Are Hedge-Fund UCITS the Cure-All?

Are Hedge-Fund UCITS the Cure-All? — March 2010

Executive Summary

Most respondents fear that structuring hedge fund strategies as UCITS will distort strategies and diminish returns. After all, although most hedge funds meet the leverage (Value-at-Risk limits) requirements made of sophisticated UCITS, liquidity requirements and obligations to limit concentration/issuer risk mean that many a hedge fund strategy would need to be altered to earn the UCITS label. For instance, 69% of participants (52% “somewhat” and 17% “very much so”) think that the “liquidity premium of hedge fund strategies will disappear and that performance will fall” when hedge fund strategies are structured as UCITS. Likewise, two-thirds of respondents report that there are problems with the distribution of hedge funds to retail investors, and 80% percent think that institutional investors should have access to alternative strategies without the need for the expensive UCITS framework. Ninety- seven percent of institutional investors believe that UCITS should not be necessary to access HF strategies. In addition, hedge-fund UCITS pose operational problems. Seventy percent of respondents think that the definition and the role of the depositary are appropriate,

in stark contrast to depositaries and custodians themselves, an overwhelming majority (80%) of whom consider their roles and responsibilities inappropriately defined. This disconnect seems to indicate that the role of depositaries and the problems they encounter when modifications to the UCITS framework are made have been neglected by most respondents (except depositary professionals). Depositaries and custodians are concerned by the opacity of local obligations and of the responsibilities of depositaries (77%), by due-diligence obligations that are difficult to meet (54%), by the difficulty of validating the valuation process (46%), and by the cost of depositary services for hedge fund strategies (31%). When hedge fund strategies are structured as UCITS, some of the non-financial risks are foisted onto the depositaries. The failure to harmonise responsibility rules Europe-wide raises the risk that asset management firms will choose to register in the countries with the lowest depositary costs. Harmonisation, clarification and the definition of guidelines for depositaries are thus necessary; transparency would be better served. On the whole, the use of UCITS to distribute hedge funds is the perverse outcome of a messy set of regulations; so EDHEC

If the definition and the role of the depositary are not appropriate, why not? (Multiple choice possible, depositaries and custodians)

Depositary is entrusted with safe-keeping, which is not appropriate for alternative strategies Depositaries are not in a position to validate the valuation process Depositary has due diligence obligations that are difficult to apply The cost of depositary services will impact the performance of the funds Other (please specify) Local depositary liabilities and obligations are unclear 0%

46.2%

76.9%

46.2%

53.8%

30.8%

0 10 20 30 40 50 60 70 80

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An EDHEC Risk Institute Publication