After a three-month consultation and more than 75 submissions, the U.K. Hedge Fund Working Group (HFWG) last month published its best practice standards for U.K. hedge fund managers. Launching the report, the HFWG urged all hedge fund managers to sign up to the new standards, which are voluntary, and also urged investors to use the standards when conducting due diligence of hedge funds.
The new rules operate under a so-called “comply or explain” regime. This means that a signatory must comply with the new standard or explain why it will not comply and give a “reasonable” explanation. The HFWG stresses that “there is no suggestion that explaining is an inferior option to complying.” It also 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 Standards are classified only as “unconfirmed” industry guidance by the Financial Services Authority (FSA) meaning that (unlike “confirmed” industry guidance) the FSA will not take enforcement action against managers for breaches of the Standards. Crucially, this also means that adhering to the Standards does not provide any guarantee of compliance with FSA rules.
Despite their informal status, the HFWG stresses that there are “real advantages” for hedge fund managers if they sign up to the new code. In particular, it says that adherence will make it easier for hedge fund managers to defend themselves against claims brought by investors as the new Standards “should operate to define and limit the hedge fund manager’s obligations and duties under English law.” Such claims, it says, could include alleged breaches of investment management agreements, negligent or fraudulent misrepresentation, or negligent management of the fund (for example in relation to valuation).
While largely the same as the draft HFWG code published in October 2007, the final version includes some additional rules. For example, the Standards now require hedge fund managers to periodically test their compliance procedures or have them audited by a third party.
To view the new Standards, click here: Hedge Fund Standards: Final Report.
Key points include:
- Hedge fund managers should ensure appropriate level of disclosure and explanation in funds’ offering documents about investment policies and also ensure commercial terms (for example, 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
- Managers should ensure that the methodology for valuing complex assets is “robust and transparent” and that all illiquid/hard-to-value assets are disclosed
- 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 on third-party providers should be conducted before a recommendation to the fund’s governing body
- Any use of third-party service providers should be fully disclosed
- Adequate structures should be put in place to handle potential conflicts of interest between managers and investors
- At a minimum, managers must have internal compliance arrangements in place to identify, detect and prevent market abuse and disclose to investors they have a policy in place
- Managers should not vote on borrowed stock
The new standards are intended to complement more detailed rules published by the hedge fund trade body, Alternative Investment Management Association (AIMA), specifically the: AIMA 2007 Guide to Sound Practices for European Hedge Fund Managers.
In a separate development, AIMA also recently published a new Offshore Alternative Fund Directors’ Guide, which advises on the selection and appointment of directors of offshore funds with recommendations on independence of non-executive directors and conflicts of interest (available from AIMA; £50 fee for non-members).