Hedge Funds Notice - Comments Matrix

Transcription

1 Hedge Funds Notice - Comments Matrix Clause Comments received FSB Response General Comments 1. Definitions Heading: CONDITIONS FOR INVESTMENT IN HEDGE FUNDS AND FUNDS OF HEDGE FUNDS Hedge funds and funds of hedge funds are defined separately in Regulation 28 with both subject to conditions as prescribed. This addition will make it clearer that this notice describes the conditions for both. Agree foreign hedge fund means a hedge fund domiciled in a country other than the Republic, which may include a fund eligible under UCITS regulation, which as part of its investment strategy employs hedge fund strategies such as leverage and short selling through derivatives; hedge fund includes a fund of hedge funds as defined in Regulation 28; foreign hedge fund means a hedge fund domiciled in a country other than the Republic, which may include a fund eligible under UCITS regulation, which as part of its investment strategy employs hedge fund strategies such as leverage and short selling through derivatives; ASISA members suggest that the definition be simplified as proposed. The reference to UCITS funds may cause confusion in that it may create the impression that all UCITS funds are hedge funds which is not the case. Furthermore, registered collective investment schemes outside the European Union will not be UCITS funds. The definition of foreign hedge fund should align with the definition of hedge fund and thus the last part of the definition is superfluous. hedge fund includes a fund of hedge funds as defined in Regulation 28; ASISA members submit that the conditions set out in the Draft Notice will not be applicable to hedge funds and fund of hedge funds in exactly the same way as the products differ. Please refer to the proposal to separately identify the conditions applicable to a fund of hedge funds. It is therefore Agree Disagree, we are of the view that the conditions apply equally to fund of hedge funds

2 UCITS means the Undertakings for Collective Investment in Transferable Securities published by the European Union. 2. Hedge fund structures 2.1 Without derogating from any of the requirements of Regulation 28 or the other requirements of these Conditions and subject to sub-paragraph 2, a fund may not make any investment resulting in the fund having an exposure to a hedge fund unless the hedge fund is structured as- suggested that the definitions of hedge funds and fund of hedge funds should not be repeated in these Conditions as the Draft Notice in condition 1 stipulates that words or expressions which have been defined in Regulation 28 shall have the meaning so assigned. UCITS means the Undertakings for Collective Investment in Transferable Securities published by the European Union. The expression is only used in the definition of foreign hedge fund. ASISA members propose that this definition be deleted to align with our comments on the definition of foreign hedge fund. Proposal 1: A fund may make an investment resulting in the fund having an exposure to a hedge fund or a fund of hedge funds if the fund is satisfied that- (a) the hedge fund or fund of hedge funds is held within a limited liability structure; and (b) the fund will not suffer a loss in excess of its capital or initial investment or contractual commitment. Given that Regulation 28 introduced principles in respect of the asset spreading requirements for pension funds, ASISA members are of the opinion that conditions in respect of hedge fund structures will be more authoritative if it follows the same philosophy and introduces principles in respect of hedge fund structures. It is thus suggested that condition 2 stipulate the principles which should be applied when a pension fund considers investing in a hedge fund rather than listing the structures within which a hedge fund should be housed. A pension fund should be satisfied that the hedge fund is held within a limited liability structure and that the fund will not lose more than its investment. Please refer to Proposal 1 in the left hand column. The reference in condition 2.2 of the Draft Notice to where the assets should be held will be covered in conditions 6 and Agree Disagree, it is the FSB s opinion that until Hedge Funds are regulated we have to retain the proposed structures.

