MADRID, Spain (HedgeWorld.com)–Despite the calm, non-alarmist tone of its report, the conclusion of the International Organization of Securities Commissions is quite clear: Regulators should require more disclosure from hedge funds and funds of funds for the sake of the retail investors just now entering the market.

IOSCO, an advisory/umbrella body of regulators from 100 countries and with no enforcement authority, has released a paper prepared by its standing committee on investment management. The paper surveys the regulatory and investor-protection issues arising from the participation of retail investors in hedge funds and funds of funds. It concludes that “hedge funds marketed and sold directly to retail investors should be subject to the same disclosure requirements as other” collective investment schemes, including, at minimum, annual and semi-annual disclosure of holdings.

Furthermore, the standing committee (SC5) contends that member regulatory agencies should study the management and internal-control processes of hedge funds. “The complexity of the risks, the investment strategies, the management of the administrative organization and the valuation of the assets can demand special skills.” The report suggests that agencies should consider the adequacy of those skills.

On the other hand, in many respects the report is modest in its claims for a regulatory role in the hedge fund industry. It accepts the impropriety of regulatory second-guessing of the commercial judgments made by the manager. It takes the view that the amount of retail investment involved in hedge funds, however defined, still is quite limited. Furthermore, it holds that new regulatory structures will be unnecessary to deal with the issues that arise in connection with such retail investment because the existing regulatory and supervisory structures applicable to collective investment schemes are sufficiently flexible.

For purpose of its international survey, SC5 defined hedge funds as those that exhibited at least some of six characteristics: *The inapplicability of borrowing and leverage restrictions that would otherwise affect a collective investment scheme in the same jurisdiction;

*Significant performance fees (often in the form of a percentage of profits) in addition to an annual management fee;

*Periodical (i.e. quarterly or semi-annual) redemption of interests by investors;

*Significant ‘own’ funds invested by manager;

*Use of derivatives, often for speculative purposes, and the ability to sell securities short; and

*More diverse risks or complex underlying products than traditional funds.

The report acknowledges that hedge funds so defined can give rise to a number of regulatory issues that it does not specifically address, such as short selling, fee structures and “whether the use of derivatives by hedge funds could lead to a more relaxed regulation of use of derivatives by traditional funds.” But these issues are not limited to the hedge fund or fund of funds markets, so they warrant consideration in broader contexts.

In related news, the United Kingdom’s Financial Services Authority is expected to publish its recommendations on retail hedge fund sales either late this month or in April.

CFaille@HedgeWorld.com