It has not been a great month for hedge funds, what with George Soros the billionaire financier and philanthropist quitting the business, and the Financial Stability Forum (FSF) threatening regulation. For institutional investors the latter is the more interesting, suggesting as it does a tightening up by regulators across Europe which could affect the range of asset classes and instruments open to asset managers.
Last month, the Financial Services Authority (FSA) chairman, Howard Davies, warned hedge funds that they may face direct regulation if progress is not made on the recent recommendations on highly leveraged institutions (HLIs) made by a FSF working group, which he chaired. The group’s conclusions have been endorsed by the G7 Finance Ministers. “I hope there is progress on the recommendations I have outlined. If there is not, and particularly if there is another market destabilising collapse, then we might find ourselves developing a closer and more formal relationship with the hedge fund industry, something which I am sure they do not want.”
Although the working group was focussing on the impact macro hedge funds can have on small open economies and the financial system as a whole, its report’s support for greater disclosure and transparency, and improved risk management in institutions that provide leverage to HLIs and in HLIs themselves will be noted by regulatory bodies around Europe.
Currently, similarly to derivatives investment, most European regulators rely on the details of any trust deed, the trustees, and the prudence of the asset managers to limit the impact of hedge funds on pension fund portfolios. “In the UK, funds can invest in hedge funds without further reference, given they act within the terms of their trust deed,” says David Gould, head of investment at the National Association of Pension Funds in London. “The larger funds make use of them, but the ‘sub’-billion ones tend to steer clear. They are using them to restructure their portfolios, say changing a benchmark, or to offset risk in a particular market. It remains a minority interest, mainly due to lack of knowledge.”
In Ireland, Des Crowther at the Irish association of Pension Funds confirms that although there is no restriction on the use of hedge funds, their impact to date has been insignificant.
Across Europe it is a similar story, as, unsurprisingly, many funds adopt a more conservative approach than their UK counterparts. Georg Hagström, secretary general of the Swedish Association of Institutions for Retirement Provision, says that there are no specific restrictions on hedge funds. In fact, in Sweden there are no real restrictions other than prudence, and the board of an institution could authorise 100% investment in equities, provided there is liquidity. “That could be a problem with investment in a hedge fund if it was not very liquid and represented a significant proportion of the fund. But, for all practical purposes, provided they represent say, 10%, of the fund, there would be no problem, but if it was say, 30%, the prudence rule could come into operation,” says Hagström. “Although people have been a little reticent about hedge funds, I think the situation is changing in Sweden.”
Anna Seiersen at the Danish Association of Pension Funds meanwhile believes that Danish fund managers are steering clear of hedge funds. “This is despite the fact that there are no specific restrictions on this class of investment, as the Danish investment restrictions relate to asset categories. So, the restrictions applying for hedge funds depends on the underlying assets.”
Over in Iceland, Thor Hallsson of Landssamtok Lifeyrissjoda confirmed a similar situation, with no restrictions on hedge fund investment, but said: “If such investment takes place at all it is a very small fraction of the pool.”
In Holland, Nico Obolonsky of OPF says that the supervisory body merely states that the fund must be invested in a ‘solid manner’. He went on to say that if a fund uses an investment in a defensive way, to check a currency risk or firm up an equity investment, the regulator would approve: “Pension funds are not speculators, however, and this kind of investment would have to be modest in comparison with the whole pool.”
The Association Suisse de Institutions de Prévoyance in Zurich confirms that there were no specific restrictions on investment in hedge funds imposed by the Swiss regulator, but that in any event, it was very rare for them to be used.
In Luxembourg, meanwhile, the Banque Génerate du Luxembourg said that the ‘prudent man’ principle applied to pension funds, which have not been subjected to the same restrictions on investment as have investment funds. “How the hedge funds are structured and where they are domiciled will have an influence on how they are viewed, but I think the general trend is to use these investments,” a spokesperson confirms.
Amauld d’Yvoire of Observatoire des Retraites in France, says that legislation on regulation of pension funds was limited, and no specific attention has been paid to hedge funds. Meanwhile, whilst the regulator in Germany is far more strict on where asset managers can invest, hedge funds are viewed separately, because of the tax consequences of private equity funds, fund managers are very cautious about hedge funds.
In Brussels, Toni Ossenblokk of the Association of Belgian Pension Funds confirms that given the legislation of last year, Belgian funds have much wider scope to invest in diverse instruments, which means hedge funds can be used. To date, however, there has been little take up.