3 9 of the Draft Notice and need not be repeated in condition 2. Condition 2.2(c) of the Draft Notice is likely to be problematic for a pension fund to interpret and to practically implement. It is contended that the consideration of associated risks as required by condition 8.1 of the Draft Notice and the proposed introduction of a new and separate condition in respect of risk management will adequately cover what is contained in condition 2.2(c) of the Draft Notice. Proposal 2: A fund may make an investment resulting in the fund having an exposure to a hedge fund or a fund of hedge funds if the fund is satisfied that- (a) the hedge fund or fund of hedge funds is held within a limited liability structure; and (b) the fund will not suffer a loss in excess of its capital or initial investment or contractual commitment. 2.2 Without derogating from any of the requirements of Regulation 28 or the other requirements of these Conditions and subject to subcondition 1, a fund may not make an investment resulting in the fund having an exposure to a hedge fund unless the hedge fund is structured as- (a) an en commandite partnership, if the pension fund is an en commandite partner; (b) a trust, if the pension fund is a trust beneficiary of the trust; (c) a company; if the assets and liabilities of that company are limited to assets and liabilities arising from investments made by the hedge fund; subject to the condition that if the company uses a trust to hold the underlying assets of the hedge fund, the pension fund must be the beneficiary of the trust; (d) a linked policy issued by a registered long-term insurer; (e) a collective investment scheme as contemplated in the Collective Investment Schemes Control Act, 2002; (f) in case of a foreign hedge fund- (i) a structure referred to in subparagraphs (a) to (e); (ii) a limited liability partnership; (iii) an open-ended investment company; or Partially agree, see revised draft The FSB is of the view that the other trust structures do not provide sufficient protection to pension funds

4 (iv) a portfolio regulated as a collective investment scheme in its jurisdiction; or (g) any other structure approved by the registrar. If Proposal 1 is not acceptable to the Registrar due to the absence of product regulation, ASISA members propose that the condition be restructured to first introduce the principles and then list the acceptable structures. Please refer to Proposal 2 in the left hand column. ASISA members propose that the subparagraphs (b) and (c) of the Draft Notice be amended to refer to trusts in general. The majority of hedge funds held in trusts are held in vesting or discretionary trusts and not in bewind trusts. ASISA members submit that section 5(2)(e) of the Pension Funds Act does not, on its terms, apply to assets owned by the trustees of a discretionary or vesting trust in respect of which trust a pension fund is a beneficiary. The fund will hold the hedge fund asset and the underlying assets of the hedge fund will be in trust with the pension fund as beneficial owner. Similarly, a pension fund will hold a linked policy as an asset and not the underlying assets of the linked policy as those assets belong to the insurer and a pension fund will hold participatory interests in a collective investment scheme portfolio but the underlying assets in the collective investment scheme portfolio will be the property of portfolio which is currently structured as a trust. The approval of trusts should thus not be a requirement. The pension fund s beneficial ownership is protected by the Trust Property Control Act and the requirement that the hedge fund will be held in a limited liability structure. Furthermore, ASISA members raised the following concerns in respect of the approval of vesting and discretionary trusts: The basis on which such approval will be granted, in other words the criteria that needs to be met to obtain approval are not detailed as part of the Conditions. ASISA members wish to emphasise that the majority of local hedge funds and fund of hedge funds held in trusts are held in vesting or discretionary trusts and not in bewind Transitional provisions have been provided for and the Registrar will on application consider exemption to specific hedge funds that were in

5 trusts. If these trusts require approval at least 35 single hedge funds (approximately R11 billion assets under management) as well as the majority of funds of hedge funds (assets under management estimated to be in excess of R10 billion) will be affected. These trusts will require an extended transition period to enable the trusts to apply for approval and the Registrar to consider such application. It will also effectively exclude foreign hedge funds structured as vesting or discretionary trusts as it is unlikely that a foreign hedge fund will apply for approval. ASISA members are concerned that the approval of these trusts may not be meaningful. Some retirement funds may have to exit some hedge fund investments which may result in grandfathered members losing their grandfathered status. (e) proposed new paragraphs Proposed condition 2.2(e) - ASISA members propose that collective investment schemes be included in the list of acceptable structures. According to information at our disposal, the FSB Collective Investment Schemes Department envisages that hedge funds could be structured as collective investment schemes in terms of the Collective Investment Schemes Control Act. existence prior to the implementation of the conditions. Don t agree as the CIS Structure does not exist yet, will be reconsidered once it is finalised (e) in case of a foreign hedge fund- (i) (ii) the structures referred to in subparagraphs (a) to (c); a limited liability partnership; Condition 2.2(f)(i) should provide for pension funds to obtain exposure to foreign hedge funds through linked policies issued by South African long-term insurers. Similarly a pension fund should be able to obtain exposure to foreign hedge funds through a domestic collective investment scheme. Agree, see revised wording (iii) an open-ended investment company; or (iv) a portfolio regulated as a collective 2.1(e)(iv) relating to foreign hedge funds allows for a portfolio regulated as a collective investment. It is our understanding Agree, see revised wording

