- On 18 September 2012, ASIC released guidance on new disclosure benchmarks and principles for hedge funds in the form of Regulatory Guide 240 entitled ‘Hedge funds: Improving disclosure’ (RG 240).
- Responsible entities of hedge funds should disclose against the benchmarks and apply the disclosure principles set out in RG 240 in any product disclosure statement (PDS) dated on or after 22 June 2013 and also in any ongoing disclosure from that date.
- By 22 June 2013, responsible entities of hedge funds should update any PDS still in use to include the benchmark and disclosure principle information.
On 18 September 2012, ASIC released RG 240 which sets out new disclosure benchmarks and principles for hedge funds.
RG 240 provides that responsible entities of hedge funds should:
- disclose against the benchmarks and apply the disclosure principles in any PDS dated on or after 22 June 2013 and in any ongoing disclosure from that date,
- by no later than 22 June 2013, update any PDS still in use to include the benchmark and disclosure principle information and bring it directly to the attention of existing investors, and
- deal with any material changes to the benchmark or disclosure principle information in ongoing disclosure.
ASIC’s guidance in RG 240 follows industry consultation earlier in 2012 and the Parliamentary Joint Committee on Corporations and Financial Services report on the Trio collapse released on 16 May 2012.
In the media release of RG 240 on 18 September 2012, the ASIC Commissioner Greg Tanzer said:
- hedge funds can pose more diverse and complex risks for investors than traditional managed investment schemes because of their diverse investment strategies and use of leverage and offshore investments, and
- disclosure needs to provide retail investors with all the information they require to make an informed investment decision given the risks for retail investors associated with investing in hedge funds.
Definition of ‘hedge fund’ and ‘fund of a hedge fund’
The definitions of ‘hedge fund’ and ‘fund of a hedge fund’ used in RG 240 closely follow the approach taken in Class Order 12/749 ‘Relief from the Shorter PDS regime’ (CO 12/749).
A hedge fund is defined in RG 240 as a registered managed investment scheme which:
- is promoted by the responsible entity using the expression, and as being, a ‘hedge fund’, or
exhibits two or more of the following characteristics:
complexity of investment strategy or structure – the scheme:
- pursues investment strategies that aim to generate returns with a low correlation to equity and bond indices, or
- has a complex investment structure that invests through three or more interposed entities (or two or more interposed entities if at least one of the entities is offshore) where the responsible entity of the scheme or an associate has the capacity to control the disposal of the products or two or more of the interposed entities,
- use of leverage – the scheme uses debt for the dominant purpose of making a financial investment,
use of derivatives – the scheme uses derivatives other than for the dominant purpose of,
- managing foreign exchange or interest rate risk, or
- more efficiently gaining an economic exposure, through the use of exchange-traded derivatives, to the underlying reference assets of those derivatives, but only on a temporary basis (ie less than 28 days),
- use of short selling – the scheme engages in short selling, and
- charges a performance fee – the responsible entity or investment manager has a right to be paid a fee based on the unrealised performance of the scheme’s assets (this is in addition to any management fee the responsible entity or investment manager may have a right to receive).
- complexity of investment strategy or structure – the scheme:
This approach to determining a hedge fund raises a number of difficulties and challenges for responsible entities:
- as a practical matter, hedge funds are not often promoted using the expression, or as being, a ‘hedge fund’, so the first limb of this test (in paragraph (a)) will rarely have application, and
- the second limb of the test (in paragraph (b)) is so broad that a simple managed investment scheme which would not be commonly regarded as a hedge fund may qualify as a hedge fund.
For example, the definition would capture a leveraged fund (such as a property trust) where the responsible entity is entitled to a performance fee.
A ‘fund of hedge funds’ is defined in RG 240 as a registered managed investment scheme:
- where at least 35% of a fund’s assets are invested by the responsible entity in one or more hedge funds (including a scheme or body in or outside this jurisdiction that would be a hedge fund if it were a registered managed investment scheme), or
- that promotes itself as a fund of hedge funds.
