms.³ These changes were dictated by different reasons, as we shall see below. Indexation and also fee constrain have forced mutual funds to advance brand new models of investment strategies which used to be dictated in the past by hedge funds. A main characteristic of the last decade is that numerous corporate investors are currently choosing an inactive investing manner.⁴ Another feature, observed mainly in the United States, refers to the fact that hedge funds’ investment discretion was strongly reduced by the requirements that were imposed lately, such as new registration and other reporting requests, all these measures having as main aim the increase of transparency. In addition, Brexit and everything referring to it that is still unknown to investors, also impact the industry. Also, adding value is becoming more difficult for hedge fund managers and investors, since the market is defined through both strong equity and bond markets. These changes are constantly challenging hedge funds industry, raising doubts and unanswerable inquiries for investors concerning the future of hedge funds.

According to Barclay Hedge, and their Global Hedge Fund Database as of March 26, 2020, currently, the situation can be found in Table 1.1.

Table 1.1

The global hedge funds databases as of March 2020

Number of reporting funds	7091
Number of reporting management companies	1982
Number of funds added in previous month	116
Managers domiciled in United States	57.62%
Managers domiciled in Europe	24.32%
Managers domiciled in Caribbean	15.74%
Managers domiciled in Rest of World	2.32%
% of Funds with February Returns	94.43%
% of Funds with January Returns	99.01%

Source BarclayHedge (2020a)

Figure 1.1 illustrates the global hedge funds managers percentage according to their domicile, as of March 26, 2020.

Fig. 1.1

Global hedge funds managers as of March 26, 2020 according to their domicile

(Source BarclayHedge 2020a)

All tendencies noticed above are reflected in the growth of the hedge funds’ AUM, as seen in Fig. 1.2. Thus, after the crisis, the growth of AUM for hedge funds was constant, but it has however reached 8.4% yearly in comparison to a rate of 20.3%, registered between 2000 and 2010. Therefore, even if hedge funds are on a growing tendency, this last 10 years were characterized by difficulties. Additionally, their liquidations grew very much in comparison to the years before the financial crisis.

Fig. 1.2

Assets under management in the global hedge fund industry

(Source BarclayHedge 2020b)

If it were also to examine launches of hedge funds as compared to liquidations, “between 2012 and 2018, new hedge fund launches outpaced liquidations. But, as the industry has grown, the number of fund launches has trailed liquidations. Just 529 hedge funds and CTAs launched in 2019, fewer than half the number (1169) that launched in 2018.”⁵ On one hand, the reasons for these are that, some of liquidations occurred due to high fees and low performance⁶ in the last period. On the other hand, the global hedge fund landscape seems saturated, particularly if we consider the major trends which defined the industry last year: “consolidation and investor concerns over market volatility growing focus on ethical investment and the higher costs of starting a fund amid increasing regulation – all while maintaining performance.”⁷

1.2 The Worldwide Total Size of the Hedge Funds Industry

The world’s total size of the industry remains yet uncertain. Even though regulators have been paying increased attention and have been constantly adjusting regulation concerning hedge funds since LTCM’s failure in 1998, the total size of this industry is yet questionable. As Barth et al. (2020) assess in their research paper “The Hedge Fund Industry Is Bigger (and Has Performed Better) Than You Think,” “the potential data gaps in hedge fund activities are not confined to questions of size; the extent to which hedge fund performance and investor flows have been comprehensively measured is similarly uncertain.”⁸

Of course, there are several reliable estimates regarding the size of hedge funds, but their ambiguity resides in the fact that, until recently, there were limited regulatory data collections on hedge fund activities. In this respect, the most accurate data on the industry are provided by Hedge Fund Research (HFR) and Lipper TASS. Even these databases collect their information from funds on an essentially voluntary basis, the biggest hedge funds usually choosing not to list in these databases.⁹ This idea is also supported by Cary who underlines that, “access to transparency likewise depends on the bargaining power of investors as hedge fund advisers are not obligated to provide any such information to investors.”¹⁰ Contemporary regulation both in Europe and the United States try to fill this gap, still, data are not complete because of a lack of jurisdictional overlap. We mention in this respect the differences in these data. According to Eurekahedge the world total size of the industry is around 2.33 trillion US dollars.¹¹ Meanwhile, HFR estimates around 3.21 trillion US dollars. Also, eVestment estimates 3.31 trillion US dollars, while Barclay Hedge asses the total AUM industry at USD 3.54 trillion. Also, Preqin estimates the industry at USD 3.55 trillion.¹² As seen above, most of these estimates are between USD 3.0 and 3.55 trillion.¹³ The biggest estimates come from the SEC, around USD 3.89 trillion.¹⁴

Indeed, scholars generally rely on hedge fund indices in the evaluation of their performance, which in itself raises various limitations, because, as already observed above, “these indices rely on hedge funds that are self-reporting because these entities are not required to disclose returns pursuant to any regulatory mandate.”¹⁵

1.3 Rationales of Financial Regulation Applicable to Hedge Funds

The vast literature¹⁶ on the issue suggests that there are three objectives that provide the rationale for financial regulation in general and for hedge fund regulation in particular. These objectives are: (a) protection of investors, (b) promotion of market integrity, but also (c) preservation of financial stability.¹⁷

As remarked by various observers, such as Sander Van Berkel, Peter Cartwight, Niamh Moloney, Phoebus Athanassiou, the above-mentioned aims are connected and they overlap, in certain regards. For instance, the provision and insurance of fair, efficient, and transparent markets need some requirements, which are also used for investor protection and mitigation of systemic risk. Similarly, some of the systemic risk mitigation measures afford investor protection.¹⁸

Consequently, capital flows to hedge funds in various countries are influenced by the strength and the enforcement of investor protection laws in these countries. All the above-mentioned principles are being addressed in the current chapter, in relation to the ap...

Table of contents

• Cover
• Front Matter
• 1. The Rationales of Hedge Fund Regulation
• 2. Regulation of Hedge Funds in the EU
• 3. Regulation of Hedge Funds in Selected Single European Jurisdictions: Italy, France, Ireland, Luxembourg, Malta, and Switzerland—The Impact of the AIFM Directive
• 4. The Regulation of Hedge Funds in the United Kingdom and the Impact of Brexit
• 5. The Non Regulation of Hedge Funds in Offshores Jurisdictions: Cayman Islands, British Virgin Islands, Mauritius, and Delaware
• 6. Regulation of Hedge Funds in the US
• 7. Litigation and Arbitration Regarding Hedge Funds
• Back Matter