Hedge fund FCA regulation

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Hedge fund FCA regulation

Most hedge funds are located offshore. Therefore, the fund itself is not within the scope of the FCA’s rules. However, those who manage, market, and facilitate investments are within the FCA’s scope. If you don’t ensure that individuals and entities who assist the fund have appropriate approvals, then penalties apply.

Since the 2008 crisis, the UK government has reshaped the regulatory landscape. Hedge funds attract the government’s focus since they provide alternatives to traditional investments.

FCA compliance

A hedge fund is notoriously difficult to define. There is no statutory definition. However, the FCA confirmed that a hedge fund is an alternative investment fund. Thus the FCA has the authority to intervene.

Hedge fund structure

If the fund itself is offshore, then it’s likely the FCA has no supervisory power. However, UK fund managers are probably supervised by the FCA if they:

  • Advise on investments;
  • Arrange deals in investments;
  • Act as agent;
  • Manage investments; and
  • Carry on a regulated activity.

Penalties for poor market behavior are also intended to deter others.  Consequently, hedge fund managers require systems and controls appropriate to their business’ scale and nature. Otherwise they face striking off and licence revocation.

Authorisation process

Any individual discharging the above activities requires authorisation. The entity at which the individual operate, also requires authorisation. We manage your application process.

Portfolio documents

Investors require portfolio documents. Clearly, the content depends of the funds strategy.

Key information document

Potential investors should receive the key information document, a pre-contractual disclosure document. Each investor should confirm they received this document, which must:

  • Be fair & accurate;
  • Free of marketing material;
  • Precisely worded;
  • Contain information on key contractual documents, e.g. the management agreement;

Target investors

If the fund seeks investment within the EU, then EU rules apply. Compliance issues depend on the fund’s structure. Forthcoming and recent amendments include:

Markets in Financial Instruments Directive II

The Markets in Financial Instruments Directive, MiFID II, comes in effect in early 2017. It repeals and recasts the previous directive. It will form the legal framework for investment funds, trading platforms, and venues. It also includes data protection requirements.

European Long Term Investment Fund

The European Long Term Investment Fund, ELTIF, came into effect in 2015. These funds investors seeking long term returns on capital, sometimes termed patient capital. The funds mainly invest in tangible assets, and require authorisation.

Individuals

Marketing a fund to individuals requires special care. Usually, funds target high net worth or sophisticated individuals. Best practice is for managers to meet the individual investors.

The FCA considers these individuals may have the requisite knowledge and skill to understand investment risks.  We draft appropriate paperwork, that should include certain declarations from investors.

Different rules apply to different jurisdictions. The jurisdiction depends on the structure, i.e. the location of the fund, the individuals and investors.

Fund marketing risks

Usually, managers can market the fund, although there are risks.  If managers lack appropriate authority to market the fund, investors may bring claims. The FCA may intervene. Usually, funds target institutional investors and sophisticated individual investors. If you step outside these boundaries, you require higher levels of authorisation.

Risk reduction

The FCA publishes lists of firms and individuals undertaking activities that lack required regulatory approval. Avoid this list.

Hires and exits

When hiring employees, you require a greater level of due diligence.  In your employment documents, each employee should confirm and warrant that they:

  • Are an approved person;
  • Will seek to remain an approved person;
  • Will not risk losing approved person status; and
  • Have not faced any disciplinary action from any regulatory body.

Exit documents

When an approved person leaves, usually the management entity and individual sign a settlement agreement. The approved person should provide warranties and indemnities, stating the individual has:

  • Acted within the scope of their instructions;
  • Acted in accordance with the fund’s internal policies; and
  • Not received any FCA notices.

Fail to address these risks at employee level and you risk investor claims and the FCA’s attention.

Track record: regulation & compliance

Recent instructions include:

  • Employee exits and hires for management entity: ensured compliance with the application of FCA rules. We acted on a fixed retainer.
  • FCA approval: applied and obtained approval for entity undertaking regulated activities in the UK.
  • Cayman island fund compliance: ensured compliance of marketing approaches to UK investors.
  • Newly incorporated Luxembourg fund targeting EU institutional investors: prepared portfolio and investment documentation.

Summary

All financial practices in the UK fall under the FCA’s umbrella. Even if hedge funds incorporate overseas, there are no exceptions. Authorisation is required.

We manage your authorisation alongside the structural and management paperwork. Our objective viewpoint clarifies grey areas.