ASIC has released Consultation Paper 147 Hedge funds: Improving disclosure for retail investors (CP 147), which describes ASIC proposal to introduce disclosure principles and benchmarks for hedge funds. CP 147 prescribes various key features and risks that ASIC considers will need to be addressed in the Product Disclosure Statement (PDS), and other communications, for a hedge fund.
A separate disclosure regime does not currently apply to hedge funds and the application of the law and general ASIC policy to a particular hedge fund is left to the individual issuer and its advisers to determine.
The paper follows a recent approach by ASIC to prescribe specific disclosure principles and benchmarks for particular asset classes such as mortgage schemes, unlisted property schemes and infrastructure funds.
Scope of CP 147
It is proposed that the disclosure principles and benchmarks will apply to any registered managed investment scheme that is, or has been promoted as, or is generally regarded as, a hedge fund or a fund of hedge funds. ASIC is formulating its definition of hedge fund for these purposes and it seems it will apply a broad definition that looks at whether a fund has some or all of the following features:
- strategy – the fund pursues complex strategies that aim to generate absolute returns, returns with low correlation to equity and bond indices, or a positive return in both rising and falling markets
- leverage – the fund often uses leverage to increase investment returns
- derivatives – the fund often uses derivatives to create complex investment strategies or for gearing purposes
- short selling – the fund often engages in short selling
- complexity – the fund often has exposure to diverse risks and complex underlying products.
This approach could potentially sweep up a broad range of funds with any or some of these features, even those which may not traditionally be regarded as hedge funds.
The disclosure requirements outlined in CP 147 consist of a combination of disclosure principles and 'if not, why not' benchmarks. An issuer is required to state in the PDS and in certain 'other disclosures' whether it meets a benchmark (and if not, why not). Failure to comply with the disclosure principles and benchmarks may result in ASIC issuing a stop order on an offer.
Interestingly, ASIC also notes that 'as a matter of best practice', disclosure of information similar to that set out in CP 147 would be useful for investors in other types of funds, not just hedge funds.
ASIC is also considering excluding any fund that would fall within the scope of the CP 147 disclosure guidance from being able to use the new 'shorter PDS' regime.
The proposed disclosure principles and benchmarks
A brief summary of the proposed disclosure principles and benchmarks applicable to a PDS for a hedge fund is set out below:
Disclosure principle – Investment strategy |
The PDS should disclose the following information:
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Disclosure principle – Investment manager |
The PDS should disclose a description of:
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Disclosure principle – Fund structure |
The PDS should explain:
|
Disclosure principle – Assets |
The PDS should disclose the following information:
|
Benchmark – Custody |
The PDS should disclose that all custodians (including custodians of any funds invested in by the fund) involved in the fund structure are independent third party custodians. If the fund does not meet this benchmark, it should disclose why not. |
Disclosure principle – Liquidity |
If more than 20% of a hedge fund's assets cannot be sold at market value in less than 10 days, the PDS should disclose the following information:
|
Disclosure principle – Leverage |
The PDS should disclose the following information:
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Disclosure principle – Derivatives |
The PDS should disclose the following information:
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Disclosure principle – Short selling |
If a hedge fund intends or is likely to engage in short selling, the PDS should disclose the following information:
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Benchmark – Periodic reporting |
The PDS should disclose that the fund will report on the following as soon as practical following the relevant period end:
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Benchmark – Periodic reporting |
The PDS should disclose that the latest periodic report is available on the fund's website. If the PDS does not meet this benchmark, it should disclose why not. |
Disclosure principle – Withdrawals |
The PDS should disclose the following information:
|
Key issues
The paper requires careful consideration and fund managers will
need to adopt additional measures to be in a position to comply.
Some of the key issues for consideration by issuers of 'hedge
funds' and 'fund of hedge funds' arising out of the
proposals in CP 147 include the following:
- as mentioned above, the proposed approach for determining whether a scheme is a hedge fund, involving consideration of a number of 'indicia', may potentially sweep up a broad range of funds, even those which may not 'traditionally' be regarded as hedge funds
- ASIC has indicated that, where a scheme could be characterised as a hedge but also falls 'more specifically' within another category of schemes covered by other ASIC disclosure guidance, the more specific disclosure guidance will apply. This may lead to some confusion as to the applicable disclosure guidance e.g. if a scheme can be characterised as a hedge fund and an unlisted property fund, both the CP 147 requirements and the requirements under ASIC Regulatory Guide 46 Unlisted property schemes: Improving disclosure for retail investors may apply
- ASIC is considering whether to 'encourage' issuers to apply the disclosure benchmarks and principles when providing similar offers to wholesale investors and offers by listed investment companies that have some of the features of hedge funds
- ASIC indicates that it is separately considering alternative or supplementary measures to deal with the perceived risks of investing into hedge funds, e.g. investor education, enhanced licensing requirements, enhanced compliance plan requirements, statutory suitability tests and banning retail investor access to hedge funds. No detail is provided in the paper. These possible measures may have major implications for 'hedge fund' issuers if implemented
- if an underlying investee scheme of a hedge fund makes up more than 10% of the fund's net asset value, the identities of key service providers for the underlying scheme will need to be disclosed in a PDS and updated in periodic disclosures. This may require a hedge fund issuer to ensure that suitable reporting or notice requirements are in place with operators of underlying schemes (e.g. in side letter arrangements) to ensure it can comply with such disclosure requirements
- ASIC suggests that, although the Corporations Act requires a fund to give investors at least an annual periodic statement regarding FUM and investment returns, it is 'current market practice' to provide more frequent reports. Going forward, issuers of hedge funds may need to provide more frequent periodic statements regarding the fund and ad hoc reports (in addition to the periodic reports) where there are changes to key features of a hedge fund that might not currently be required under the Corporations Act.
Way forward
ASIC proposes 1 July 2012 as the commencement date for:
- new and current issuers of hedge funds to apply each of the disclosure principles and address each of the benchmarks in PDSs given after that date, and
- existing issuers of hedge fund to provide updated disclosure to existing investors that applies each of the disclosure principles and addresses each of the benchmarks.
The deadline for comments on the paper is 21 April 2011. ASIC has
flagged that it may undertake a second round of consultation in
mid-2011 once it develops more detailed proposals following on from
the first round of consultation. It is expected that, following the
close of the consultation and subject to comments from
stakeholders, ASIC will release a regulatory guide in late
2011.
In addition, ASIC has indicated that it is considering what
'other measures' may be desirable to adopt in light of
recommendations flowing from the 'Hedge funds oversight'
report issued by the International Organization of Securities
Commissions (IOSCO) in June 2009 and the 'Review of the
differentiated nature and scope of financial regulation' report
issued by the Joint Forum in January 2010.
Norton Rose Australia is advising various leading fund managers on
a response to the paper and implementation of the new measures. If
you require further information or advice on the proposals, please
contact us.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.