FSB raises concerns about South African hedge funds

In its efforts to licence the country's hedge fund managers, the South African Financial Services Board (FSB) has found problems with mandate compliance, levels of professional indemnity cover and the use of external business partners.

The moves to regulate managers are the FSB’s first attempt at getting to grips with the country’s fast-flowering hedge fund industry, which had previously been self regulating. To apply for the new licences, managers had to submit lengthy applications and accommodate on-site visits by the FSB, which lasted up to a day.

Wendy Hattingh, Pretoria-based head of supervision in the FSB’s financial advisory and intermediary services division, said conditions were placed on around 80% of the new licences granted by the FSB. These were related to specific shortfalls at various hedge fund providers, she explained, and some repeat problems that arose at several firms.

“Mandate compliance procedures were a concern. Some people had them, but only on a monthly basis, in a specific way that we were not satisfied with. We would like to see closer monitoring of mandate compliance on an ongoing basis,” she said.

Another common problem was a lack of sufficient professional indemnity cover, she added. The FSB has set the minimum level of cover at R5 million ($650,000).

Since the beginning of the licensing round in November 2007, the FSB has received 123 applications from hedge fund managers for the new licences. Of these, 104 have been awarded, while 19 are still under consideration – some of which are problematic, according to Hattingh.

The FSB’s findings will contribute to a new code of conduct for hedge fund managers – the "next step", remarked Hattingh. This is expected to be released for industry consultation in 2009.

The FSB is expected to tighten up procedures surrounding feedback from external business partners, such as administrators, risk managers and prime brokers. Such third parties play a heavy role in South Africa’s hedge fund market, with 78% of funds employing external administrators in June 2007, according to an annual industry survey by Cape Town-based fund of funds Novare Investments.

“What’s important from a market conduct point of view is to discover who’s taking responsibility for what. Normally if there is any problem with hedge funds, one party identifies an issue and it goes straight to the hedge fund manager. If it doesn't act properly on the information, there might be a serious problem or a failure,” said Hattingh. These concerns were addressed by the FSB in some of the conditions it placed on about 80% of licences, she added.

The FSB intended to complete the licensing programme by April this year, but time constraints meant it was forced to grant licences pre-emptively to some managers and conduct on-site visits afterwards. Most of the new applications were for upgrades to existing licences for financial services providers, according to the agency. Holders had to comply with more stringent criteria than for long-only managers, particularly in the fields of risk management and compliance.

South African hedge funds held a total of R25.89 billion ($3.35 billion) in assets under management in June last year, according to the Novare survey.

See also: Riding out the storm
A model of self-regulation
Giving clarity
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