6 (g) proposed new paragraph investment scheme in its jurisdiction. 2.2 Despite sub-paragraph 1, a fund may make an investment resulting in the fund having an exposure to a hedge fund if the assets of that hedge fund are held in a segregated depository account at a central securities depository, and the fund is satisfied that- 3. Financial services A fund may only invest in a hedge fund on condition that any person rendering discretionary financial services to that hedge fund, whether local or foreign, on behalf of the fund is an authorised hedge fund FSP, or a representative of such hedge fund FSP; unless such a person rendering financial services is exempted from the provisions of the FAIS Act in terms of section 45(1)(a)(i) of that Act. that the Collective Investment Scheme department of the FSB is working on an expansion of CISCA to allow domestic hedge funds to be structured as a collective investment scheme. In order to be consistent with this work we suggest that collective investment schemes also be included under the allowed structures for domestic hedge funds and fund of hedge funds. Proposed condition 2.2(g) - ASISA members also suggest that a provision be included to enable the Registrar to approve structures that are not included in the list to ensure the sustainability of the condition should any new appropriate structures become available. The theme of this Notice appears to be that of limiting the retirement fund s liability when utilising various structures for hedge fund investments. In light of this we suggest that given its general nature paragraph 2.2. be placed ahead of paragraph 2.1. The only comment I have probably fit s in here and that is would a hedge fund require authorisation as an Investment administrator in terms of section 13B of the PFA? Is it also a condition for pension funds to invest in this asset class? Either way I feel a statement here saying that either Hedge Funds require 13B, or alternatively Hedge Funds do not require 13B, may clear up the prevailing confusion in the industry. I would like to know your thoughts. We note that under the definition of hedge fund in Regulation 28, a foreign hedge fund is defined as being managed by a person licensed as a Category I FSP. It appears that the intention of paragraph 3 of the hedge fund Notice is that the managers be registered as a Category IIA FSP. Do not agree with the proposal, notice needs to be reissued should it be necessary Agreed, see revised wording in paragraph 6(1)(a) No, a hedge fund would not be required to obtain a section 13B approval. No The intention is to ensure level playing fields between domestic and foreign hedge funds and regulation 28 will need to be amended to accommodate this allignment

7 This requirement for a foreign hedge fund may be overly prohibitive. We suggest that any foreign hedge fund provider be required to register with the appropriate regulatory authority in its jurisdiction or possibly an international federation of regulators. Can be deleted as it is already contained in Regulation 28 The proposed condition conflicts with the definition of hedge fund in Regulation 28. The proposed condition requires a foreign hedge fund manager to have a FAIS Category IIA licence as a Hedge Fund FSP. The definition of hedge fund in Regulation 28 requires the foreign hedge fund manager to have a FAIS Category I licence. The proposed condition may be regarded as ultra vires. ASISA members suggest that condition 3 be deleted and a requirement included in condition 8 that a pension fund must consider whether the manager of a hedge fund is appropriately licensed (whether in South Africa or a foreign jurisdiction) before investing in a hedge fund. ASISA members understand that the Registrar wishes to ensure that the manager of the hedge fund is a regulated person but the requirement to hold a FAIS Category I licence in the definition of hedge fund in Regulation 28 is in itself problematic. The following regulatory provisions are relevant: FAIS Regulation 3 stipulates that no person may canvass for, market or advertise any business related to the rendering of financial services by any person who is not an authorised financial services provider or a representative of such a provider. Section 65 of the Collective Investment Schemes Control Act requires a foreign collective investment scheme to be registered in South Africa if that collective investment scheme solicits investments from South African investors. Section 13B of the Pension Funds Act requires a person who administers the investments of a pension fund to be approved. The following documents are also relevant: ASISA letter to the FSB dated 21 July 2009 and the reply from the FSB dated 7 August 2009.

