UK: Hedgeline - November 2008 Issue

Last Updated: 14 December 2008
Article by Philip Rubens

In this Month's Update:

  • FSA publishes draft Contracts for Difference (CfD) disclosure rules
  • New website offers complete guide to hedge fund best practice standards
  • US hedge funds appeal to UK regulators to speed up Lehman insolvency

FSA PUBLISHES DRAFT CONTRACTS FOR DIFFERENCE (CFD) DISCLOSURE RULES

  • New disclosure rules for CfDs; come into force 1 September 2009
  • CfD holdings must be aggregated with shareholdings; disclosure level will be 3%
  • All economic interests similar to CfDs will be included in new regime
  • Only gross long positions fall within scope

The FSA has published draft rules for its new disclosure regime for Contracts for Difference (CfDs). As announced in a policy update in July, the new regime will introduce a disclosure threshold of 3% and will also require share and CfD holdings to be aggregated for disclosure purposes - a more comprehensive regime than was first proposed.

Hedge funds are major investors in CfDs as they offer easy leverage and the ability to build up stakes unnoticed. One of the concerns with the current regime is that it enables hedge funds to suddenly acquire a large stake in a company - by converting CfDs into the underlying equity - and in doing so take the market by surprise. The new rules will prevent activist investors from using this tactic.

Previously, the FSA proposed a 5% threshold for disclosure of CfDs. Explaining its change in tack, the FSA said that "once the view is taken that CfDs should be aggregated with shares," it would be "logical and pragmatic" to keep the disclosure level at the same 3% level currently required for shareholdings under existing Disclosure and Transparency Rules (DTRs).

In another modification to the initial proposals, the FSA has introduced an exemption for "CfD intermediaries", or sellers of CfDs.

Key elements of CfD disclosure regime:

  • Disclosure of any financial instrument having similar economic effect to qualifying financial instrument (as defined under existing DTRs) will be required
  • Only gross long positions fall within the scope of the new rules
  • New rules will apply to instruments relating to shares of UK issuers traded on regulated markets
  • The same position need not be disclosed more than once where firms move positions between accounts or group companies
  • Disclosure required once aggregate position reaches 3% and subsequently where holdings increase or decrease by 1% (as with existing DTR thresholds)
  • Exemption for CfD writers when done in a client-serving capacity, not for proprietary business
  • Existing trading book exemption will apply to CfD disclosure

To view the policy conclusions, consultation feedback and draft technical instrument, click here. To view the FSA press release, click here.

NEW WEBSITE OFFERS COMPLETE GUIDE TO HEDGE FUND BEST PRACTICE GUIDELINES

  • New "matrix" tool for hedge fund best practices
  • Aims to harmonize global hedge fund standards
  • Hedge Fund Standards Board creates new hedge fund standards document for internal compliance

A new website has been launched that enables users to compare hedge fund guidelines produced by leading hedge fund and financial markets associations across the globe including the UK-based Alternative Investment Management Association (AIMA) and Hedge Fund Standards Board and the US-based Managed Funds Association and the US President's Working Group on Financial Markets.

Known as the Hedge Fund Matrix, the website enables users to compare guidelines side-by-side. The ultimate aim of the initiative, according to AIMA, is to provide a "first step" toward harmonised hedge fund practices.

The Matrix is split into five sections:

  • Creating and Managing a Hedge Fund Business
  • Investment Process and Portfolio Risk Management
  • Portfolio Administration and Operational Controls
  • Raising Capital and Investor Relations
  • Hedge Fund Structure and Organisation

The Matrix compares the standards of each association across each section, drilling down into specific areas (eg, compliance). It also provides links to the relevant rules of each body.

The tool is aimed at hedge fund practitioners, investors, professional advisers and the regulatory community and is available at no cost. To access, click here: Hedge Fund Matrix.

Meanwhile, the Hedge Fund Standards Board has created a new version of its Hedge Fund Standards in an Excel spreadsheet format. The spreadsheet is designed to facilitate internal due diligence for complying with the standards. To download the document, click here.

US HEDGE FUNDS APPEAL TO UK REGULATORS TO SPEED UP LEHMAN INSOLVENCY

  • Managed Funds Association argues hedge funds should be priority as creditors; claims delay in Lehman administration could lead to failure of prime brokerage industry
  • PwC says Lehman administration "would move as expeditiously as possible"

US hedge funds that have had client assets frozen following the collapse of Lehman Brothers International Europe (LBIE) are pressing UK regulators and administrator PricewaterhouseCoopers (PwC) to unlock the assets in the failed bank. According to the US hedge fund association, the Managed Funds Association (MFA), an estimated $40 billion to $70 billion in assets is being held by LBIE under 1,300 prime brokerage arrangements.

In a letter to the Governor of the Bank of England, the MFA argues that Lehman Brothers' prime brokerage clients should be prioritised in the administration, before other creditors. If not, it warns that many hedge funds with exposure to LBIE could fail. Worse, it argues that delay in the administration could lead to a wider failure in the prime brokerage industry that could be "disastrous for UK plc".

Lehman Brothers went into insolvency on 15 September with PwC appointed administrators in the UK. Under UK insolvency law all creditors must be treated equally - no group of creditors can be preferred in any way. However, the MFA argues that the UK administration process is likely to be very slow because of the lengthy process of identifying client asset claims and would be "wholly at odds with the interests of restoring confidence and liquidity in the global capital markets." It claims a disparity exists "in terms of confidence and speed of response" between the liquidation of Lehman Brothers Inc in the United States, and the administration of its European arm in the UK.

Following meetings with the Bank of England and Financial Services Authority, the MFA invited PwC administrator Tony Lomas to the United States to meet with hedge fund creditors. In a statement, Lomas said he recognized the "confusion and frustration" regarding the UK's administration process and stated that he hoped to assure MFA members that the administration "would move as expeditiously as possible under our legal system."

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.

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