If a responsible entity is uncertain about whether a registered scheme is a hedge fund or fund of hedge funds:
- the responsible entity can elect to state that they are a hedge fund and disclose against the benchmarks and apply the disclosure principles in RG 240, otherwise
- ASIC expects the responsible entity to seek clarification from ASIC.
Benchmarks and disclosure principles for hedge funds
ASIC’s disclosure model in RG 240 is a combination of disclosure principles and ‘if not, why not’ benchmarks. The benchmark and disclosure principle information should be:
- addressed upfront in the PDS,
- updated in ongoing disclosure as material changes occur (for example, in a supplementary PDS), and
- supported in, and not undermined by, advertising material.
ASIC expects responsible entities to clearly and prominently disclose a summary of the information identified in the benchmarks and disclosure principles in the first few pages of the PDS, with cross-references to where further information can be found in the PDS.
Failure to disclose against the benchmarks and apply the disclosure principles may result in ASIC issuing a stop order.
RG 240 identifies two ‘if not, why not’ benchmarks for hedge funds:
- Valuation of assets – the hedge fund should require valuations of its assets that are not exchange traded to be provided by an independent administrator or an independent valuation service provider.
- Periodic reporting – the hedge fund should provide periodic disclosure of certain key information on an annual and monthly basis.
The hedge fund’s PDS and other disclosures must disclose whether it meets these benchmarks and if not, why not, and explain any additional risks that this may pose for the investor.
RG 240 identifies nine “disclosure principles” for hedge funds for inclusion in its PDS:
- Investment strategy - details of the investment strategy for the fund.
- Investment manager – details about the people responsible for managing the fund’s investments.
- Fund structure – the investment structures involved, the relationships between entities in the structure, fees payable to the responsible entity and investment manager, the jurisdictions involved (if these involve parties offshore), the due diligence performed on underlying funds, and the related party relationships within the structure.
- Valuation, location and custody of assets – the types of assets held, where they are located, how they are valued and the custodial arrangements.
- Liquidity – the fund’s ability to realise its assets in a timely manner and the risks of illiquid classes of assets.
- Leverage – the maximum anticipated level of leverage of the fund (including embedded leverage).
- Derivatives – the purpose and types of derivatives used by the responsible entity or investment manager, and the associated risks.
- Short selling – whether and how short selling may be used as part of the investment strategy, and of the associated risks and costs of short selling.
- Withdrawals – the circumstances in which the responsible entity of the hedge fund allows withdrawals and how this might change.
If the responsible entity is unable to provide the information above, the PDS should disclose the reasons why the information has not been provided and outline how and when investors will be provided with the information.
Where a benchmark or disclosure principle is not relevant, responsible entities need not disclose against them.
Interaction with the shorter PDS regime
The shorter PDS regime applies to ‘simple managed investment schemes’ as defined in the Corporations Act 2001 (Cth). CO 12/749 released on 18 June 2012 specifically excludes hedge funds and funds of hedge funds from the shorter PDS regime until 22 June 2013.
Given the definition of hedge funds and funds of hedge funds closely follow the approach taken in CO 12/749, ASIC expects all hedge funds and funds of hedge funds to disclose against the benchmarks and apply the disclosure principles in RG 240, regardless of whether the fund meets the definition of a ‘simple managed investment scheme’.
Please see our article entitled ‘ASIC releases guidance for, and class order exemptions from, the shorter PDS regime’ for more information on the shorter PDS regime.1
Application to other products
Even though the benchmarks and disclosure principles in RG 240 are primarily directed at PDSs for hedge funds, ASIC encourages issuers to disclose against the benchmarks and apply the disclosure principles when providing information to investors in similar situations, such as:
- similar offers to wholesale investors, and
- offers of shares in investment companies pursuing investment strategies normally associated with hedge funds.