THE HEDGE FUND REGULATIONS

Tuesday, December 11, 2007
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Introduction

The South African hedge fund industry has been quoted as being worth approximately R20 billion and continues to grow at a significant rate each year. The Financial Services Board (“FSB”) promulgated new regulations relating to hedge funds in South Africa, under the Financial Advisory and Intermediary Services Act, 2002 (“FAIS Act”), in August 2007 (“the Hedge Fund Regulations”). The Hedge Fund Regulations set stricter rules for hedge fund managers with the aim of offering protection and information to investors. Below we provide you with a brief outline of the Hedge Fund Regulations in South Africa.
 
The Hedge Fund Regulations

The Hedge Fund Regulations, which came into law as on 29 August 2007, have been welcomed by various industry organisations as the need for an increased monitoring system of hedge funds in South Africa has been long awaited. The FSB introduced the Hedge Fund Regulations through amending the Fit and Proper Requirements for Financial Services Providers (2006), the Code of Conduct for Administrative and Discretionary Financial Services Providers (2003) and the Application by Financial Services Providers for Authorisation by the Financial Services Board (2003), all of which are regulations under the FAIS Act. The amendments to the various regulations of the FAIS Act create a new category for hedge fund managers.
 
The Hedge Fund Regulations generally seek to ensure that all applicant hedge fund managers are assessed on their operational ability, risk management processes as well as the types of the investors of the fund. The Hedge Fund Regulations govern the activities of financial service providers that previously engaged in hedge fund activities, in addition to those that provided intermediary services to hedge funds.
 
The Hedge Fund Regulations have defined a hedge fund as “a portfolio which uses any strategy or takes any position which could result in the portfolio incurring losses greater than its aggregate market value at any point in time, and which strategies or positions include but are not limited to leverage or net short positioning.” In brief, a hedge fund is “a sophisticated financial instrument used to bet or hedge against falls and rises in share markets and currencies.”
 
The essence of the Hedge Fund Regulations is to place a greater emphasis on the qualifications and experience of hedge fund financial service providers (“hedge fund FSP’s”) as they are referred to in the FAIS Act (more commonly known as hedge fund managers). A hedge fund FSP is a financial services provider that renders intermediary services of a discretionary nature in relation to a particular hedge fund in connection with a particular financial product.
 
The Hedge Fund Regulations require anyone wishing to manage a hedge fund to apply to the FSB for a Category IIA License (“License”) which authorises the applicant to lawfully act as a hedge fund FSP in terms of the FAIS Act. There are certain fairly stringent criteria which the applicant must satisfy before being granted a License, including specifically stating in the application that the applicant has a track-record of a minimum of 5 (five) years experience in managing hedge funds and particular hedge fund strategies and is able to adequately demonstrate knowledge, skill and competency in managing hedge fund portfolios. Furthermore, the applicant must have achieved a minimum academic qualification of a grade 12 and the applicant must within 4 (four) years after the date of licensing complete a full business honours degree as stipulated by the FSB.
 
The FSB has by way of notice issued on 29 August 2007, advised that all hedge fund FSP’s may continue to buy and sell shares on behalf of their clients, however, to the extent that they in addition wish to manage a hedge fund or, alternatively, sell hedge funds to clients, they will be required to apply for and obtain a License. Before such License has been obtained, the managers may not under any circumstances represent to any client that they have the necessary approval to act as a hedge fund manager or further market how hedge funds are regulated in South Africa. In order to ensure that the applicants are in fact fit to act as hedge fund FSP’s, the FSB has indicated that it will perform random on-site visits at institutions which are applying for Licenses. Furthermore, notices and warnings to investors indicating the risks associated with investing in a hedge fund, in addition to the overall compliance requirements of the FAIS Act, must be included in all marketing material or other documentation supplied to investors.
 
The FSB evaluate License applications with due consideration to factors including the applicant’s risk management processes, operational ability as well as the types of investors targeted to participate in hedge funds. Non-compliance with the Hedge Fund Regulations relating to hedge funds is a criminal offence, punishable by a fine of R1 000 000 (one million Rand) or imprisonment of up to 10 (ten) years.
 
The FSB have given all existing hedge fund managers until 29 February 2008 to obtain a License to operate as a hedge fund FSP otherwise a fine or imprisonment as indicated above may be imposed on the hedge fund FSP, or any person purporting to be or conducting the business of a hedge fund FSP.
 
Conclusion
 
It is clear from the brief discussion above, that the Hedge Fund Regulations only regulate hedge fund managers and not the actual product being sold or bought on the market. Due to the high risks and general volatility associated with hedge funds, the FSB has specifically set high standards of experience and education and more stringent internal controls for investment managers to meet before a License is granted.