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The challenge of creating a hedge fund-friendly environment

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Over the past few years the Middle East has been increasingly touted as the next big hedge fund centre.

Over the past few years the Middle East has been increasingly touted as the next big hedge fund centre. Proponents draw parallels to Hong Kong and Singapore, both of which have experienced explosive growth in assets under management over the past three years.

However, predictions of a mass of hedge funds (including fund of hedge funds) cropping up in the Middle East have yet to materialise. This has left observers questioning whether the region is destined to develop its own hedge fund market, and if so, when this is likely to happen.

In analysing the potential of the Middle East region as a major hedge fund centre, it is useful to first explore the attributes of other key locations such as Hong Kong, London and New York. All three of these hubs are major centres of commerce with deep, relatively mature capital markets operating within credible financial and regulatory infrastructures. As such, hedge funds are able to become part of existing frameworks, enabling them to attract capital, investment talent and professional external partners.

The key challenge for Middle Eastern domiciles is to create a hedge fund-friendly environment in the absence of deep and mature capital markets. There are currently a small number of states in the Middle East region that are actively seeking to develop financial hubs where hedge funds can enjoy the same degree of professionalism from regulators and external service providers.

Qatar and the United Arab Emirates in particular appear to be developing their markets in a manner conducive to attracting hedge funds. Both countries already benefit from the surge in liquidity that has emerged as a result of the huge rise in oil prices. This has produced a favourable capital-raising environment for investment managers. An increasing number of firms, including Man Group, Permal and Superfund. have opened marketing offices in the Middle East.

Recent investments by Middle Eastern sovereign wealth funds suggest that there is an appetite for alternative investments in the region. Carlyle Group, GLG Partners and Och-Ziff Capital have sold stakes in their management companies to Middle Eastern investors this year. If these firms are able to increase distribution in the region as a result of stake sales, further deals are expected in 2008.

The current state of the region’s financial and regulatory infrastructure is some way behind the developed markets, but the pace of change within states such as Qatar and the UAE indicates that they are fully committed to building competitive financial markets. The UAE, in particular, has been active in consulting with hedge fund firms and their service providers with the aim of formulating a balanced regulatory regime.

From a service provider perspective, the Middle East looks likely to become a major source of business in the future. Larger firms that can provide a range of services to a diverse client base already find it to be an attractive location in which to operate. Indeed, Fortis Prime Fund Solutions has recently won a mandate to service a USD300m Middle Eastern fund of hedge fund portfolio, but until the domestic hedge fund industry reaches a critical mass, smaller service providers will find it an expensive place to do business.

Charlie Woolnough (photo) is European director of business development and Usman Cheema is a senior research analyst with Fortis Prime Fund Solutions

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