PricewaterhouseCoopers summarises its recent paper entitled the Regulation and Distribution of Hedge Funds in Europe: Changes and Challenges.
This paper is an update to the May 2003 paper on the regulation and distribution of hedge funds. It provides an overview of the recent challenges and changes to the regulatory environment surrounding European hedge funds in the year to May 2004.
Over the past year, the European hedge fund industry has continued to develop at pace, with investors, product manufacturers and regulators all playing their part:
On the demand side, a wider group of investors is becoming aware of the potential for achieving positive returns together with capital preservation.
From a regulatory viewpoint, national regulators are showing increasing acceptance of hedge funds and products utilising hedge fund techniques.
On the supply side, manufacturers are seeking to provide solutions to investors' needs within this framework rather than simply developing products they would like to sell.
Despite recent tentative moves at a pan-European level towards a framework for the distribution of hedge fund products on a cross-border basis, national regulators (and fiscal authorities) within Europe continue to adopt a variety of approaches to the regulation and taxation of hedge fund products and hedge fund managers.
In particular, national regulators have different appetites for changing their existing rules to enable the development of an onshore hedge fund industry in Europe.
Obviously, these different approaches present challenges to those seeking to operate in the European hedge fund arena.
The main challenge ahead for the hedge fund industry is to use its influence to shape the regulatory environment of the future and the destiny of the industry in Europe. Hedge fund managers can play a pivotal role in influencing European regulators. In the current market, regulators need to be seen to considering ways in which investors can obtain access to alternative types of products which may assist, for example, in addressing issues associated with the European pensions "time bomb".
It is paramount that the inevitable rule changes are not imposed by regulators without consultation with the industry. Looking forward, the industry should consider setting voluntary standards in such areas as control of operational risk, valuations and fund corporate governance.
Regulation is typically less well-developed in the ten accession countries that joined the EU on 1 May 2004. This will allow them to take full advantage of the development of the hedge fund industry, as some have fewer old rules to unscramble, allowing regulators greater flexibility in determining appropriate regulatory frameworks.
Administrators setting up in these countries are likely to be cost-competitive and, with the ability to embrace the latest technology, they are in a strong position to challenge the existing traditional centres for hedge fund administration.
Substantial regulatory change is on the horizon, but will it always be beneficial for the hedge fund industry? Hedge fund managers should actively seek to participate in consultations and dialogue with European regulators to influence and shape the rules; workable and beneficial solutions must be developed so that the industry can benefit from a framework that is competitive with the US and increasingly, Asia.