Feb. 25, 2016

Hedge Funds Face Increased Trading Costs Under Final Swap Rules (Part Two of Two)

The new joint final rule adopted by the U.S. prudential regulators – establishing minimum initial and variation margin requirements for certain non-cleared swaps – likely means cost increases for hedge funds and other investment funds trading those swaps. Hedge funds face comparable issues under the substantially similar final rule adopted by the CFTC for margin requirements for non-cleared swaps entered into by registered swap dealers or major swap participants that are not regulated by a U.S. prudential regulator. In a guest two-part series, Fabien Carruzzo and Philip Powers, partner and associate, respectively, at Kramer Levin, discuss these final rules and their impact on hedge funds. This second article explores minimum transfer amounts; eligible collateral and haircuts; netting of exposure; documentation and industry initiatives; compliance obligations; and practical implications of the final rules on hedge funds. The first article focused on calculating a fund’s material swaps exposure, as well as the final rules’ requirements for collecting and posting initial and variation margin with respect to non-cleared swaps. For more from Kramer Levin practitioners, see “Risks Faced by Hedge Fund Managers That Access the Alternative Mutual Fund Market Via Turnkey Platforms” (Mar. 13, 2014); and “Kramer Levin Partner George Silfen Discusses Challenges Faced by Hedge Fund Managers in Operating and Distributing Alternative Mutual Funds” (Apr. 18, 2013).

Operational Considerations Hedge Fund Managers Must Address When Redomiciling Their Hedge Funds (Part Two of Two)

When making the decision to redomicile its hedge fund to a more favorable jurisdiction, a manager must consider more than the potential marketing or other advantages the move promises. Redomiciliation involves potential regulatory burdens, conflicts of interest and operational issues, including investor notification and redemption obligations. In a recent interview with the Hedge Fund Law Report, Jonathan Law and Donnacha O’Connor, partners at Dillon Eustace, discussed the prime reasons hedge fund managers consider redomiciliation of their hedge funds. This article, the second in a two-part series, details the potential drawbacks and operational considerations of redomiciliation. The first article addressed the regulatory implications of, and potential conflicts of interest inherent in, the decision to redomicile. For more on redomiciliation, see “Redomiciling Offshore Investment Funds to Ireland, the European Gateway” (Mar. 4, 2011). For additional commentary from Law and O’Connor’s colleague, Derbhil O’Riordan, see “Four Strategies for Hedge Fund Managers for Accessing E.U. Capital Under the AIFMD” (Feb. 13, 2014).

Insurance Products Provide Tax-Efficient Means for Investors to Access Hedge Funds

Certain life insurance products permit policyholders to invest the cash values of their policies in various investment products, including hedge funds. A key benefit of those policies is that such investments can grow on an income tax-deferred or tax-free basis. Katten Muchin Rosenman recently hosted a panel discussion on the use of private placement life insurance (PPLI) and private placement variable annuities (PPVA) as tax-efficient investment vehicles for high net worth individuals. The program, entitled “Tax-Efficient New Products for Sophisticated Investors, Family Offices and Alternative Asset Managers,” featured Katten partners as well as representatives from insurance brokers, investment firms and a Big Four accounting firm. This article examines the key takeaways from the discussion. For more on PPLI and PPVA, see “Insurance Dedicated Funds Offer Hedge Fund Exposure Plus Tax, Underwriting and Asset Protection Advantages for Investors” (Jul. 18, 2013).

Hedge Fund Managers Trading Distressed Debt Must Understand LMA Standard Form Documentation

The second decision handed down from the new U.K. Financial List addresses how failing to fully understand LMA standard form documentation can be disastrous for hedge fund managers. In 2013, certain funds purchased a surety bond position under a 2007 credit facility. That trade was subject to the Loan Market Association’s (LMA) 2012 Standard Terms and Conditions for Par and Distressed Trade Transactions (Bank Debt/Claims). However, the trade failed to settle because the parties disagreed as to whether the funds had purchased only the right to receive payment from the borrower or whether the funds were also obligated to pay claims to the surety bondholders. The U.K. High Court of Justice (Commercial Court) recently ruled on the trade. This article summarizes the underlying facts and the Court’s analysis. For a recent decision involving other LMA standard terms, see “U.K. Supreme Court Resolves Ambiguity in Standard LMA Terms for Sales of Loan Participations” (Apr. 2, 2015). For more on loan transactions governed by LMA standard terms, see “Should Hedge Funds Include Automatic Termination As a Term of Bank Debt Trades on the New Loan Market Association Forms?” (Mar. 11, 2010); and our two-part series on hedge funds’ trade risk in European secondary loans: Part One (Oct. 21, 2011); and Part Two (Oct. 27, 2011).

