Hedge funds warned against moving to less regulated markets as extraterritoriality starts to bite

InvestorsOperational RiskPeople MovesRegulation
05 Jul, 2012

Increased extraterritoriality is closing the ability for alternative managers to decamp to less regulated jurisdictions to escape EU and US rules, The IMS Group has said.

Peter Moore, head of regulation and compliance at The IMS Group in London, said the extraterritorial nature of regulation emanating from the US and EU made it redundant for managers to attempt to avoid some of the rules.

“Rules such as FATCA and AIFMD are extraterritorial in nature and they will impact managers wherever they are located,” said Moore. FATCA, for example, requires managers to disclose the details of all of their investors, irrespective of whether they are American or not, to the Internal Revenue Service (IRS) or to their own national regulators who will subsequently pass it onto the IRS.

Similarly, AIFMD could force non-EU jurisdictions with significant hedge fund markets to meet EU standards so as to market to EU investors, although experts said this rule has been liberalised substantially.

“AIFMD is a disproportionate solution to a perceived problem.  But it will be tolerable for managers and will not drive managers out of business, and the most onerous aspects have been eased such as depositary liability. Furthermore, I cannot think of any piece of regulation that has driven an industry to extinction. Take big tobacco, for example, there was outrage when lawmakers forced the tobacco industry to write health warnings on the packets but it didn’t kill off the industry,” he said.

The cost of moving to another jurisdiction also outweighs the cost of meeting regulatory standards, according to Moore.  “Not only does extraterritoriality make it pointless for managers to relocate but so do investors. Institutional investors want their managers to be well regulated. Many investors will not put money into a manager who is non-compliant or in a less regulated jurisdiction. If a manager is serious about raising money from high quality investors, they must be compliant with US and EU rules and based in a sound jurisdiction. This is surely much more persuasive than enjoying a slight regulatory arbitrage,” observed Moore.

There was widespread talk in 2009/10 about hedge funds potentially decamping to Switzerland to escape AIFMD. Not only did this fail to materialise but for those managers which did move, they are now being bombarded with new rules in Switzerland as the country seeks to get into line with the AIFMD.  Managers also threatened to move to Asia back in 2010. Again, this has backfired as managers have discovered Hong Kong and Singapore are not as light touch as they had assumed. KPMG even released a report last week warning managers to words of that effect.

AIFMDAsiacomplianceEUextraterritorialityFATCAhedge fundsinstitutional investorsIRSKPMGregulationSwitzerlandThe IMS Group