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Masterarbeit, 2009, 52 Seiten
1.1 Purpose and objective
1.2 Method and materials used
2 Characteristics of hedge fund schemes
2.1 Origin and history
2.3 Legal landscape
2.4 Market participants
3 Existing EU and German law on hedge funds
3.1 German legislation
3.1.1 Hedge fund structures and rules
3.1.2 Authorized institutions
3.1.3 Contractual and prospectus terms
3.2 EU regulations or directives apply
3.3 Financial supervisory frameworks in Germany and the EU
3.4 Hedge funds associations
4 Expected EU and German law on hedge funds
4.1 The proposed AIFM Directive
4.2 Scope and exclusions
4.4 Conditions for the operation of hedge funds
4.4.1 Conduct of business
4.4.2 Capital requirements
4.4.3 Organizational duties
4.4.4 Delegation of functions
4.4.5 Transparency obligations
4.5 Obligations to specific hedge fund types
4.6 Provision of services in the EU
4.7 Specific rules for non-EU hedge fund participants
4.8 Competent authorities
5 Personal statement and final summary comparison
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During the last 15 years the hedge fund industry has become one of the most creative and rapid growing areas within the financial industry and has made it hard for regulators to mitigate the potential risks posed to investors and the financial system.
In light of the financial crisis, international interest in the supervision and regulation of the financial industry has increased rapidly, particularly with regard to hedge funds and there is no doubt that international and European initiatives will influence hedge fund operations in European and German law.
The aim of this thesis is to introduce the reader from a legal perspective to the general characteristics of hedge funds as well as the existing and expected legal schemes for the operations of hedge funds in European and German law.
The thesis explains the characteristics of hedge fund schemes by describing their origin and terms of hedge funds used. In general, the reader will be introduced to the European and German legal landscape as well as to market participants in the hedge funds business by analysing applicable German law as well the practability of existing EU Directives and Regulations. Furthermore a brief summary of the financial supervisory framework will be presented as well as the role of hedge fund associations.
The reader will also find a chapter analyzing and describing the proposed Directive for Alternative Investment Fund Managers (AIFM) by following its table of contents resulting in a comparative summary on expected European regulation and possible impacts to German law.
Finally, I highlight two conclusions. First on the proposed AIFM Directive, which is still in draft, and therefore a statement of political intent, has no binding effect and I expect that the proposed regulations encompassed in the Directive will evolve significantly prior to the passage of new legislation due to lobbying by hedge fund associations and the United Kingdom (UK) government.
The second conclusion is that Germany is already prepared to provide a regulatory framework for the operations of hedge funds in the context of the AIFM Directive. Also, existing hedge fund providers in Germany are already able to provide the required regulatory infrastructures when entering or offering hedge funds business in Germany, which could result in a competitive advantage to other EU Member States.
During the last 15 years the hedge fund industry has become one of the most creative and rapid growing areas within the financial industry and has made it hard for regulators to mitigate the potential risks to investors and the financial system.
While writing this thesis, I have noticed that expected hedge funds regulations will increase control and reporting duties requiring to establish robust operational infrastructures, which will extend operational expenses for hedge fund market participants in Europe. On the other hand investors’ protection and transparency to the financial system is expected to be improved. In order to analyse and discuss any regulation in the complex world of hedge funds it is also substantial to have a profound knowledge in the disciplines of finance and economics.
I would like to thank Professor Dr. Halfmeier at the Frankfurt Business School of Finance & Management, Louise Krohn - Securities Country Manager Switzerland at Citigroup Global Transaction, Nina Kleinbongartz - Head of European Product Management at Citigroup Alternative Investments and Gregory Rodeheaver - Global Relationship Manager at Citigroup Global Transaction Services for their support and encouragement.
Also I would like to mention, given the rapid pace of change in the hedge fund industry and legislation, that the factual data in this thesis may be quickly superseded. Up-to-date advice about existing regulations should always be obtained.
In light of the financial crisis, international interest in the supervision and regulation of the financial industry has increased rapidly. On 2 April 2009 the Group of Twenty (G20) leaders met in London and agreed to extend regulation and oversight to all systemically important financial institutions, instruments and markets, and included, for the first time, systemically important hedge funds.
The International Organization of Securities Commissions (IOSCO), respectively the Commission of the European Communities (CEC) already launched a wide ranging public consultation on hedge funds during the period 18 December 2008 to 31 January 2009. The consultation resulted in a final report, Hedge Funds Oversight on 22 June 2009. The final report recommend high level principles on the regulation of hedge funds, taking into account the outcome of the public consultation and the hearings hold in Madrid on 20 April 2009.
Stating the above, in my opinion there is no doubt that the international and European initiatives will influence hedge fund operations in European (EU) and German law, which inspired me to take this theme as purpose of this thesis.
The objective of this thesis is to introduce the reader from a legal perspective the general characteristics of hedge funds as well as the existing and expected legal schemes for the operations of hedge funds under European and Germany law.
