On 14 September 2009, the International Organization of Securities Commissions (IOSCO) announced the publication of Elements of International Regulatory Standards on Funds of Hedge Funds Related Issues Based on Best Market Practices. The publication contains standards to address the regulatory issues thrown up by increased involvement of retail investors in hedge funds through funds of hedge funds
These standards address two key issues identified in a report published by IOSCO in June 2008, Funds of Hedge Funds - Final Report, namely:
- The methods by which managers of funds of hedge funds deal with liquidity risk.
- The ways in which managers of funds of hedge funds apply due diligence before and during investment.
- In dealing with liquidity risk the fund of hedge funds’ manager should:
- Make reasonable enquiries in order to be in a position to consider if the fund of hedge funds’ liquidity is consistent with that of the underlying hedge funds, particularly in order to meet redemptions.
- Prior to investing, and during the investments’ lifetime, consider the liquidity of the types of financial instruments held by the underlying hedge funds.
- If introducing limited redemption arrangements, consider whether these are consistent with the fund of hedge funds’ aims and objectives.
- Before and during any investment, consider whether conflicts of interest may arise between any underlying hedge fund and any other relevant parties.
Due diligence processes should be carried out prior to any investment being entered into and on a continuous basis following the commitment. These processes can be divided up into the following areas:
- Elements requiring constant monitoring and analysis by the funds of hedge funds’ managers. These include establishing and implementing appropriate due diligence procedures for the purpose of investment into hedge funds, which are reviewed regularly.
- Adequate resources, procedures and organisational structures necessary for the purpose of carrying out a proper and robust due diligence. These include documented and traceable procedures for selecting hedge funds.
- Regular assessments of whether selection procedures for eligible underlying hedge funds have been properly met, or not met, and an explanation regarding any deviations
- Outsourcing due diligence. If a fund of hedge funds’ manager wishes to authorise the outsourcing of any aspect of its due diligence it should: (i) determine that any conflicts of interest are adequately addressed; and (ii) consider the extent that outsourcing of due diligence is consistent with the IOSCO Principles on Outsourcing of Financial Services for Market Intermediaries.
View IOSCO publishes regulatory standards for funds of hedge funds, 14 September 2009