Hedge Fund Developments In 2006

Author:Mr Donnacha O'Conner
Profession:Dillon Eustace

1. Introduction

There have been a number of significant international

developments since last year including the publication in July,

2006 of the Report of the Alternative Investment Expert Group

(the "Expert Group's Report") under the auspices

of the European Commission as envisaged by its Green Paper on

the Enhancement of the EU framework for Investment Funds

published in July, 2005, the decision of a U.S. federal appeals

court to strike down the SEC's Rule 203(b)(3)-1(d)

containing the "hedge fund amendments" to the

Investment Advisors Act, 1940, and recent market data released

showing the state of health of the hedge fund industry as a


2. Development in the EU

The European Commission asked the Expert Group in 2005 to

report how it sees the future development of the European hedge

fund industry and what obstacles could be removed or steps

taken to make the business more efficient. While it remains to

be seen how many of the Expert Group's proposals will be

taken on board by the Commission, as a possible pointer to

future developments, the Expert Group has agreed with past

public statements from the Commission itself, in so far as it

suggests that the European hedge fund industry is developing in

such a way that does not give rise to a need for targeted

legislation at European level and that any such legislation, to

the extent that it impinges on hedge funds' unrestricted

freedom to invest or their business models, is likely to fail.

The Report recommended that it was premature to consider

broadening the investment restrictions of the existing UCITS

framework so as to accommodate a broader range of hedge fund

strategies. The Report recommended moving towards mutual

recognition of a nationally regulated retail-oriented hedge

fund product outside of the UCITS framework by firstly imposing

a minimum investment threshold of 50,000 on such hedge

funds and secondly by ensuring that those who sell the products

are appropriately regulated and supervised and observe the

appropriate conduct of business rules and duties of care to the

end-investor (as, it suggests, would be the case under proposed

MiFID standards). The regulatory capital requirements of

regulated institutional investors, under Basel II and the soon

to be in force Capital Requirements Directive, should be

carefully examined, the Report urges, such that arbitrary

restrictions on hedge fund investment by such regulated

institutions be removed. The Report also suggested that in

order to make the market for custody services more efficient,

that hedge funds not be required to appoint a local custodian.

It will be interesting to see how the latter proposal is

treated by the Commission as most European hedge funds,

including Ireland's, are created under regulations based on

the UCITS model and have as their cornerstone the independent

functions of custody and management as well as management

oversight by a locally based custodian.

The Commission has said it will publish an investment fund

strategy paper later this quarter, which will outline the

actions it proposes to take in this regard. outlining the

actions it proposes to take in this regard.

3. Market Developments

Data published in the May 2006 semi-annual HFMWeek Fund

Administrator Survey (the "HFMWeek Survey") made

interesting reading for those who continue to predict the doom

of the hedge fund industry, and was timely, as it coincided

with the call from the Expert Group to the European Commission

to rationalise European hedge fund servicing and distribution

in order to make Europe more attractive to the growing hedge

fund market.

The HFMWeek Survey suggests an increase in both single

manager hedge funds and funds of hedge funds but a slow-down in

the growth of funds of hedge funds. The Report indicates...

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