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FSA Places Fund Values Under Greater Scrutiny

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LONDON (–A speech by a top official of the U.K.’s Financial Services Authority has targeted asset valuation practices as the core of its growing oversight of hedge funds and has publicly criticized “poor experiences” in this area in the United States.

The declarations came in a speech by Dan Waters, the FSA’s Sector Leader on Asset Management, delivered in Edinburgh to an annual conference held by the National Association of Pension Funds, the U.K.’s biggest investment interest group. The remarks come just days before the FSA is expected to unveil new guidelines that could permit some scope for the marketing of hedge funds to U.K. retail investors.

Mr. Waters said that that regulators and funds need to give “due regard to implementing appropriate systems and controls around the valuation process.” As part of the valuations review, Mr Waters said the FSA was probing reporting lines within funds as well as the appropriateness and timing of independent valuations.

“All of this may seem to stating the obvious, but how are hedge funds doing in respect of valuing complex and illiquid assets? The answer is mixed, with some particularly poor experiences in the United States,” Mr. Waters said. He also estimated that valuation-related losses in hedge funds amounted to US$1.6 billion in 2005.

The FSA is eager to be seen extending regulatory oversight over the fast-growing hedge fund industry. It currently licenses fund managers but not individual funds. For the moment, this distinction looks set to be retained, notwithstanding the rising use of hedge funds by U.K. pension managers and the likelihood of their soon-to-be expanded availability to retail investors.

Mr. Waters also emphasized the need for international cooperation in regulating hedge funds under the aegis of the United States and United Kingdom, where about 85% of funds are managed. He noted that the International Organization of Securities Commissions, in which Mr. Waters chairs a sub-group, is to “assist in establishing what constitute as a minimum good valuation principles.” The sub-group is expected to produce within 18 months a statement of best practice on valuing illiquid and complex assets.

A study by the Alternative Asset Management Association in late 2005 estimated that about 20% of hedge fund assets were in hard-to-value securities such as distressed debt, emerging markets and mortgage-backed securities. Many of these assets were concentrated within specific strategies, the AAMA noted, leaving investors in a non-diversified fund with up to 100% exposure.

Privately, the FSA points out that there have been no reported instances of hedge fund valuation problems in the United Kingdom. Though a fund collapse has yet to occur, industry observers say that dozens of U.K. funds have closed because of poor performance, often after incurring heavy losses.

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


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