The Australian Securities and Investments Commission (ASIC) has finally released (3 October 2013) the long-awaited changes to the definition of a ‘hedge fund’ (and ‘fund of hedge funds’) for the purposes of determining the application of the shorter Product Disclosure Statement (PDS) regime, and the application of enhanced PDS disclosure under ASIC Regulatory Guide RG240. The original ‘hedge fund’ definition was unclear and too broad which had the unintended consequence of capturing many types of funds that should not have be treated as hedge funds.
The troubled history of this definition is reflected in the number of delays in its finalisation. The shorter PDS regime applying to simple managed investment products commenced on 22 June 2012. At the last minute, ASIC issued interim relief to exclude ‘hedge funds’ from the application of the shorter PDS regime and to allow those ‘hedge funds’ that had prepared shorter PDSs until 22 June 2013 to transition back to a long form PDS. The transition date had to be extended to 1 February 2014 as it became clear that the original definition of ‘hedge fund’ was too broad and unworkable. ASIC has since consulted significantly and widely with industry to refine the definition. It is intended that that the re-worked definition of 'hedge fund' will allow the more accurate targeting of the types of funds which pose more complex risks for investors. As ASIC Commissioner Greg Tanzer stated, “Our changes will benefit the industry by relieving some lower-risk funds from the more extensive disclosure obligations imposed on a hedge fund.”
How has the definition of ‘Hedge Fund’ changed?
The Fund is promoted by the responsible entity using the expression and as being a “a hedge fund”
The Fund is covered by two or more of the following characteristics:
|The Fund is covered by two or more of the following characteristics:|
||Complexity of Investment Strategy and Structure
- (complexity of investment strategy) the use of investment strategies to generate returns with a low correlation to equity or bond indices; and/or
- (complexity of investment structure) the use of at least three or more interposed entities (or at least two if one of the entities is a foreign entity) and the RE or associates have the capacity to control the disposal of the underlying investment or the interposed entities.
Complexity of Investment Strategy
A new definition of a ‘prescribed published index’ has been inserted. The list of asset classes covered by published indices has been expanded from equity and bonds to include bills of exchange, managed funds, promissory notes, certificates of deposit and other negotiable short term money market instruments.
The definition also clarifies that a scheme which pursues a balanced strategy correlated to an index over one or more assets classes would not trigger this limb of the definition.
Complex Investment Structure
A new definition of ‘interposed entity’ has been inserted to:
- clarify that the calculation of the number of interposed entities is to be referenced to each vertical stream of interposed entities; and
- exclude registered schemes and certain foreign entities in co-operative jurisdictions or which are authorised by a prescribed regulatory authority.
The use of leverage for the dominant purpose of making a financial investment.
The fund uses derivatives, other than for the dominant purpose of:
- managing foreign exchange or interest rate risk; or
- more efficiently gaining an economic exposure to an investment, through the use of exchange-traded derivatives referenced to that specific asset for a period of less than 28 days.
- The meaning of derivatives is extended to deferred purchase agreements.
- The definition clarifies that where derivatives are used on a temporary basis for the dominant purpose of gaining more efficient economic exposure to the underlying asset reference assets, a fund will not trigger this limb simply because the derivative has a term of more than 28 days, but it will be triggered if it is not closed-out within 28 days.
- The scheme will not be caught under this limb if the scheme has up to 10% of its net asset value in exchange traded derivatives and is not subject to a defined purpose or duration limit. The 10% limit may be exceeded temporarily for no more than 3 business days for reasons that could not have been reasonably foreseen (eg. market movements or large run on redemptions). There are also specific definitions in relation to the calculation of derivatives exposure.
- Where the use of derivatives also triggers leverage or short selling limbs of the definition, it will only be taken to trigger the derivatives limb.
The use of short selling.
Rights to charge a performance fee.
|Performance Fee |
The definition has been amended so that the limb is only triggered where there is a right to a performance fee and the responsible entity has disclosed to investors that performance fees will be payable when the performance fee conditions are satisfied.
This eliminates the risk that funds which have performance fee provisions in their constitutions, but do not otherwise charge such a performance fee, would be captured by this characteristic.
||Anti Avoidance |
An anti-avoidance clause has been inserted into the definition to ensure that a responsible entity cannot structure schemes with the dominant purpose of avoiding the scheme being characterised as a hedge fund.
What should you do now?
Fund managers should review their fund investment structure and strategy against the revised definition of ‘hedge funds’ and ‘funds of hedge funds’.
If the fund meets (or continues to meet) the definition:
If a short PDS is currently being used for the fund (because the fund was previously thought to be outside the definition), a long PDS must be in place by 1 February 2014 and the PDS must satisfy RG240 enhanced disclosure requirements.
If a long PDS is currently being used for the fund, the RE must consider the extent to which it needs to meet its enhanced disclosure requirements under RG240 from 1 February 2014.
If the fund no longer meets the definition and is using a short or long PDS, the RE should consider the application of the shorter PDS regime to the fund and ensure compliance from 1 February 2014.
This article was written with assistance from Avi Gordon, Lawyer.