Dermot Butler, chairman, Custom House Global Fund Services Ltd and Custom House Group

Comment: Regulatory overload

Regulation must be 'targeted, appropriate and relevant', says Dermot Butler, chairman of Custom House Global Fund Services Ltd and Custom House Group…

Despite numerous statements to the contrary, there are apparently many who believe that I am against regulation in our industry – this is not true. I am totally in favour of regulation that is targeted, appropriate and relevant. What I am against is regulation for regulations’ sake, badly written and ill thought through regulation and “blanket regulation”, originally targeted at one specific problem, but which is written in such a way as to take out everything and everybody in several miles radius – “the baby with the bathwater” syndrome.
 
I also have no time for regulations introduced for purely political motives. The glaring example of this was the draft AIFMD (Alternative Investment Fund Manager Directive) which was published in April 2009 to a barrage of criticism, both as to content and motivation. The political motivation was clearly demonstrated when a high-profile EU politician was asked to comment on credible evidence that hedge funds were not responsible for the ‘07/’08 financial debacle, to which he replied – “I know, but I just don’t like hedge funds”, or words to that effect.
 
Unfortunately, no amount of rational or logical discussion and reasoning can penetrate political dogma. So now we have a plethora of regulation emanating from the EU, the UK, the USA and almost every other country you can name. This has had one clear result – a huge increase in compliance costs which, in my opinion, far outstrips the value provided by most of the regulations themselves. Certainly as far as the investor is concerned.
 
As examples, I propose to briefly refer to two pieces of regulation that we have seen this year – the UK Bribery Act and the US FATCA Regulations.
 
The UK Bribery Act does very little, if anything, to protect investors from fraud, but it is designed to ensure that if you have a business (office) in the UK, you employ UK citizens or supply services to a UK entity, then you fall under the Act. Accordingly, these persons have to be able to show (as of the 1st July 2011) that they have adequate controls and procedures in place to prevent bribery occurring in or around their firm. Of course, this act is not just directed at the financial services industry in general or the hedge fund industry in particular, but it is intentionally designed to cover all businesses from widget makers to the largest banking institutions. The worrying thing about the Act is that it carries criminal sanctions for those who do not comply. Compliance includes, for example, anti-bribery and corruption training for your staff.
 
The cost of instituting training and other compliance controls will be quite high, depending upon the size of your organisation, but whatever the case, it will be an added expense that somebody is going to have to bear if the company complying is not going to lose out as a result of doing their duty and once again acting as a policeman for society.
 
The other regulations requiring a considerable amount of compliance fall under the new US FATCA legislation. These regulations will require non-US financial service
companies, including administrators, managers and others, to advise the US tax authorities and register with them if they have any American clients or assets. In a recent survey by KPMG, a lot of the fund managers surveyed expected to have problems meeting the deadlines for compliance. There is a longer lead-in for this particular legislation in that reports of details of those US investors with assets in excess of USD50000, which have to be passed to the US Internal Revenue Service under FATCA, will come into force on 1 January 2013. The penalty for those who don’t comply will be a 30% withholding tax on all payments made to them in the US.
 
According to KPMG, approximately one third of managers surveyed anticipated that they would be ready in time for the deadline and “a significant 42% have not yet assessed the time needed to comply”.
 
The cost of complying with this is going to be high and 35% of those questioned in the KPMG survey anticipate spending more than EUR1million.
 
Furthermore, because of the complexities of the reporting, more than a quarter of managers interviewed indicated that they will be excluding US investors from subscription into their funds and this will be provided for in the subscription forms. Indeed, over 40% of both fixed income and equity funds “refused to rule out the possibility of leaving the US market as a result of the legislation”.
 
All this shows that regulations can prove to be very expensive, not only in terms of the actual cost of compliance, but in their effect upon the market in general. Dramatic regulations, such as FATCA, can also induce an attitude of isolation, which it would be better to avoid.

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