8 Joint Circular from the Registrars of Collective Investment Schemes, Stock Exchanges and Financial Markets dated 13 March If a local investment manager with a discretionary mandate decides to include a foreign hedge fund in a portfolio of assets it manages in behalf of a pension fund client, it is purchasing a product and there will be no direct contractual relationship between a pension fund and the foreign hedge fund manager. The foreign hedge fund will not render any financial service in South Africa if it does not canvass, market or advertise any business related to the rendering of financial services. In a collective investment scheme context, if an investment manager with a discretionary mandate decides to include a foreign collective investment scheme in a portfolio of assets it manages on behalf of a pension fund client, it purchases a product and there is no direct contractual relationship between the pension fund and the foreign collective investment scheme. The foreign collective investment scheme will not require a section 13B licence, a FAIS licence if it does not render financial services to the pension fund client or section 65 approval in terms of the Collective Investment Schemes Control if it does not solicit investment in South Africa. The requirement to hold a FAIS Category I licence limits the pension fund s ability to invest in foreign hedge funds. 4. Investment reports A fund must ensure that the administrator of the hedge fund provides the fund with investments reports, detailing the hedge fund s performance, activities and the value of the fund s investment, at least quarterly, or at such intervals to enable the fund to fulfil any of its reporting requirements. Proposal A fund must, at least quarterly, obtain reports as contemplated in section 6 of the Code of Conduct for Discretionary FSPs published in Board Notice 79 of 8 August ASISA members assume that the reference to administrator is intended to refer to the investment administrator, in other words the Hedge Fund FSP or the foreign hedge fund manager. It is suggested that the condition be phrased to require the pension fund to obtain reports and not to specify Agree with the proposed provision included in paragraph 8 Agreed

9 5. Conflict of interest The administrator of, or advisor to, a hedge fund must disclose to the fund any possible conflicts between its interests and its duties to the hedge fund and the hedge fund s investors and any direct or indirect benefit that it may obtain or may have obtained as a consequence of any transaction concluded by the hedge fund or in the acquisition or disposal of assets in the execution of the business of the hedge fund. 6. Confirmation of assets A fund must ensure that the hedge fund confirms, at least every six months, the existence of the assets of the hedge fund through a scrip count by an administrator independent who should provide the reports to the pension fund as the sources of the information may differ. In terms of section 6 of the FAIS Code of Conduct for Discretionary FSPs, a Hedge Fund FSP is required to furnish a written report to a client on request and at least quarterly, unless the client consents in writing not to receive the report because such client is able to access the information made available through electronic means, such as the Internet or a facsimile service, on a continuous basis. Such report must contain such information as is reasonably necessary to enable the client to - (a) produce a set of financial statements; (b) determine the composition of the financial products comprising the investment and the changes therein over the period reported on; and (c) determine the market value of the financial products comprising the investment and the charges therein over the period reported on. ASISA members are of the opinion that the regulatory requirements should be aligned and the fund should thus obtain the information as required in FAIS. We suggest that the notice make it clear that the fund should be administered by a third party administrator ASISA members submit that the requirements in terms of FAIS adequately provide for conflict of interest and it should not be repeated in these conditions. The reference to administrator may cause confusion as will the reference to advisor which is not a defined term. We suggest that the notice indicates that the central securities depository should perform a reconciliation of scrip at the administrator to the independent custodian records at Noted We agree, but feel this statement must be included but will refer to the FAIS requirement Agree, see revised wording Don t agree, it is not be practical, see revised wording requiring an independent person to conduct the confirmation of assets

10 of the hedge fund and annually by the auditors of the hedge fund. 7. Auditing requirements 7.1 The financial statements of the hedge fund must be audited annually in accordance with the International Standards on Auditing by an external auditor, to obtain sufficient evidence that the financial statements are in accordance with the underlying records, and are prepared in accordance with the International Financial Reporting Standards so as to fairly present the financial position and cash flows of the hedge fund and such audited financial statements must be made available to the fund within 90 days after the each dealing date and / or on a monthly, quarterly basis. Proposal: A fund must, at least every 6 months, obtain confirmation of the existence of the assets of the hedge fund from a party who is independent from the hedge fund and the Hedge Fund FSP and annually from the auditors of the hedge fund. Scrip count is a term which relates to listed instruments. In a dematerialised environment, positions are reconciled by the independent administrator and the term scrip count may cause confusion. Furthermore, the underlying assets of a hedge fund may include unlisted instruments or OTC derivatives such as CFDs (Contracts for Difference). ASISA members understand the intention of the condition to be that a fund must ensure that the assets exist. This can be achieved by rephrasing the condition to require the pension fund to obtain confirmation of the existence of the assets of the hedge fund rather than prescribing the method of confirmation of the assets. Foreign hedge funds typically provide this confirmation on an annual basis only. ASISA members also propose that independent be qualified as independent from the hedge fund and the hedge fund manager. The confirmation could be obtained from the administrator or the custodian or the auditor. Some, not all Hedge Funds prepare their financial statements on an IFRS basis. We recommend that the notice also allows the Hedge Funds to prepare their financial statements in accordance with an entity specific basis of accounting i.e. accounting policies which is the current practice with a number of the hedge funds in South Africa. and such audited financial statements must be made available to the fund within days after the end of the hedge fund s financial year. Agree with the principle, see revised wording quarterly reporting required to be aligned with SARB reporting and proposed reporting requirements going forward Agreed Don t agree, must provide for a set and comparable basis