To research the theme in question I have used first the academic method by analysing, studying and evaluating the existing and highly expected European and German legal frameworks. Secondly, the practical method based on practical experience and skills, which I have obtained in the oversight & research function as Fiduciary Officer for hedge funds in Germany in the areas depotbank and fund administration.
Materials were primarily obtained from laws, EU directives, reports and media releases viewed by regulators as well as journals or articles published by associations and auditors of the financial industry.
This thesis focuses on exploring hedge funds in existing and anticipated European and German law; therefore the following limitations are made.
In this thesis, the term hedge fund is used to cover alternative investment funds (AIF) including single hedge funds (SHF) and in special cases (referred to) funds of hedge funds (FoHF).
I excluded tax-related issues and regulations related to hedge funds. Still it should be mentioned that the complexity of the local tax system is often perceived as a serious barrier by (foreign) hedge fund managers indicating the importance of jurisdictions.
The largest hedge fund markets subject to assets under administration in the EU are located in Ireland and Luxembourg implying developed hedge fund industries and legal frameworks. United Kingdom, Belgium, Denmark, France, Greece, Italy, Malta, Netherlands, Spain as well as Sweden have established more or less developed hedge funds legislation resulting in a huge quantity of different laws, opinions and views in each EU Member State. To illustrate the principles for the operation of hedge funds in the EU and national laws, this thesis will explore Germany as example, because with the introduction of the German Investment Act (InvG) in 2004, German legislation already offers a legal framework for the admission and regulation of hedge funds.
As mentioned above, legal hedge fund frameworks in EU Member States are often varying, therefore it has to be questioned if there are common EU regulations or directives which apply to hedge funds. After analysing existing “applicable” European and German law, the next step explores the proposed AIFM Directive and the possible impact to German law for the operation of hedge funds.
Based on the limitations mentioned, chapter 2 explains the characteristics of hedge fund schemes by describing their origin and terms of hedge funds used. In general, the reader will be introduced to the European and German legal landscape as well as to market participants in the hedge funds business.
Chapter 3 analyses “applicable” German law and verifies the practicability of existing EU Directives and Regulations. Further, a brief summary of the financial supervisory framework will be presented as well as the role of hedge fund associations.
Chapter 4 describes and reviews the proposed AIFM Directive by following its table of contents to provide a comparative outlook on expected European regulation and the possible impacts to German law.
The last chapter 5 covers a final summary including my personal statement on the operations of hedge funds according to European and German law.
To understand hedge fund operations from a legal perspective, first of all it is important to describe the characteristics of hedge fund schemes by way of a brief summary of hedge funds’ origin and history, defining hedge funds as well as to explain the legal landscape and market participants in the industry.
With reference to known literature Alfred Winslow Jones (1900-1989), Sociologist, author and financial journalist created the first kind of hedge funds in 1949, when he opened an equity fund organized as a general partnership to provide maximum latitude and flexibility in constructing a portfolio. The equity fund was able to hold long and short positions in securities to hedge returns and use leverage to further enhance the performance. Due to “hedging” parts of the risk to overall market movements, this became known as a hedge fund. The first fund of hedge funds, Leveraged Capital Holdings, was created by Georges Karlweis in 1969 in Geneva.
Beginning in the 1970s the aggregated assets of hedge funds was probably less than $300 million. As most of funds were organized as a limited partnership (LP) no regulations were required. During the 1980s most of the hedge fund managers were not registered with the financial supervisory authority in the United States (US). In the 1990s, one of the characteristics of hedge funds was that the hedge fund industry became extremely heterogeneous resulting in more strategies becoming available for investors to invest in.
Since 2000, assets under management (AuM) in global hedge funds have increased significantly and reached nearly $2.9 trillion compared to Europe which had nearly $325 billion at end of 2008 (see image 1).
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Image 1: Number of hedge funds and AuM in Europe
Given the increased volume and the share of hedge funds in the financial industry, their role cannot be ignored in consideration of financial stability and regulation.
Alternative investments (AI) are defined as investment products other than traditional investments such as stocks, bonds or cash. Further examples of AI are real estate, private equity, venture capital and commodities. But also wine, art, antiques, shows, movies etc. might be considered as an AI. The most known vehicles for AI are hedge funds, which are able to cover the list of AI nearly one-to-one and only minor investment restrictions apply in some EU Member States.
In no EU Member State is the term hedge fund really defined. In this thesis I would like to define hedge funds according to the most known investment strategy meanings used in the hedge fund industry and as per the AIFM Directive, which illustrates for the first time a legal definition for undertakings of AI, which applying to hedge funds, too.
Investment strategies for hedge funds are mainly based on the investment style and have their own risk and return characteristics. The main strategies are as follows:
- Global macro (Macro, Trading) – anticipate global macroeconomic events using all markets and instruments;
- Directional (Equity hedge) - hedged investments with exposure to the equity market;
- Event driven (Special situations) - exploit pricing inefficiencies caused by anticipated specific corporate events;
- Relative value (Arbitrage, Market neutral) - exploit pricing inefficiencies between related assets that are mispriced.
