Hedge fund start-up essentials
Andrew Dougherty (AD): We’ve seen a shift in hedge funds’ ability to secure the level of financing and access to credit that they have historically enjoyed. In recent years, many of the world’s largest investment banks conducted balance sheet optimisation exercises in order to meet more stringent regulatory requirements. Although financing temporarily loosened, we are seeing access to credit once again tightening and a new cycle emerging whereby hedge funds are seeking additional prime brokerage and financing counterparties.
AD: It has become increasingly important to have a long-term distribution strategy. A fund needs to consider what investors it will market to, as well as the geography and classification of those investors. As a start-up, the significant questions to ask are: “Will we primarily target high-net-worth individuals, family offices or institutional investors, and will we focus on the domestic US market or will we also target Europe, Asia and Latin America?” The answers become the determining factor for the structure of the fund itself – whether a fund is set up as a single entity domiciled within the US, or as a side-by-side fund with an offshore component (a master feeder structure or mini-master, for example).
Major overseas regulations need to be considered. If there is an ambition to distribute globally, especially in Europe, regulations such as the AIFMD come into play. This directive carries significant requirements in terms of transparency, reporting, liquidity, depositary banking and custody. Those requirements will set the stage for the types of relationships and service providers that fund managers will require prior to launch. Getting the structure right from the start is critical.
From an operational perspective, two important factors to consider are the optimisation of the front-to-back operational structure of the fund and determining of the
line between what can be controlled and operated inside the firm and what should be outsourced. This is important because there are significant expenses involved in structuring the fund in such a way whereby most of the activity is in-house.
This setup may be operationally and economically inefficient. Generally, expenses that are internal to the management company may not be charged to the funds;
they remain expenses of the manager, essentially eating into potential profitability. Expenses from outsourced operations can be charged to the fund, increasing profitability
for the manager.
The regulatory environment is already burdensome, and will certainly become more complex in the years to come. As a hedge fund evolves, and begins to cross jurisdictions, the regulatory environment multiplies in terms of compliance efforts. As such, there is an increasing degree of reliance upon your service providers to keep you
up to date on regulatory changes and requirements to assist you, your fund, and your investors in navigating these various regimes.
In the coming years, there will continue to be significant changes. The National Private Placement Regimes (NPPRs) in Europe will essentially discontinue in 2018, as part of the AIFMD. A sizable portion of the industry is currently depending on those NPPRs in order to market their funds to European investors. As the deadline approaches, there will be a shift away from NPPRs, which will require fund managers to engage with service providers and custodians that are able to provide the necessary products and services compliant with the AIFMD.
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