11 end of the hedge fund s financial year. The current FAIS requirement is for the Hedge Fund management company to submit their financial statements within 4 months of the financial year end of the entity, so we suggest that consistency be maintained Proposal: 7.1 A fund must obtain confirmation from the hedge fund structured as an en-commandite partnership, trust or company that the financial statements of such hedge fund shall be audited annually in accordance with the International Standards on Auditing by an external auditor. 7.2 A fund may request a hedge fund to provide the fund with the audited annual financial statements within 120 days after the financial year end of the hedge fund. 7.3 A fund must require a hedge fund to immediately report any qualifications or emphasis of matter reported on by the auditor of the hedge fund to the fund who must report such qualification or emphasis of matter to the registrar without delay. A long-term insurer and a collective investment scheme management company are required by law to be audited annually. ASISA members are of the opinion that it will be more practical and efficient to require the pension fund to confirm that a hedge fund other than a hedge fund structured as a linked policy or collective investment scheme will be subject to an annual audit by an external auditor. The pension fund may request a copy of the audited annual financial statements but must require the hedge fund to report qualifications to the hedge fund immediately who in turn must report to the Registrar. The financial statements of foreign hedge funds are not always prepared in accordance with the International Financial Reporting Standards and ASISA members propose that this requirement be deleted so as not Mostly agree, see revised wording Mostly agree, see revised wording Don t agree a consistent basis needs to be applied See revised wording

12 8. Suitability of investment Before investing in hedge fund, a fund must consider, inter alia- to exclude foreign hedge funds. UCITS funds typically allow 120 days within which audited annual financial statements will be made available and the hedge fund domiciles of the Cayman Islands and the British Virgin Island allow for 180 days. It is noted that the annual audited financial statements of private equity funds should be made available within 120 after the financial year end of the hedge fund. ASISA members therefore suggest that the condition be aligned. Proposal Before investing in hedge fund, other than a hedge fund structured as a collective investment scheme, a fund must consider, inter alia- 8.1 the hedge fund s investment strategy and objectives, investment and borrowing powers, restrictions and associated risks (including types and sources of leverage); 8.2 the procedures by which the investment strategy and policy might be changed; 8.3 that the investment manager of the hedge fund is authorised or licensed to act as manager of the hedge fund and regulated in the jurisdiction within which it operates; 8.4 details about the custodian, valuator, auditor, prime broker, administrator and any other service provider, including a description of their respective duties; 8.5 details about the rights of the fund as investor in respect of (a) the solvency of the hedge fund; (b) insolvency risk arising from other hedge funds managed by the same Hedge Fund FSP; (c) subscriptions and redemptions both in normal and exceptional circumstances; (d) the liquidity profile of the hedge fund; and (e) fair treatment to all the investors of the hedge fund; 8.6 the ownership of the assets; and 8.7 details of the fee structure including management fees, performance fees and any initial charges or early redemption fees. This condition is covered by the principles set out in In South Africa hedge funds are not yet accommodated in the CIS regulatory framework, this Notice will be reconsidered once the the framework is finalised and implemented. Don t agree with deleting paragraph (e) Accepted most of the revised wording - See revised wording