The most known and commonly used hedge fund strategy at the end of 2008 was “long/short” equity (directional strategy) with an estimated worldwide market share of 35%. Long/short equity means that the fund manages long and short positions in equities.
From my understanding the industry meaning of hedge funds can be summarized as follows. Hedge funds are pooled investment vehicles that are open to a limited range of investors, more or less permitted by local regulations to undertake a wide range of investments and trading activities than known regulated investment funds.
At the EU level , for the first time, the AIFM Directive (2009/0064 (COD), Article 3 a) illustrates a legal definition for undertakings of AI, meaning any collective investment undertaking, including investment compartments thereof whose object is the collective investment in assets and which does not require authorisation pursuant to Article 5 of Directive 2009/…/EC. After adopting the AIFM Directive this definition will also cover the term hedge funds.
When discussing the operations of hedge funds we have to consider international initiatives and activities that will possibly affect the legal frameworks in Europe and Germany (see image 2).
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Image 2: International initiatives / European and German legal frameworks
International samples are the G20 agreement to strengthen financial supervision, regulation and global financial institutions as well as to establish a new Financial Stability Board (FSB) with a strengthened mandate, as a successor to the Financial Stability Forum (FSF). As an aside, the Organisation for Economic Co-operation and Development (OECD) could be mentioned as it publishes the list of countries which are against the international standard for exchange of tax information. Also, international associations like the Alternative Investment Management Association (AIMA) could impact legislation processes by lobbying or providing advice on codes of conduct.
In the EU, the European Union treaty and the treaty establishing the European Committees build the legal framework for regulatory bodies to initiate and implement directives or ordinances affecting local legislations.
In Germany, the Ministry of Finance, the Federal Supervisory Authority and the German Bundesbank act as the most important regulatory bodies. The legislation of major importance are the InvG, the German Banking Act (KWG), the Securities Trade Act (WpHG), the Securities Custody Act (DepotG) and Minimum Requirements on Risk Management (MaRisk) that apply when launching or managing hedge funds, but they are not limited to.
Within the legal landscape, this section briefly describes the general market participants (see image 3) in the context to be used for this thesis.
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Image 3: Market participants in the hedge fund market
Investors  are defined as professional (e.g. institutional investors) or non-professional (e.g. retail investors) making investments (buy or sell) in hedge funds, with respect to the AIFM Directive (2009/0064 (COD), Article 5 f) and Section 31 a WpHG.
Fund Managers are any legal or natural person whose regular business is to manage one or several hedge funds. It has to be noted that the majority of fund managers are acting as advisors for investment companies used as legal vehicles to launch or administer hedge funds.
 According to the London Summit (2009, s. 15), Global plan for recovery and reform.
 Final Report, Hedge Funds Oversight (International Organization of Securities Commissions (IOSCO) 2009).
 Note: The wording European including the acronym EU covering the European Members States of the European Community and its contracting partners that have to adhere to EU regulations and directives.
 Note: Alternative investment funds (AIF) will be defined and explained in section 2.2 as well as single hedge funds (SHF) and funds of hedge funds (FoHF) in section 3.1.1 of this thesis.
 Summary of the country-by-country overview (PriceWaterhouseCoopers (PWC), September 2008, pp. 12-57).
6 Note: The German Investment Act (InvG) was amended beginning of 2009, in case of reference made, the InvG effective 12 March 2009 applies.
7 AIFM Directive, 2009/0064 (COD).
 Ineichen/Silberstein (2008, pp. 132-135).
 Limited partnership (LP) is a form of partnership similar to a general partnership, except that in addition to one or more general partners (GPs), there are one or more limited partners (LPs). It is a partnership in which only one partner is required to be a general partner (like the German ‘Kommanditgesellschaft‘).
 (Eurekahedge 2009) published an overview of 2008 key trends in European hedge funds.
 (Blessing 2008, p. 1) defines alternative investments as a negation to traditional assets.
 According to the International Organization of Securities Commissions (IOSCO) (2006, p. 24), ‘No surveyed jurisdiction has a comprehensive, legal definition of “hedge fund”’.
 I recommend ‘Wikipedia’ (2009), reflecting a structured summary and verified link collection on hedge funds.
 Ineichen/Silberstein (2008, p. 18), introducing key hedge funds strategies.
 Here I would like to refer to my understanding of the term hedge funds used in documents (e.g. service level agreements for Prime Brokers, Fund Administrators or Depotbanks).
 Samples of initiatives/EU and German regulatory bodies as well as legislations, but they are not limited to.
 According to the London Summit (2009, s. 15-21), Global plan for recovery and reform.
 This information is taken from MiFID Directive, 2004/39/EC, OJ L 145, 21.4.2004, pp. 43-44 and I strongly recommend to read the section in conjunction with AIFM Directive (2009/0064 (COD), s. 5 f) to understand the meaning of professional and non-professional investors.
 Note: In many cases fund managers acting as advisers for investment companies and are not regulated in Germany as the investment company is acting as the regulated entity (explained in section 3.1.2).
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