Hedge Fund Managers Face Imminent NFA Cybersecurity Deadline

The NFA’s recent Interpretive Notice on cybersecurity is poised to become effective in a matter of days. NFA members, including hedge fund managers registered with the NFA as commodity pool operators or commodity trading advisers, are now required to adopt an Information Systems Security Program. See “NFA Notice Provides Cybersecurity Guidance to Hedge Fund Managers Registered As CPOs and CTAs” (Nov. 19, 2015). To help NFA members prepare for the impending deadline, the NFA recently held a “Cybersecurity Workshop” featuring a number of senior NFA personnel and industry experts. Among other topics discussed during the presentation, panelists offered an overview of the requirements set out in the Notice and insight into what NFA examiners will look for after the notice takes effect. This article summarizes the panelists’ discussion of these issues. For more on CFTC and NFA requirements applicable to hedge fund managers, see our three-part CPO Compliance Series: “Conducting Business With Non-NFA Members (NFA Bylaw 1101)” (Sep. 6, 2012); “Marketing and Promotional Materials” (Oct. 4, 2012); and “Registration Obligations of Principals and Associated Persons” (Feb. 7, 2013).

FCA Report Enjoins Hedge Fund Managers to Improve Due Diligence

In a recent report, the U.K. Financial Conduct Authority (FCA) noted that hedge fund managers and other financial advisory firms must improve due diligence of products and services they recommend for their clients. Firms must also appropriately manage conflicts of interest between themselves and their clients. This article details the key points raised in the FCA report. For more on due diligence conducted by hedge fund managers, see “How Should Hedge Fund Managers Select Accountants, Prime Brokers, Independent Directors, Administrators, Legal Counsel, Compliance Consultants, Risk Consultants and Insurance Brokers for Their Funds?” (Jun. 13, 2013); and “Best Practices for Due Diligence by Hedge Fund Managers on Research Providers” (Mar. 14, 2013).

Julie M. Riewe, Former Co-Chief of SEC Asset Management Unit, to Join Debevoise

Debevoise & Plimpton has announced that Julie M. Riewe, former Co-Chief of the Asset Management Unit of the SEC’s Division of Enforcement, will join the firm in March as a partner in its white collar and regulatory defense group. Riewe brings a broad range of experience in SEC and FINRA enforcement program areas, including FCPA, broker-dealer regulation, insider trading, financial reporting and securities registration issues. For insight from Riewe, see “Current and Former SEC, DOJ and NY State Attorney General Practitioners Discuss Regulatory and Enforcement Priorities” (Jan. 14, 2016); “SEC Settlement Highlights Circumstances in Which Hedge Fund Managers Must Disclose Conflicts of Interest” (Apr. 23, 2015); and “Conflicts Remain an Overarching Concern for the SEC’s Asset Management Unit” (Mar. 12, 2015). For commentary from Debevoise attorneys, see “Options Under the Volcker Rule for Bank Investment in Unaffiliated Private Equity and Hedge Funds” (Mar. 7, 2014); and “SEC Risk Alert Discusses When Social Media Interactions May Constitute Prohibited Hedge Fund Client Testimonials” (Apr. 5, 2012).

Duff & Phelps Welcomes Former FCA Head of Department

Global valuation and corporate finance advisor Duff & Phelps welcomes Nick Bayley – former Head of Department in the U.K. FCA Markets Policy & International Division and a Senior Markets Adviser – as a managing director in its compliance and regulatory consulting practice in London. Bayley will lead the firms wholesale markets practice, with a particular focus on assisting clients to prepare for forthcoming markets regulation such as MiFID II and Market Abuse Regulation. For insight from Duff & Phelps, see “What Should Hedge Fund Managers Understand About Transfer Pricing and How to Manage the Related Risks?” (Nov. 1, 2013).