January 12, 2007 by Canadian Underwriter
Canadian Securities Administrators (CSA) will be requiring the registration of hedge fund managers and will also be looking to improve referral arrangements to hedge funds and the distribution and sale of Principle Protected Notes (PPNs).
Its proposals are a result of the regulators’ review of hedge funds in Canada, which began in early 2005 and continued into 2006. Details of the review are available on the Ontario Securities Exchange Web site at:
“We concluded that our regime contains an appropriate securities regulatory framework for hedge funds, but that certain areas within it could be improved,” CSA concluded in its Staff Notice 81-316, posted on the OSC Web site.
Foremost among its recommendations, CSA called for the registration of hedge fund managers.
“Currently, fund managers need not be registered unless they are also managing portfolio assets, in which case they must be registered as advisers,” CSA noted in a press release. “However, recognizing the role fund managers play in establishing, promoting and running investment funds and providing or overseeing a broad range of services (including fund valuation and registrar and transfer agency activities), the CSA is proposing to require the registration of fund managers, including hedge funds, through the Registration Reform Project.”
The registration requirements for fund managers would focus on ensuring that managers have the resources to carry out their functions, manage their conflicts of interest, have adequate capital and insurance to provide protection for investors, and have “sufficient proficiency and integrity to carry out their functions.”
CSA also raised a number of concerns about PPNs, which will undergo a further review.
Basically, PPNs are financial products that combine key investment characteristics of both stocks and bonds. Like a bond, investors receive on maturity the full value of the bond plus payments over the term of the bond. But in PPNs, the amount of interest paid over the principal may be linked not only to stocks or equity indices, but also mutual funds, interest rates, commodities and sometimes even currencies or bonds.
Among its concerns, regulators said PPNs “give retail investors access to alternative asset classes that are not usually available to retail investors without a prospectus, and that carry different risks.” Also, the CSA noted: “Investors may not be getting sufficient disclosure about the PPN (for example, on the structure, fees and risks) to make an informed investment decision.”
CSA also identified risks with referrals to hedge funds. “One of the risks is that the roles and responsibilities of the different registrants involved in the referral, including who must disclose the arrangement to the client, may not always be clearly established,” the CSA said. “Another risk is that registrants will refer clients to someone selling hedge funds or products linked to hedge funds simply because of the fees the registrants will receive, without considering whether the referral is in the best interests of their clients.”