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More rules for hedge funds 'not necessary'

Date: Wednesday, November 8, 2006
Author: Jonathan Chevreau, Financial Post

Contrary to popular belief, the hedge fund industry in Canada is already well regulated, says Paul Moore, vice-chair of the Ontario Securities Commission.

However, "that doesn't mean we can't or won't do any additional things," Mr. Moore told the World Hedge Funds Summit in Woodbridge, Ont. yesterday.

Hedge fund managers are already required to register as portfolio managers with various provincial securities commissions. In addition, "distributors of hedge funds as securities must also be registered," Mr. Moore said. Under a regulatory system that has existed for decades, oversight is supported by a compliance and "enforcement regime which deals with breaches of securities laws and rules."

The Canadian public may be confused because the regulatory environment is not comparable to that in the United States, where hedge fund portfolio managers are not registered, Mr. Moore said.

The United States has a large exemption for hedge funds or any advisor with less than 15 clients. There is also a provision that allows a fund with many investors to be treated as one client "so virtually all hedge fund managers are not subject to registration." The U.S. Securities and Exchange Commission created a rule that would have made that country's hedge fund managers register but the rule was subsequently overturned by the U.S. Court of Appeals.

One important step being recommended by the Canadian Securities Administrators (the CSA, the umbrella group of 13 regional securities commissions) is that managers or administrators of hedge funds (as opposed to portfolio managers) also be made subject to registration.

In May, the CSA completed a review of the hedge fund landscape in Canada, after public concern over such well-publicized debacles as Portus and Northshield. It concluded the current platform for securities regulation -- including the exemption regime -- is also appropriate for mutual funds.

"There is no need for a separate new regime for hedge funds." The concerns about certain hedge funds are the same ones regulators have about mutual funds or any other pooled capital investments, Mr. Moore said.

The recently released Task Force on the Modernization of Securities Legislation (chaired by Tom Allen) found that with both Portus and Northshield, investors' money was not invested as indicated in the offering documents. "It wasn't really a hedge fund problem."

The one recommendation he doesn't agree with in the Allen report is a call for a new platform for publicly offered hedge funds.

"The problem is I don't agree with regulating the underlying investment. We regulate the package. If we followed what was suggested in the Allen report we would have all kinds of regulatory regimes."

The CSA has already launched enforcement proceedings against both Portus and Northshield. The charges involve unregistered trading and failing to meet the duties of a fund manager, Mr. Moore said. The charges involve breaches in existing laws.

Regulators are also wrestling with how to deal with principal protected notes or PPNs, typically issued by banks or other federal institutions. These are "either an exempt security not subject to securities laws or not even a security: namely a bank deposit."

Wrapped around a hedge fund or other alternative investment, PPNs may look and smell like securities. The initial capital is guaranteed but once the time value of money is considered, they "might not be that great an idea."

In theory, such products can be sold by bank tellers although "we're told by the banks that they realize that's not a good thing."

Mr. Moore says he tells his colleagues at the OSC that hedge funds are good for retail investors and there's no reason to restrict their sale only to the wealthy or institutions. Canada's regulatory regime is disclosure-based, not merit-based.

In practice, decisions on whether investments are good or bad must be left to the market. All prospectuses passed through securities commissions are headed by statements that declare it an offence to state a regulator has approved the investment merits of a particular product.

While some hedge funds are available by prospectus, many more are available on a non-exempt basis or through the offering memorandum exemption.

At this Friday's Dialogue with the OSC, a small business panel will urge that Ontario adopt the offering memorandum exemption, Mr. Moore said. If that happens, there would no longer be a minimum investment level for hedge fund investments.

"I'm half persuaded but I'm not there yet."

The conference continues today.