For the second time, the 32nd conference of securities market regulators of more than 100 countries held a panel discussion on the regulation and valuation of hedge funds. Not surprisingly, this particular discussion found the maximum interest among the audience.
With assets of more than $1 trillion, the hedge-fund industry is an important area of concern for the regulators across countries. We spoke to industry insiders, Alternative Investment Management Association (AIMA), which is the global trade body for the alternate asset classes like hedge funds, managed futures and managed currency funds.
In an interview with Mint, Mary Richardson, director for regulatory and tax matters at AIMA, and Peter Douglas, chairman of the Singapore chapter of AIMA as well as founder and principal of GFIA Pvt. Ltd, an Asian hedge fund consultancy firm, talked about various issues concerning the hedge-fund industry.
How much exposure do hedge funds have in Indian stock markets?
As per ballpark estimates, there are around 50 India-dedicated hedge funds with assets of $2-3 billion under management. Another $1-2 billion is coming from around 300 funds which have an allocation to Indian markets in their funds.
Do you think hedge funds will be keen on getting registered with Sebi, rather than coming through the participatory notes?
Peter: They would prefer to register directly with Sebi because it would be cost-effective for them. A typical hedge fund ends up paying 2-2.5% annually if it trades through participatory notes and this portion of its performance fee goes into the pocket of the investment banker who is issuing the notes. P-notes is a gift from India to the investment bankers. A hedge fund would much rather give it away to the regulator. Also, a majority of the Indian hedge funds have their consultancy or research firm already in place in India.
Mary: Our association has a committee which is looking into this issue of p-notes.
What is the underlying fear of the market regulators about the hedge-fund industry?
Peter: The regulators’ fear arises from the fact that a large volume of capital is participating in their market which they don’t understand. It’s not about short-term money or foreign money. It’s about the lack of understanding about how the industry operates. Among the various national regulators, my perception is that over the past two years, Sebi has been diligent in trying to understand this industry. The managing authority of Singapore has been very supportive as they understand that hedge funds bring in liquidity and high levels of skills set in the domestic market.
Mary: National regulators we met at this conference seem to be just at the starting level as far as their understanding is concerned. And there are some like FSA of UK, who are quite familiar with the issues of the industry and engage in regular interaction, dialogue and debate.
AIMA came out with a research paper on valuation of hedge funds. How big is the issue?
Peter: Originally, hedge funds were glorified mutual funds who would buy public securities like mutual funds. Increasingly, the former have become a funding mechanism for all kinds of capital-market transactions. They are capital providers. We have seen hedge funds disintermediating banks, by providing equity or debt capital to companies. Or a bankrupt or distressed company often finds them as the buyers of the last resort. But at the end of the day, they’re managing other people’s money. So, accountability has to be there. That’s why the valuation methodologies are crucial.
Globally, as long-term institutional players like pension funds are turning to hedge funds to generate higher returns, how has it changed the face of the industry?
Peter: Entry of the institutional investors has forced the industry to adopt more structural reforms. These funds have the fiduciary responsibility of the money they are bringing in. So, they are expecting a lot of infrastructure, risk management systems and processes to be in place.
Mary: We at AIMA have an institutional committee which looks in to the interest of the institutional investors. Their feedback and views are taken into consideration while drafting concept papers on valuation of hedge funds.