Nov. 23, 2023

Recent International Developments Impacting Hedge Fund Managers

Any doubts about the international nature of the hedge fund industry can easily be dispelled by looking at the statistics. According to the Alternative Investment Management Association and Preqin, at the end of 2022, there were 27,617 hedge funds managed by 8,849 fund managers. Although 65% of those managers were located in North America, 17% were based in Europe, 13% operated from Asia-Pacific and the remaining 5% were located in the rest of the world. Moreover, the institutional investors that allocate to hedge funds are similarly dispersed across the globe, with 68% in North America, 18% in Europe, 8% in Asia and the remaining 6% elsewhere. Thus, the many non‑U.S. hedge fund managers in the private funds space must be aware of applicable regulatory and other developments in the various jurisdictions in which they, their funds and/or their investors may be based. Therefore, as the U.S. is celebrating Thanksgiving today, this issue of the Hedge Fund Law Report features five articles that discuss legal issues relevant to non‑U.S. fund managers, including the SEC’s aggressive approach to examining such managers and recent developments in Ireland, China, the U.K. and the E.U. that effect hedge fund managers. The week starting December 4, 2023, we will resume regular publication of new content, including articles on a recent SEC risk alert on investment adviser exams; speeches by SEC officials on CCOs; and a CFTC proposal that would expand the compliance obligations of commodity pool operators and commodity trading advisors.

U.S.: SEC Examinations of Non‑U.S. Advisers

All investment advisers that are registered with the SEC – including those that manage private funds and are based outside of the U.S. – are subject to examination. According to the SEC’s Division of Examinations (Division) 2021 Examination Priorities, there were more than 900 offshore registered investment advisers, managing nearly $12 trillion in investor assets. Given that many of those non‑U.S. advisers manage private funds, such as hedge and private equity funds, and the SEC’s increasingly aggressive approach to private funds in general, it is unsurprising that the Division appears to have stepped up its efforts to conduct examinations of non‑U.S. advisers to private funds. The first article in a three-part series discusses the SEC’s authority to conduct examinations of non‑U.S. advisers and the recent trend of more exams of those advisers. The second article compares SEC exams of U.S. advisers to exams of non‑U.S. advisers and SEC exams to exams conducted by foreign regulators. The third article provides practical tips for non‑U.S. advisers that may face an SEC exam for the first time. See “Emerging Trends and Themes in the SEC’s Oversight of Private Funds” (Jun. 8, 2023) and “SEC Risk Alert Reflects Growing Concerns About and Focus on Private Funds” (Feb. 24, 2022).

Ireland: Department of Finance Consults on Framework for Funds Sector

Ireland’s Minister for Finance, Michael McGrath T.D., announced a wide-ranging review of the Irish funds sector in early 2023. As part of that review, Ireland’s Department of Finance began conducting a consultation (Consultation) and will report back to the Minister in mid‑2024. The Consultation provides a broad overview of the Irish funds sector; the available fund structures; the regulatory and supervisory framework; taxation of investment products; and real estate and securitization vehicles. It also poses multiple questions about all of those topics. The article parses the Consultation. See our two-part series “ALFI Seminar Examines E.U. Funds Landscape and Regulatory Developments Affecting Distribution”: Part One (Nov. 18, 2021); and Part Two (Dec. 9, 2021).

China: Compliance Measures to Mitigate Sanctions Risk for U.S. Hedge Funds Investing on the HKEX

Unbeknownst to many hedge fund managers, U.S. funds are operating in a complex economic sanctions environment, with serious potential consequences for inadvertent trades in banned securities. The Trump administration imposed sanctions on a list of Chinese companies identified as supporting the Chinese military industrial complex (CMIC). Those sanctions prohibit U.S. persons, including hedge funds, from trading in the securities of “CMIC companies” – even if the securities are offered only on foreign exchanges, such as the Hong Kong Stock Exchange (HKEX). Although the CMIC list continues to grow and additional HKEX-listed securities are becoming subject to sanctions, many U.S. hedge fund managers trading in HKEX securities are not aware of the sanctions or do not understand the scope of the restrictions. Sanctions ban not only direct investments but also trading in derivatives and exchange-traded funds (ETFs) that provide exposure to the sanctioned securities. In an environment of software-managed trading, instant transactions, relentlessly shifting portfolios and little to no see‑through to the composition of ETFs or index funds, how do U.S. hedge fund managers mitigate sanctions risk? The guest article by Lowenstein Sandler attorneys Abbey Baker and Laura Fraedrich reviews the U.S. sanctions regime and sanctions regarding China; examines the sanctions outlook in China and beyond; explains the intersection between hedge funds and sanctions compliance; and discusses the importance of restricted-person screenings. For more insights from Lowenstein Sandler, see “Use of Alternative Data Continues to Grow, Says New Survey” (Mar. 2, 2023).

U.K.: FCA Explores Updates to Its Asset Management Regulations

When the U.K. left the E.U., it temporarily transferred E.U. financial services legislation into U.K. law, leaving for future consideration which E.U. laws to adopt permanently. In December 2022, His Majesty’s Treasury concluded its Future Regulatory Framework review, which sought to ensure the country’s “regulatory framework for financial services continues to be coherent, agile and internationally respected,” according to the discussion paper (Discussion Paper) issued by the U.K. Financial Conduct Authority (FCA). The FCA is now considering updates to the U.K. asset management regulation, including certain rules affecting alternative investment fund managers. “Given the U.K.’s leading role as a centre for asset management, we want to make sure our rules are fit for the future. We want a U.K. wholesale market which supports the economy and is open to innovation, while remaining consistent with high standards of consumer protection and market integrity,” said Camille Blackburn, Director of Wholesale Buy-Side at the FCA, in the press release announcing the Discussion Paper. The article discusses the key takeaways from the Discussion Paper. See “New FCA Consultation: the U.K. Version of the E.U.’s SFDR?” (Jan. 5, 2023).

E.U.: ELTIF 2.0 Poised to Jump Start Retail Investment in Alternatives

The vote by the European Parliament on February 15, 2023, to confirm the reform of the E.U.’s European Long‑Term Investment Fund (ELTIF) Regulation was never in doubt – broad political agreement on the changes had been in place since late 2022. Nevertheless, the final passage of the legislation represents the culmination of a revision process that aims to jump-start an initiative intended to both open up alternative investment strategies to individual investors and boost funding for critical infrastructure projects, including elements of the sustainability transition, as well as for smaller businesses in Europe. The revised ELTIF Regulation was published in the E.U.’s Official Journal on March 20, 2023, following technical revision, and will apply as of January 10, 2024. Accompanying regulatory technical standards implemented through European Commission delegated acts are expected to take effect soon afterwards. The guest article by Linklaters partner Silke Bernard reviews the first version of the ELTIF regime and the issues with it; explains the goal for the revision process; and discusses the key changes in the revised regime. For additional insights from Bernard, see “ALFI Seminar Examines E.U. Funds Landscape and Regulatory Developments Affecting Distribution (Part Two of Two)” (Dec. 9, 2021).