Asset Management Changing rules The regulation, taxation and distribution of hedge funds around the globe June 2009 Contents Foreword 03 Changing rules 04 Regulatory developments 08 Taxation developments 10 Country-by-country overview 14 Table 1: Availability of hedge funds and funds-of-hedge funds to investors by country at June 2009 72 Table 2: Channels of distribution of hedge funds by country at June 2009 78 Table 3: Regulation of hedge fund managers by country at June 2009 86 Table 4: Taxation of hedge funds and hedge fund managers 90 Contacts 96 Whilst this information represents our understanding at the time of going to press, given the rapid pace of change in the global hedge fund industry, the factual data in this paper may quickly be superceded. Up-to-date advice should always be obtained regarding current regulations and fiscal rules. PricewaterhouseCoopers 02 Changing rules PricewaterhouseCoopers Changing rules June 2009 3 Foreword This is the 7th year we have produced our whitepaper report. Our last report was dated September 2008 and was published just as Lehman Brothers announced that it was in administration and the US Government announced massive support for AIG. These events signalled the start of a period of extreme financial turbulence and volatility. The reduction in worldwide securities in the draft Directive will affect not If you would like to discuss any of the markets coupled with net redemptions only the managers of hedge funds issues in this paper in more detail, over the last 9 months have resulted but also private equity, real estate, please speak with your usual contact at in industry assets under management infrastructure and some traditional long PricewaterhouseCoopers1 or one of the falling significantly – estimates suggest only managers. Although there is bound country members listed in the contact some 30% from their peak. Some to be much debate and lobbying to section at the end of this document. hedge funds have closed, some change the proposals, history shows have restructured and some fund that a lot of the original text will remain. managers have gone out of business. The changes proposed would have far The business environment remains reaching effects on the European extremely challenging yet the regulatory non-retail asset management industry consequences of the credit crunch and quite probably, a number of and their potential impact on the unintended consequences. marketplace are only beginning to emerge. All industry participants will need to monitor developments carefully as the At the end of April 2009, the European new rules emerge. Commission published a draft proposed Graham P.N. Phillips European Directive that will apply to all Once again our international network Partner, PricewaterhouseCoopers (UK) Alternative Investment Fund Managers has successfully collaborated with our European Hedge Fund Practice Leader central team to produce this paper and established in an EU member state. June 2009 In their current form the proposals I am indebted to all those involved. 1. “PricewaterhouseCoopers” refers to the network of member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity. 01 Changing rules In September last year, the consequences of the credit crunch accelerated. Coupled with the demise of Lehman Brothers and the intervention of governments to “bail out” banks, the sub prime crisis became a banking crisis and then a macro crisis. For the sector, the deleveraging by financial institutions and flight to cash by all investor classes caused significant redemptions and, together with the falls in securities markets worldwide, is estimated to have reduced assets under management in the industry to about 30% of the position at December 2007. Last year we were predicting that some vision on the future business more institutional money would be environment – a tough challenge given allocated to hedge fund strategies and the huge upheavals in financial markets. that this money would fuel a focus on operational risk – both by investors But just as managers have started and managers. We anticipated that to see a slow down in redemptions the larger hedge fund managers would and started to achieve some positive need to embrace the published Best investment performance, they are Practice Standards and Practices (both being faced with a new challenge – of the Hedge Fund Standards Board a challenge from the regulators. and the US President’s Working Group on Financial Markets) to demonstrate The Draft EC Directive robust controls and processes. It is fair to say that since the European We also commented that compensation Parliament approved the Rasmussen strategies would need to be modified report in July 2008, it has been known and aligned to achieve adherence that the European Commission would to a strong operational control have to draft proposals to address the framework and avoid bias to risk and recommendations of this Parliament short term thinking. approved report. However, it was That was then. Whilst these issues not expected that the draft Directive remain valid the extreme financial published at the end of April 2009 market dislocation over the last 9 would be so wide in scope and months has caused every financial released with such limited consultation. institution to reappraise its business The draft directive is proposed to model. Necessarily, the emphasis apply to Alternative Investment Fund has been on survival and trying to get Managers (AIFMs) established in an PricewaterhouseCoopers 404 Changing rules PricewaterhouseCoopers Changing rules June 2009 5 EU member state and who provide It is unclear whether there is sufficient management services to alternative supply of expertise in the EU investment funds (AIFs). The definition marketplace for such an independent of an AIF includes all non-UCITS funds valuation process, especially when it and therefore also covers for example, comes to hard–to-value assets. real estate funds, infrastructure funds, exempt unauthorised unit trusts and UK In addition, the AIF will need to appoint investment trusts. a depository. The depository needs to be an EU credit institution and this will Issues with the Directive exclude most existing prime brokers – it is thought that there are only four Not only was the scope much broader prime brokers who currently have EU than expected, but also the provisions credit institution status. Consequently, in the draft Directive were much an EU credit institution will need to be more extensive. For the hedge fund appointed as a depository to a hedge industry, it is proposed that EU hedge fund and in turn sub-delegate to a fund managers with assets under prime broker. This is feasible except management of EUR 100 million or that the draft Directive also requires the more will be subject to a minimum level depository to take the liability risk for of capital of EUR 125,000 plus a further breaches of the Directive, irrespective of 0.02 per cent of the value of assets the sub-delegation arrangements which under management in excess of EUR probably makes such arrangements 250 million. uneconomic and possibly unworkable. There are also detailed reporting The Directive also requires disclosure requirements for the AIFM to both the about leverage to both the investors home state regulator (e.g. information and the regulator. The definition of on governance structures, internal leverage is unclear but it appears that risk management systems, valuation the regulatory authorities including the procedures and risk management Commission itself will have the power systems and to investors (e.g. to impose limits on leverage. descriptions about valuation procedures, liquidity risk management, The reaction of the Industry redemption rights, identity of the AIF’s Associations has been negative and depository, the third party independent reflects their perception that only limited “valuator”, when the AIF may use consultation has taken place. Clearly, leverage, any investors who benefit the draft Directive will be subject to from preferential interests etc.). much lobbying and negotiation and it must be remembered that it only More fundamentally, the draft Directive represents Level 1 principles under the seeks to change some of the existing Lamfalussy process and the fine detail relationships and infrastructure within is yet to be worked out; however, most the industry. Under the proposals, it will commentators believe that the basic be necessary for each AIF to appoint thrust of the Directive will remain. an independent valuer to value the assets and then the units/shares of the AIF each dealing or subscription/ redemption day and at least annually. US Regulatory Developments Business Implications The US is moving at a different pace. What is clear is that the financial At the time of writing a US House environment in which hedge funds Sub-committee had just finished a operate has changed fundamentally. hearing on “Perspectives on Hedge The regulators are rewriting the rules. Fund Registration”. There is a bill Therefore, hedge fund managers need proposing an amendment to the to start re-thinking what this means Investment Advisors Act of 1940 to their business and operating model. which would lead to a mandatory Although the new rules are not yet registration regime for all US investment completely clear, there is enough advisors and non-US investment information in the proposed Directive advisors if they have US clients. This to start working through the issues, registration requirement differs to the considering their impact and then proposed European AIFM model (where potential solutions. We have set out an registration is required if the AIFM action plan opposite of the key areas operates from a place of business in the to consider. EU) because the US model, by virtue of linking the registration requirement to Conclusion clients, makes it extra-territorial. Hedge fund managers need to get up The US appears to be moving at a to speed quickly with the proposed slightly slower pace than the EU and new rules.