European regulators last week brought the inclusion of derivatives based on hedge fund indices in funds sold across European Union borders a step closer. But doubts remain that such complex products are a suitable means of providing retail investors with access to hedge fund returns.
The news comes as US regulators strengthen market surveillance methods amid concerns that hedge funds and other large investors are systematically engaging in hard-to-detect forms of insider trading.
The Committee of European Securities Regulators (Cesr) has been deliberating since last October on whether the products should be considered eligible assets under the Ucits III regime. It had been expected at that time to make a recommendation to the European Commission on the subject, but the matter was opened for consultation instead with an issues paper.
The committee has now published a consultation paper with its conclusions and draft proposals. It plans to publish finalised measures in May.
Cesr said that many respondents to its issues paper argued against tighter guidelines for hedge fund indices than for other indices. But it feels that hedge fund indices are still developing and reports concern, within the industry as well as from other commentators, on whether retail investors should be exposed through Ucits funds.
The US initiatives include a communications system in which regulators around the world can alert one another to suspicious trades and traders and to databases which track connections between funds, their investors and officers and sources of information about companies.
The efforts extend to the Securities and Exchange Commission's inquiry into whether the big Wall Street firms are warning favoured customers about pending large trades and the SEC inquiry into research firms which pay employees of public companies to serve as consultants to hedge funds.
Concern about insider trading was one of the reasons the commission tried unsuccessfully to require the $1,100 billion (€838 billion) industry to register and submit to examination. The New York Stock Exchange has been leading an effort, via the Intermarket Surveillance Group, to make it easier to share concerns.
In Europe, the Cesr notes the recommendation from the EC's Alternative Investment Expert Group last July that Ucits investment in derivatives based on hedge fund indices be deferred until concerns had been resolved. But Cesr said that its guidelines would address these issues, allowing Ucits funds to use derivatives based on some hedge fund indices.
Florence Lombard, executive director of the Alternative Investment Management Association, said that Aima still had concerns about the structure of some hedge fund indices and the extent to which they were representative of the industry.
There was also a view that hedge funds of funds would be a better vehicle for retail investors unfamiliar with hedge funds than a derivative on a hedge fund index. The Ucits directive did not allow the inclusion of funds of funds, but that should not prevent a discussion on the subject, she said.
