FSA publishes discussion paper on hedge funds

Michael Folger, FSAs Director of Conduct of Business Standards, said:

"The hedge fund market has grown significantly in recent years, as increasing numbers of wealthy investors and trusts have decided to place a proportion of their portfolio in alternative investments. Just as some of our international counterparts have also done recently, we are therefore reviewing our regulatory regime in respect of hedge fund activities in the UK, particularly the sale and marketing of such funds."

"We come into this with an open mind. Hedge funds cannot readily market themselves direct to the UK public, and ordinary investors generally do not seem to have become involved. But financial advisers may recommend investors who understand the risks to put some money in them as part of a diversified portfolio. Is this the right balance, or is there scope to make hedge funds more accessible?"

The FSA is seeking views, from industry and consumer groups, on whether it should change the rules on the sale and marketing of hedge funds, to make them more readily accessible. This could potentially increase the product choice available to UK investors. But it also raises significant consumer protection and education issues, which would have to be addressed satisfactorily before any changes were made. In particular, there are legitimate concerns about the comprehensibility to retail investors of the information provided by hedge funds about their activities and risk profiles.

Michael Folger added:

"Although hedge funds are usually incorporated and governed in offshore jurisdictions, mainly for tax reasons, many employ fund managers onshore. The UK-based fund managers providing services to hedge funds are legally required to seek authorisation from the FSA. Our powers under the Financial Services and Markets Act cover the activities of such a firm and the services it has contracted to provide its clients."

"But, if a UK-authorised fund manager is engaged by an offshore hedge fund that brings no FSA oversight of the fund itself or its risk profile. Recognising that, we are explaining our approach to regulating UK-based hedge fund managers and invite comments. We also describe our approach to monitoring the effects of hedge fund activities on UK markets. We have regular dialogue with market participants so that we maintain up-to-date knowledge of the hedge fund sector. As users of the UK-based securities markets, they are of course subject to the same market standards as similar institutional investors."

Notes for editors

1. The FSA must have regard in its activities to the desirability of facilitating innovation in the areas it regulates.

2. Hedge funds cannot currently be marketed freely to the general public. The discussion paper asks for views on whether there is a case for liberalising this regime and explores a number of options for authorising or listing such funds.

3. Feedback on the discussion paper is sought by 29 November 2002. The FSA will then publish a feedback statement summarising the views of respondents. Any changes to the regime for authorising hedge funds would be made through the review of Collective Investment Scheme (CIS) regime. The current review of the Listing Rules would take forward any work proposed on listing of hedge funds. There would be a full consultation process on any proposed changes in our rules.

4. The FSA regulates the financial services industry and has four objectives under the Financial Services and Markets Act 2000: maintaining market confidence; promoting public understanding of the financial system; securing the appropriate degree of protection of consumers; and fighting financial crime.

5. The FSA aims to maintain efficient, orderly and clean financial markets and to help retail consumers achieve a fair deal.