13 8.1 the hedge fund s investment strategy and objectives, investment and borrowing powers, restrictions and associated risks (including types and sources of leverage); 8.2 the procedures by which the investment strategy and policy might be changed; 8.3 details about the custodian, valuator, auditor, prime broker, administrator and any other service provider, including a description of their respective duties; 8.4 details about the investor s rights should there be a contractual breach by the hedge fund or its service providers; 8.5 details about the investors rights with regard to the Regulation 28(2). ASISA members suggest that the level of detail to be considered by a fund should not be required in respect of a collective investment scheme. The envisaged regulatory framework for collective investment schemes should be sufficient. This will encourage pension funds to invest in hedge funds structured as collective investment schemes. ASISA members submit that conditions 8.4, 8.5, 8.6, 8.8 and 8.11 should be combined and simplified as the requirements may overlap or set out to achieve a similar goal, i.e. that the pension fund s rights as investor should be properly considered. It is proposed that risk management processes and procedures as set out in the proposed condition 8.10 form part of a separate condition on risk management. Please refer to the comments in this respect below. Proposed conditions 8.12 and 8.13 are covered by the principles set out in Regulation 28 and the proposed condition 8.1. ASISA members suggest that it be deleted. Clarification is sought on whether a fund will have to demonstrate the application of these principals for any reporting purposes. Don t agree, not regulated yet and all regulatory environments are not the same See revised wording Agree Agree Will be part of the reporting in the annual financial statements

14 insolvency of the hedge fund, including whether the hedge fund structure is appropriately ringfenced from insolvency risk pertaining to other hedge funds managed by the same hedge fund FSP; 8.6 liquidity risk management of the hedge fund as well as the fund as investor, including redemption rights both in normal and exceptional circumstances, and how fair treatment is ensured across investors; 8.7 the ownership of the assets; What is meant about ownership? See revised wording 8.8 the frequency of and any limitations on on-dealing; Not sure what is meant with on-dealing deleted 8.9 details of the fee structure including management fees, performance fees and any initial charges or early redemption fees; 8.10 the manager s risk and compliance management standards, including the necessary independence of these functions from portfolio management, the application of a proper risk management programme ; and 8.11 the liquidity profile of the hedge fund relative to the liquidity and liability profile of the pension fund 8.12 details of diverse risks and complex underlying products; 8.13 details of any deficit positions of the short seller, uncovered positions, leverage used and side agreements. 9. Ownership, encumberment and protection of the assets of the hedge fund 9.1 The assets of the hedge fund must be held in the Proposal:

15 name of the hedge fund with- 9.2 The hedge fund may not have side-letters or agreements with other investors which may prejudice the fund s access to or ownership of its assets; and The assets of the hedge fund structured as an en commandite partnership, trust or company must be held in the name of the hedge fund - (a) in a segregated depository account through a participant in a central securities depository as defined in the Securities Services Act, 2004; (b) with an approved nominee; (c) with an authorised user as defined in the Securities Services Act, 2004; (d) with a bank registered under the Banks Act, 1990; (e) with a custodian with independent fiduciary oversight, or (f) in the case of assets incapable of being held as set out in subparagraphs (a) to (e), by the hedge fund, to ensure the safekeeping of the assets and to verify transfers and ownership of assets of the hedge fund; The segregated depository account requirement does not recognise the role of the prime broker and the assets held with the prime broker in an omnibus nominee account referenced as client assets or with a custodian against financing provided or the placement of collateral with other counterparties or the holding of OTC derivative positions or other contracts with counterparties in the portfolio for which there is no physical asset. Not all assets of a hedge fund are listed or dematerialised and held by a nominee or in a segregated depository account with a central securities depository participant. Please also refer to the comments on the proposed condition 2 in respect of the ownership of the assets of the hedge fund. ASISA members suggest that the condition be rephrased as proposed in the left hand column. A pension fund will be protected further through the proposed conditions 6 and 7. Proposal The hedge fund may not have side-letters or agreements with other investors which may prejudice the exercise by the fund of its right as an investor to redeem its direct or indirect investment in the hedge fund; and Don t agree, too wide and does not give sufficient protection STRATE has confirmed that an SDA can be set up by a participant on request of a prime broker while recognising that this account can only accommodate securities that are listed and materialised, to protect the pension fund other assets may be held in an approved nominee company. This should give adequate flexibility Agree, see revised wording

