Spanish hedge funds await rules

Regulation governing Spain's hedge fund market is set to be finalised this month, following more than a year of uncertainty. The rules, expected to be approved by the Spanish parliament within the next few weeks, will provide a massive boost to the country's hedge fund industry, say market participants.

The finalisation of the rules follows the publication by the Spanish Treasury of draft regulation on Spanish collective investment institutions (CII) on July 18, itself a revision of the first draft on CII of October 2004. The 2004 draft was the first attempt at regulating the hedge fund sector in Spain, but some of the basic requirements stipulated within the rules were considered by many in the industry to be over-rigorous. For example, net asset value (NAV) had to be calculated daily and investing in offshore hedge funds was impossible.

The July 18 draft, which is not expected to undergo drastic change while it passes through Spain's Council of Ministers, takes on board some of the industry's demands. For instance, funds have to provide only quarterly rather than daily NAV, while a minimum investment of €50,000 is required for single-manager funds, replacing a previous restriction that only institutional investors could invest in hedge funds. The new draft also allows the marketing of hedge fund investments to qualified investors. And there is no restriction on assets, including credit derivatives, or on derivatives leverage.

The only requirement is that funds have an investment policy in place that follows principles of liquidity, diversification and transparency. Fund managers are also required to implement risk management systems and perform regular simulations or stress tests to evaluate the effects of adverse market developments.

Welcome

Market participants generally welcome the new draft. However, one lawyer at a Madrid-based law firm says a few key areas still require clarification. These include the scope of prime brokerage agreements that Spanish hedge funds can enter into; the eligibility for investment by Spanish multi-manager funds; and the requirements that will be imposed on the Spanish management companies that intend to manage alternative investment products.

But Pedro Rapallo, a director at Mercer Oliver Wyman in Madrid, says there are other, non-regulatory factors that explain the slow development of a hedge fund market in Spain so far. For example, Spain has until recently been poorer than other large countries in the European Union, with fewer high-net-worth individuals who might consider investing in hedge funds.

"The financial culture of retail investors in Spain is also a lot more conservative than in other European countries," explains Rapallo. "People often don't have a good knowledge of the products being sold to them and tend to want to protect their capital. In recent years, the dominant alternative investment for Spaniards has been property, exacerbated by the equity bear market of 1999–2003."

Nonetheless, Rapallo welcomes the move, which he believes can only help nurture the market. "Hedge funds in Spain are in their infancy compared with other European countries and the US. So far, hedge fund-like trading activity has been restricted to internal proprietary desk operations within the largest institutions, such as Banco Bilbao Vizcaya Argentaria and Banco Santander Central Hispano. But with the property market slowing down significantly, this could be a good opportunity for investors who had never considered hedge funds. In the end, though, cultural factors remain strong in Spain."