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AIMA Comments on FSA's New Soft Commission Requirements

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LONDON (–The Alternative Investment Management Association, in a comment submitted to the United Kingdom’s Financial Services Authority, has made the case for exempting hedge fund managers from increased disclosure requirements concerning soft commission and bundled brokerage arrangements.

The comment comes a month after the FSA sought to clarify its position on the transparency and accountability issues that arise when investment funds pay for a bundle of services, including research, with their commissions to brokers. In a November policy statement, the FSA praised industry groups for their efforts to develop a self-regulatory regime in accordance with its guidelines.

The Investment Management Association, a trade group chiefly representing traditional investment funds, has been developing a “comparative disclosure” model for all U.K. fund management clients, in collaboration with the National Association of Pension Funds and the London Investment Banking Association. The FSA said that it is encouraged by their progress.

The FSA also acknowledged that certain types of investment management firm and industry activity may warrant “differential treatment that takes account of their specific circumstances,” and it said that it would give further consideration to the scope of proposed regulation early in 2005.

This acknowledgement was a sonata to the ears of the AIMA, which in its comment, filed Dec. 17, said that it had “first thought that it would review the IMA/NAPF improved disclosure model, with a view to adapting or adopting it for use in the alternative investment management industry.” But it has now decided, rather, to seek exemption from that model because it is being framed for pension fund interests, whose requirements and investment perspectives are very different from those of hedge fund investors.

There are two pertinent differences between the AIMA’s membership and that of the IMA/NAPF. First, hedge fund managers’ clients are sophisticated investors. Second, hedge funds are intermediate customers and offshore. The FSA itself “recognizes these facts for the purposes of the regime applicable to financial promotions in the United Kingdom, acknowledging that hedge fund interests may only be marketed to such sophisticated investors,” the comment said.

Within the hedge fund context, the use of soft money to pay for research performs a valuable function. It allows small startups to fund the information that they need to make profitable use of their entrepreneurial skills. Excessive restriction of these arrangements may stifle the competitive edge of the industry in the United Kingdom, weakening that country’s international financial position.

“Further tightening of the U.K.’s regulations would favour the larger, multi-office managers who could, for example, simply direct all their trading through an office in Luxembourg or the US in order to continue to get the benefits [of softing] through a different route.”

Even if the requirement is only a matter of disclosure, it may prove burdensome to small managers, the comment contended. “Although the broad services and counterparties used could be easily disclosed, it would be extremely difficult to break down that information (e.g. as to research supplied by a Japanese broker with no U.K. presence) and it might not, in fact, result in any cost savings at all.”

The FSA’s concern with this issue has a long history. In March 2001, the U.K. Treasury published a report by Paul Myners entitled “Institutional Investment in the United Kingdom: A Review.” The Myners report charged that the bundling of services “creates an artificial bias for fund managers to have services provided by the sell-side, distorting competition, since the costs for these will not be scrutinized by the client and are not a direct charge to the fund manager’s profit.”

The FSA began its review that July. It published a consultation paper in April 2003 and a policy statement in May 2004. It plans a consultation paper with draft rule changes in the spring of 2005 with a view to finalization in the summer.

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Contact Bob Keane with questions or comments at: [email protected].


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