New hedge fund regulation not likely in Canada

Date: Monday, March 13, 2006
Author: David Clarke- Investmentnews.com

OTTAWA - After making noises about ratcheting up the regulation of hedge funds in the wake of high-profile scandals, Canada's provincial securities commissions have done an about-face.

The regulators have "pretty much decided that hedge funds do not require their own separate regulatory regime," David Wilson, chairman of the Ontario Securities Commission, said in a recent speech at a Toronto securities conference.

"We have a full group of rules that apply to all those sorts of vehicles," he said. "So we think the existing rules, by and large, if they are properly used and properly implemented and complied with, will do the job."

Naturally, the hedge fund industry welcomes the news.

"I think it is a positive step," said Jim McGovern, chairman of AIMA Canada, a Toronto-based chapter of the global Alternative Investment Management Association Ltd. of London. He also is president and chief executive of Toronto-based Arrow Hedge Partners Inc.

Last November, just after being named OSC chairman, Mr. Wilson said he would target hedge funds for greater regulation, calling them a "new frontier" for securities regulators. "Recent scandals have placed the spotlight on this new industry and the need for greater transparency," he said at that time.

Now-bankrupt Portus Alternative Asset Management Inc. of Toronto generally is considered to be at the root of the biggest scandal. And in the summer, the Toronto-based Investment Dealers Association of Canada, a self-regulatory body for brokerage firms, produced a report on hedge funds that called for greater transparency and closer scrutiny. The report stated: "The opaque nature of the industry could certainly attract fraudsters and other market malefactors."

Meetings among AIMA and regulators from some of the provinces led Mr. Wilson to change his mind, Mr. McGovern said. "Canadian hedge funds are already registered with provincial regulators," noted Barry Allan, president of Marret Asset Management, a Toronto-based hedge fund focused on Canadian high-yield debt.

"In any event, Portus was about fraud, not hedge funds," he said. "It could have happened to a different sector." Of particular concern are principal-protected notes, which come with a bank guarantee on the principal amount invested. Portus allegedly claimed that its own shares were covered by notes issued by the Montreal office of Societe Generale SA of Paris.

Mr. Wilson also said regulators are reviewing how some hedge-fund-related products are sold to retail investors without a prospectus. "We need to take a hard look at whether this [prospectus] exemption is suitable for highly complex structured products targeted at the mass market of retail investors," he said during his speech.

For the foreseeable future, it will be business as usual for the Canadian hedge fund industry.

Hedge funds are the fastest-growing segment of the Canadian financial market. In the past five years, assets under management in the Canadian hedge fund industry have increased sixfold, according to Toronto-based Investor Economics.

On March 1, about 75 European pension plan chiefs, private bankers and other institutional investors met in Zurich, Switzerland, to hear Scotia Capital Inc. of Toronto unveil an index that tracks how Canadian hedge funds are performing.

Untapped market

The Canadian market is less saturated than the European or U.S. hedge fund markets.

And the Scotia Capital hedge fund index rose 16.2% last year on an equally weighted basis, though lagging the 21.9% gain of the S&P/ TSX Composite Index.

Canadian hedge funds did, however, fare much better than hedge funds in the United States, where the CSFB/ Tremont Hedge Fund Index, which measures performance among U.S. hedge fund managers, rose 6.6% last year.

Europeans do not think the regulatory climate in Canada is a factor in making investment opportunities, said Miklos Nagy, president and chief executive of Quadrexx Asset Management Inc. of Toronto.

"To be a hedge fund company in Canada, you need to comply with a number of things with the OSC or any other provincial securities commission," he said. "Europeans are attracted, because most Canadian hedge funds are mainly long/short-type investing in the Canadian stock market," Mr. Nagy said.

"They know that [by] investing in Canadian stocks, they are getting into the resources and energy big-time," he said. "They believe that these are the sectors which will likely increase in value in the coming years, plus they can make extra returns on the back of the appreciation of the Canadian dollar."