Globally Integrated Compliance Programmes

Why managers must address their compliance arrangements

Originally published in the April 2009 issue

There was a time before the markets crashed when many UK hedge fund managers avoided going after investors in the United States because they were afraid of the complex maze of regulation in a litigious culture. Welcome to 2009 – a brave new world. Fund managers have emerged bruised and battered from the bloodbath of the previous year and are looking across the Atlantic to raise assets. New legislation introduced in both the US Senate and House of Representatives is set to significantly increase the number of UK managers required to register with the SEC as an investment adviser. This is the time for compliance officers to be thinking of how they can develop one efficient compliance programme that meets the highest regulatory hurdles of both the Financial Services Authority and Securities and Exchange Commission.

In my professional view, compliance is essentially a customer service role. Compliance officers are tasked with providing solutions to move the business forward while minimising regulatory risk. Compliance can bring significant added value in a number of ways: assisting with the launch of new products, ensuring that the fund investor experience is seamless and professional, and utilising its unique role in the firm to advise senior management on risk management and controls across the business. However, in order to perform this role properly and proactively, compliance needs to fully understand the business and its risk appetite, understand the applicable regulations and the rationale behind them.

Long gone are the days when the compliance officer could say “no” simply because he or she didn’t understand the regulations or share the same risk appetite with the firm. Today’s Compliance Officer must understand the differences between regulation, best practice, industry standard and commercial decisions. Compliance, after all, means compliance with applicable regulation.

US Regulation set to increase number of UK managers required to register with the SEC as an Investment Adviser
In the United States, almost 11,000 investment advisers are registered with the SEC. Of the advisers based outside the United States, over a third are based in the UK – more than twice the number from any other single foreign jurisdiction. Two thirds of these advisers are managing hedge funds and other pooled investment vehicles.

With the introduction of the Hedge Fund Transparency Act of 2009 in the Senate and the Hedge Fund Adviser Act of 2009 in the House of Representatives, exponentially more UK hedge fund managers will be required to register with the SEC as investment advisers. While it is premature to go into detail about the specifics of these bills due to the intricate US legislative process, one thing is clear – the exemptions that hedge fund managers have traditionally relied upon to avoid registration are probably not going to be available. This legislation closes the de minimis exemption that allowed hedge fund managers to avoid registration if they had fewer than 15 clients during the preceding 12 months and didn’t hold themselves out generally to the public as an investment adviser.

Amendments to US regulation should not come as a big surprise to any firm that has US investors in its funds. One of the SEC’s primary goals is the protection of US investors. The inability of the regulator to “look through” the funds and focus on the number of US investors on the fund register was creating a serious impediment for the SEC to meet its mission. The SEC sought to pragmatically remedy the problem by amending the rules but was rebuffed by the Goldstein Court for exceeding its mandated authority. However, the writing was on the wall. In fact, many proactive compliance officers whose firms weren’t required to register have been running SEC compliance programmes with the knowledge that this day of reckoning would come.

The time is now for Compliance to be thinking about their firms being regulated by the FSA and the SEC
Let’s face it, the regulatory environment for UK hedge fund managers is on course for unprecedented change. The FSA is part of the IOSCO’s Technical Committee which will have recently made recommendations to the G20 London Summit regarding unregulated financial instruments, unregulated financial entities and short selling. The European Union is set to introduce new regulation in the form of a directive on April 21. With all these changes, compliance officers may be tempted to put US regulation on the backburner.

Compliance officers now need to step up to the plate and assess how their activities in the United States may be affected by regulation. What is the firm’s business development and strategic plan? Does the firm plan on targeting US investors to increase its assets under management? Will new funds aimed atUS investors be launched, and if so, are US fund lawyers being consulted? By proactively planning with senior management, compliance can lay the groundwork for a successful and seamless customer experience so the portfolio managers can get on with their job.

By understanding the culture and context of regulations in both the US and the UK, compliance officers are better able to analyse and interpret changes to regulation that affects their firms. Especially important is understanding the rationale behind the regulation. This is integral in developing an efficient and integrated compliance programme – adopt the higher regulatory hurdles of each jurisdiction and implement globally.

Integrated compliance programmes aren’t as intimidating as they seem – talented compliance officers have been doing it for years but more firms need to adopt this approach. The SEC has acknowledged that the true nature of their regulatory approach is not widely understood, particularly by those outside the US. However, the regulator does see great similarity between the UK’s principles-based approach and the rules-based regulation in the United States. Both jurisdictions place great importance on central themes that apply to hedge fund managers: (1) risk management and controls, (2) identification and management of conflicts of interest, (3) disclosure, and (4) monitoring for market abuse. Embracing these common themes found in both jurisdictions leads to focusing on areas where the regulatory approach is very different – registration, introduction of new products, reporting and marketing and financial promotions. It does take some work but this is exactly the type of added value that more and more hedge fund managers will come to expect from their compliance officers. After all, compliance officers are trained to analyse changes to regulation and apply them to the business, consistent with the risk appetite of senior management. (If you aren’t comfortable with risk, you shouldn’t be working at a firm with a higher risk investment strategy; consider a long-only equity strategy). Whether those regulations come from a different jurisdiction or are driven by the FSA doesn’t really matter. Regulatory change is regulatory change.

Finally, in order for dynamic compliance officers to develop integrated compliance programmes and add the most value to their firm, senior management must set the tone from the top that minimising regulatory risk is a priority. The compliance officer is one of the very few people in the firm who intimately understands the business and all of its components. He or she must have the authority and respect to act on behalf of the firm. Utilising this often under-recognised resource to proactively provide solutions will be integral to those hedge fund managers who can see the endless opportunities in this brave new world.

Robert Quinn is the Managing Director of Robert Quinn Consulting. His firm specialises in providing regulatory advice to fund managers regulated by the both the FSA and SEC as well either jurisdiction.