16 ASISA members suggest that the condition be rephrased for the sake of clarity. 9.3 The assets of the hedge fund may not be rehypothecated. Although it is a word generally used in hedge fund practice, we suggest that the word hypothecate which means pledged as collateral be defined under paragraph 1. An outright prohibition on re-hypothecation is not feasible. The majority of hedge funds will be excluded from being available to pension funds. In a typical example of rehypothecation, securities that have been posted with a prime broker as collateral by a hedge fund are used by the brokerage for other purposes. In some foreign jurisdictions, re-hypothecation of collateral by prime brokers is limited to a percentage of the loan amount e.g. 140% in the USA. Agreed 10. Portfolio valuation 10.1 In addition to the requirement set out in Regulation 28(3)(e), a fund may only invest in a hedge fund that has clear policies and procedures in place for valuing and calculating fair value of the assets of the hedge fund as contemplated in the Alternative Investment Management Association Guide to Sound Practices for Hedge Fund Valuations (2007), as amended from time to time The policies and procedures referred to in subparagraph (1) must ensure that the assets of the ASISA will request further information from prime brokers in this respect and will appreciate it if we on behalf of our members could further engage with the Registrar in this respect. Most South African hedge funds are not members of AIMA and therefore ASISA members submit that a reference to AIMA guidelines is not appropriate. It appears as if the guidelines are only available to members of AIMA. ASISA members propose that the reference should rather be to the IOSCO. IOSCO Principles for the Valuation of Hedge Fund Portfolios. This document is available on the IOSCO website in the Public Document Library. It is also suggested that the reference to independent be qualified as independent from the hedge fund and the Hedge Fund FSP. Independently needs to be defined. Some hedge funds structures allow for an entity within the same group to perform valuations which are technically independent. Agree See revised wording See revised wording

17 hedge fund are valued independently. Proposed new Condition: Risk Management 11. Derivatives instruments The Notice in respect of derivative instruments relevant to pension funds must be adhered to where a hedge fund invests in derivative instruments in terms of regulation 28(7). Proposal: A fund must consider whether the Hedge Fund FSP has an established and maintained risk management programme in place, including a compliance risk management framework, with the necessary independence of these functions from hedge fund portfolio management. ASISA members suggest that as risk management is of significant importance, a separate condition should be included in respect of risk management. Internationally, the risk management concept is significantly emphasised and generally included separately in hedge fund related legislation. This paragraph refers to the Notice in respect of derivative instruments which we understand has not been issued yet. However, the intent shown in the latest draft available is that this Notice will mainly be aimed at limiting gearing and shorting via derivatives on the main portion of retirement fund assets i.e. the assets that do not fall under the hedge fund or private equity sub category. As such, we are of the opinion that the inclusion of paragraph 11 will largely negate the purpose of the limited liability, ring fenced hedge fund category created by the new Regulation, as it will effectively preclude hedge funds from using a large portion of generally accepted hedge fund strategies. Therefore we suggest that paragraph 11 be deleted from the hedge fund Notice. Regulation 28(4)(c) stipulates that any direct or indirect exposure to a hedge fund must be disclosed as a hedge fund and the fund need not apply the look-through principle in respect of the underlying assets of a hedge fund. National Treasury in paragraph 4 (Look-through) of its Explanatory Memorandum on the final Regulation 28, stated the Agree, included as paragraph 5 Do not agree, we don t want entities to package derivatives in hedge funds to circumvent compliance to the derivative conditions Agree

