Regulating the hedge fund market

The Collective Investment Schemes Regulations of November 2005, along with a subsequent ministerial order, a circular from the Comisión Nacional del Mercado de Valores (CNMV, the Spanish Securities Exchange Commission) and most recently amendments to the regulations published on March 17, represents the first step toward the establishment in Spain of a regulated market for hedge funds and funds of hedge funds. The legislation is the first in Spain that mentions and regulates, and hence authorises, this type of fund. However, the regulations as currently conceived appear designed principally to encourage and protect the development of a domestic hedge fund industry. At this point it is hard to envisage any foreign-based hedge funds or funds of funds, already hamstrung by disadvantageous tax rules, obtaining authorisation from the regulator.

At present requests for authorisation to manage domestic hedge funds are coming from Spanish fund managers or from foreign banking or fund management groups that have an existing local presence. The fact that most existing hedge funds are domiciled in offshore territories classified by Spain as tax havens rules out any possibility of them being approved by the CNMV at this stage. In addition, Spanish investors in such funds are currently taxed annually on any increase in their value, whether or not any distribution has been made, with the assumption of a minimum 15 per cent increase in value. Around 20 local fund managers have already obtained authorisation to manage hedge funds, but to date no foreign managers have set up from scratch a local presence in their own right. What they have done, on the other hand, is to enter into joint ventures with local players. This trend has emerged recently because Spanish fund managers need to demonstrate to the CNMV a track record and the resources to carry out management of hedge funds or funds of hedge funds.

Joint ventures are in the interest of both parties because it gives foreign managers a presence in the Spanish market, while their local partners gain access to experience in hedge fund management. This combination of management skills and domestic market knowledge seems to have been encouraged by the way the regulations have been shaped.  The government has just undertaken the first significant amendment of the regulations since their introduction nearly 18  months ago, a recognition that the legislation and the CNMV circular that implemented the rules on a practical basis left a number of areas unclear and generally provided insufficient flexibility to encourage the development of hedge fund products.

The changes allow hedge funds and funds of hedge funds to impose lock-up periods, to set notice periods for subscriptions and redemptions, to make partial redemptions where payment in full would prejudice the fund's investment policy, to set limits on the total level of redemptions that can be required on a single redemption date, and to set fees outside the limits imposed on traditional Spanish funds, as long as funds make proper disclosure in their prospectus.  In addition, the risk warning statementpreviously required for all types of investor no longer has to be signed by qualified investors or by non-qualified investors with portfolio management agreements containing equivalent warnings. The amendments also expressly authorise single-manager funds to accept unsolicited subscriptions from nonqualified investors, subject to the EUR50,000 minimum subscription, and allow Spanish funds to be used as master funds in masterfeeder structures.

Juan Sosa Pons-Sorolla senior lawyer with Simmons & Simmons in Madrid

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