Regulation - a benefit as well a burden

An increasingly vital issue for the hedge fund servicing sector in Ireland and indeed the  global industry is the impact of new types of investment strategy and innovative investment instruments such as credit derivative swaps. Investment managers and administrators are starting to recognise the importance of obtaining independent pricing  for these instruments and, in turn, of developing the right processes and models to price the underlying investments.

The Kinetic Partners Hedge Fund Survey conducted last year found that of various issues affecting the industry, including outsourcing, strengthening of back office and IT infrastructure and diversification of product offerings, a greater focus on independent valuation was most likely to grow in importance for managers in the future. Managers polled for the survey also believed that a perceived lack of skill among administrators in valuation of hedge fund assets posed a growing systemic risk to the industry.

Failure of the industry as a whole to tackle this challenge could impact the attractiveness of alternative funds as mainstream investments in the future. Fortunately, these issues are now high on the discussion agenda for regulators such as the Irish Financial Services Regulatory Authority and the Financial Services Authority in the UK, as well as industry bodies such as the Dublin Funds Industry Association and the Alternative Investment Management Association, and now firms such as Kinetic Partners are taking an active part in the debate.

The public discussion of pricing issues by regulators has drawn attention to the increasing role of regulation in the hedge fund industry, to a degree unimaginable a few years ago. Yet the shift in the investor base of hedge funds toward institutional investors, along with the parallel move to accept access to the sector by retail investors in some form, are only likely to see the level of regulation and scrutiny increase further in the future, in Ireland and across Europe as a whole.

This year has already seen hedge fund managers required to register with the US Securities and Exchange Commission, no matter where they or their funds are based, if they have more than 14 US-resident investors. It's ironic that while many US managers contested the new rules and some evaded a registration requirement by using the loophole of a longer lock-up period, many foreign managers affected by the SEC requirement - especially those based in London - were already subject to regulation at home.

Clearly some managers see regulation as a burden, but there's no doubt that SEC registration is a first step in the US toward a more regulated environment for hedge fund managers. The experience in Europe, however, is that regulation can also be beneficial for managers because it offers an important assurance to the institutional investors that are likely to be the main source of future growth for the industry.

In the UK, which is home to the managers of probably a majority of funds administered in Ireland, FSA regulation is in one sense supportive of the industry - it signifies that a manager has been through a regulatory process, and as a regulated entity is authorised to manage assets. Obviously the industry needs regulators to be sensible in terms of imposing new rules, and regulators need to be aware of the effect that overregulation could have on the industry, but regulation does offer a stamp of approval that US hedge fund managers could well benefit from.

Raymond O'Neill - is a founding member of Kinetic Partners based in Dublin

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