18 Proposed New Condition: Fund of Hedge Funds following: An exception however is made for private equity funds and hedge funds, where these vehicles themselves are seen in terms of Regulation 28 as the final asset, and must be reported as such in other words no further look-through applies (this means that hedge funds will not be subject to derivatives requirements, and listed equity held by a private equity fund will be classified as unlisted for the purposes of Regulation 28). Tight definitions of hedge and private equity funds seek to ensure that the exemption of look-through is not abused, resulting in these vehicles being used to circumvent limits under the Regulation. Hedge funds will by definition use strategies that include leverage and net short positions, strategies that are likely to be prohibited by the derivatives notice. A pension fund member is adequately protected through the limited liability structures and the exposure limit set in Regulation 28. ASISA members therefore submit that the proposed condition be deleted. Proposal 1. Without derogating from any of the requirements of Regulation 28 or the other requirements of these Conditions and subject to subcondition 1, a fund may not make an investment resulting in the fund having an exposure to a fund of hedge funds unless the fund of hedge funds is structured as- (a) an en commandite partnership, if the fund of hedge funds is an en commandite partner; (b) a trust, if the fund of hedge funds is a trust beneficiary of the trust; (c) a company; if the assets and liabilities of that company are limited to assets and liabilities arising from investments made by the fund of hedge funds; subject to the condition that if the company uses a trust to hold the underlying assets of the fund of hedge funds, the fund of hedge funds must be the beneficiary of the trust; (d) a linked policy issued by a registered long-term insurer; (e) a collective investment scheme as contemplated in the Collective Investment Schemes Control Act, 2002; Structures as proposed have been retained

19 (f) in case of a foreign fund of hedge funds- (i) a structure referred to in subparagraphs (a) to (e); (ii) a limited liability partnership; (iii) an open-ended investment company; or (iv) a portfolio regulated as a collective investment scheme in its jurisdiction; or (g) any other structure approved by the registrar. 2. A fund must obtain confirmation from the fund of hedge funds in respect of the hedge funds included in the fund of hedge funds - (a) that the hedge fund structures complies with the requirements as set out in condition 2 of these Conditions; (b) that it will ensure that the hedge fund provides the fund of funds with the investment reports as contemplated in condition 4 of these Conditions; (c) that the fund of hedge funds has considered the suitability of the investment into a hedge fund as contemplated in condition 8 of these Conditions. 3. A fund of hedge funds must, at least every 6 months, obtain confirmation of the existence of the assets of the fund of hedge funds from a party who is independent from the fund of hedge funds and the Hedge Fund FSP and annually from the auditors of the fund of hedge funds. 4. The assets of the fund of hedge funds structured as an en commandite partnership, trust or company must be held in the name of the fund of hedge funds - (a) in a segregated depository account through a participant in a central securities depository as defined in the Securities Services Act, 2004; (b) with an approved nominee; (c) with an authorised user as defined in the Securities Services Act, 2004; (d) with a bank registered under the Banks Act, 1990; (e) with a custodian with independent fiduciary oversight, or (f) in the case of assets incapable of being held as set out in to ensure the safekeeping of the assets and to verify transfers and ownership of assets of the hedge fund; 5. The requirements as contemplated in conditions 7, 9.2, 10 and X (risk management) of these Conditions shall apply to a

20 12. Transitional provision A funds investing in a hedge fund must comply with this Notice by November fund of hedge funds. Please refer to the comments on the definition of hedge fund in respect of separately identifying the requirements for a fund of hedge funds. In paragraph 3.7 of its Explanatory Memorandum of the Final Regulation 28, National Treasury indicated that accessing hedge funds or private equity funds through a fund of funds structure provides a valuable extra layer of due diligence and built-in diversification. Consequently the allowance per fund of hedge funds and fund of private equity funds is 5 percent (compared to 2,5 percent for investment into individual funds). ASISA members therefore suggest that pension funds be required to obtain confirmation from the fund of hedge funds that it will consider the same factors in respect of the underlying hedge funds in the fund of hedge funds that a pension fund would consider in respect of a single hedge fund with the necessary adjustments. The proposal takes the different structures of a fund of hedge funds into account. Condition 6 should apply to the fund of hedge funds and not to all the underlying funds in the fund of hedge funds so as to avoid duplication. Each single hedge fund will verify the existence of the assets and a fund of hedge funds need not also require that this verification be performed. Due to the possibly illiquid nature of hedge funds it is suggested that the compliance date be extended to allow for unwinding of existing investments in hedge that do not meet these requirements. The extension will also ensure that any potential prejudice to members due to a forced realisation is tempered. The Registrar has previously indicated that a 6 month period implementation period will be provided when new Notices under Regulation 28 are published. ASISA members suggest that the transitional provision be amended to indicate that funds investing in a hedge fund must comply with this Notice 6 months from the date of the publication of the Notice. Agree with the principle but will be reconsidered Agree with 6 months implementation

21 13. Short title This Notice is called the Conditions for investment by pension funds in hedge funds and fund o