UK asset management firms and hedge fund industry representatives have expressed their satisfaction with the long-awaited proposals unveiled by the Financial Services Authority that would allow retail consumers to invest in funds of hedge funds and other alternative investments sold by firms authorised in the UK.

The new regime for retail alternative funds is likely to come into force early in 2008, following formal consultation with alternative asset managers and other members of the industry. The UK regulator is asking interested parties to comment on the proposals by June 27, before it finalises the draft rules toward the end of this year.

'We welcome this development,' says Gordon McAra, head of communications at the Alternative Investment Management Association. 'The FSA's proposals seem proportionate and sensible, and we are happy to see them.'

The FSA notes that retail investors in the UK are already able to obtain access to hedge funds and other alternative products in a variety of ways, including structured products and exchange-listed investment companies.

The regulator says it now believes the time is right to allow the development of retail-oriented funds of alternative investment funds within its regulatory regime, following a widespread welcome from the financial industry when the idea was first officially floated just over a year ago.

Says Peter Grimmett, head of distribution compliance at Threadneedle: 'As a manager of hedge funds, we welcome the FSA proposals to widen hedge fund availability to retail consumers in a controlled manner.

'This is a good step in the right direction, as it's important that the UK remains competitive with other countries, such as Germany, France and Spain, which have permitted similar regimes.  The FSA has acknowledged that there is general international acceptance of such alternative investment funds - we concur with this.

'However, to make this work, it is critical that the right tax regime is in place and it is helpful to know that the FSA has worked closely with HM Treasury and HM Revenue & Customs on taxation issues.'

Jamie Murray, global head of institutional business development at HSBC Alternative Investments, says: 'Considering making funds of hedge funds available to retail investors is excellent news. This will bring the UK in line with a range of different European countries, including France, Ireland, Spain and Switzerland, which have already opened their markets to retail and high net worth investors.

'We firmly believe that a properly constructed and well-diversified fund of hedge funds is the most appropriate way for investors to access this sector. There are more than 9,000 hedge funds available worldwide, making it impossible for the average retail investor to research individual funds. Investing in a fund of hedge funds run by an experienced manager, with the resources to undertake extensive, ongoing research is a sensible solution to this problem.

'While fund of hedge funds are available via the London listed route already, the closed-ended nature of these types of vehicle is not suitable for all investors. The concept of funds of alternative investment funds may provide a good solution for this kind of investor.'

Noting that HSBC Private Bank has been advising private clients on hedge fund investment since 1989, Murray adds: 'We have observed the hedge fund industry evolve and acceptance for this investment approach spread very widely. The acceptance of the approach for UK retail investors will provide an additional investment tool, providing these investors with diversification benefits and access to a group of investment specialists able to generate much sought-after alpha, as well good risk-adjusted returns.'

The new FSA document reflects feedback from the publication last March of a discussion paper, Wider Range of Retail Investment Products: Consumer Protection in a Rapidly Changing World, which considered the increasing variety of retail investment products, the risks they posed to consumers, and how those risks could be addressed.

Providing a regulatory framework for alternative asset funds of funds, the FSA believes, would deliver substantial structural and operational safeguards for investors, including the requirement to have an independent depositary, strict rules on independent valuation of underlying assets, and timely redemption of investments.

Dan Waters, the FSA's director of retail policy and asset management sector leader, says: 'Asset management is a dynamic and innovative industry, and we believe it is important that consumers can get access to the latest techniques to manage their own savings and investments.

'We think the time is right to permit access to a wider range of innovative strategies through authorised onshore vehicles. This will allow investors more choice and a better opportunity for risk diversification, while maintaining investor protection through our rules on the operation of the product.'

A key element in the FSA's approach is its expectation that the fund manager will operate with due diligence. The consultation paper sets out the regulator's requirements in a more principles-based way, and proposes guidance for the fund manager in areas the FSA considers necessary when making and holding significant investments into unregulated schemes.

The paper is accompanied by a case study illustrating the respective responsibilities of providers and distributors of alternative fund of funds products.

The FSA proposals would introduce retail-oriented funds of alternative investment funds into the existing FSA regulatory regime for non-Ucits retail schemes. At the same time, the existing 20 per cent restriction on investment into unregulated collective investment schemes would be listed for non-Ucits retail schemes that are funds of alternative investment funds.

Under the proposals, managers of retail funds of alternative investment funds would be subject to due diligence guidance on factors to consider in making their initial and ongoing investment decisions.

The regulatory regime would remain essentially unchanged for existing non-Ucits retail schemes, subject to various amendments required to ensure overall consistency for the regime as a whole. The changes would also ensure that the regime for qualified investor schemes was in line with the revised approach for non-Ucits retail schemes.

Aima views the proposals as an endorsement of the long-held view of members that retail investors should be able to benefit from access to new opportunities for risk diversification and portfolio growth. The association also welcomes the operational safeguards that the FSA will require to ensure that investor protection is on a par with other authorised investments.

Matthew Jones, manager of Aima's regulatory department, says: 'There is a common goal shared by the industry and the FSA to optimise the investment environment for investors, and we believe this is a positive step forward.

'The FSA is right to conclude that retail investors should be given the opportunity to invest in market-leading investment products that can deliver absolute return performance in all markets, giving a better opportunity for risk diversification.

'However, as the FSA found with its QIS regime some time ago, the be all and end all for these products is the question of how they will be taxed. We are pleased to read that the FSA is confident that an appropriate taxation regime will be developed by HM Treasury, in discussion with the FSA.'

The FSA says that following the closure of the consultation period on June 27, it will finalise the draft rules in light of the responses it has received and publish a policy statement toward the end of the year, giving feedback, setting out the rule changes and announcing the date on which they will come into effect.


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