The Hedge Fund Working Group (HFWG), which represents 14 U.K. leading hedge fund managers, has published proposals for a new code of conduct. The new rules, which would be voluntary, would operate under a so-called ‘comply or explain’ regime meaning that the standards must be adhered to unless a ‘reasonable’ explanation could be given for an exception to be allowed. Although lacking any statutory basis, the HFWG argues that the new standards would be followed because of peer pressure and market pressure from investors. It recommends a ‘statement of conformity’ be published on a fund’s website to enable investors to see how the fund has complied with the standards.

The HFWG was launched in June this year as an ad hoc group with a specific mandate to create a code of best practice for UK-based hedge fund managers. Going forward, HFWG recommends a board of trustees be created to oversee responsibility for the new standards.

Responding to criticisms that hedge funds operate with excessive privacy, the report calls for more funds to publish information for investors on their websites. On the issue of shareholder activism, the report acknowledges that activist hedge funds need to be “particularly” vigilant about market abuse as they are, “…much more involved in the interplay of information between public and private domains.”

Key proposals include:

Disclosure to investors and counterparties: Hedge fund managers should ensure appropriate level of disclosure and explanation in funds’ offering documents about investment policies and also ensure commercial terms (e.g. fees and lock-ups) are highlighted in sufficient detail and with sufficient prominence in marketing materials. Side letters conferring preferential terms should be disclosed to investors in same asset classes. Managers should also provide counterparties with sufficient information to assess risk.

Valuation: Managers should ensure that the methodology for valuing complex assets is “robust and transparent” and that all illiquid/hard-to-value assets are disclosed.

Risk management: Managers should devise a risk ‘framework’ that should be explained to investors and should also employ a broad range of risk measurement techniques. Careful due diligence of third-party providers should be required before recommendation to fund governing body. Any use of third-party service providers should be fully disclosed.

Fund governance: Adequate structures should be put in place to handle potential conflicts of interest between managers and investors.

Market issues and activism: At a minimum, managers must have internal compliance arrangements in place to identify, detect and prevent breaches of market abuse and disclose to investors it has a policy in place. The HFWG also recommends that regulators introduce a regime requiring all investors to disclose their positions in companies, which if owned directly, would have to be made public. Managers should not vote on stock where they are not economically exposed (e.g. borrowed stock).

The final HFWG report is expected to be published in January, following a three-month consultation. To view the two-part consultation document, click on: Hedge Fund Standards: Part 1, Executive Summary or Hedge Fund Standards: Part 2, Best Practice Standards.

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