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With an increasing number of hedge-fund like investment strategies being launched under the auspices of the EU UCITS directive, concerns are growing over whether the sector now needs tougher regulation.
According to research from PricewaterhouseCoopers (PwC), over 200UCITS hedge funds have now been launched in Europe with many more are in the pipeline, and the accountancy firm says that as the trend towards these so-called ‘newcits’ continues to grow, tighter regulation is needed both to protect retail investors and the UCITS brand.
UCITS are a set of EU directives that aim to allow collective investment schemes to operate freely across the EU, having received authorisation in just one member state.
Why Newcits trend has taken off
As PwC explains, part of the reason why the Newcits trend has taken off is because of the safeguards the EU UCITS regulatory framework provides, given that the financial crisis has undermined many investors’ faith in straightforward equity investing.
European fund managers are currently bringing a great deal of product innovation to the UCITS arena, PwC notes in its latest research paper on the subject, which also brings with it new complexity to a universe historically dominated by traditional funds and primarily intended for retail investors. This has created contradictions to the UCITS principles and therefore, poses challenges to the regulatory rules that govern the industry.
“I believe that the rules are strong enough and flexible enough to cope with this innovation. As ever, however, the hedge funds are pushing at the boundaries of gaining exposure to asset classes that you would not normally be able to gain exposure to in UCITS,” observed Grellan O’Kelly, Senior Regulator with responsibility for the Derivatives and Risk Management Policy Group at the Irish Financial Services Regulatory Authority, who is quoted within the paper.
The PwC paper notes that as the Newcits universe grows, so does concern that innovative strategies may create investor protection issues, and tarnishing of a well-developed brand.
Regulators must strike right balance
“Many European hedge fund managers are increasingly seeking to launch their own Newcits. Such funds involve a high degree of responsibility of ensuring the product launched is fit for purpose. It is now more important than ever that regulators strike the right balance between developing UCITS funds and anticipating any potential threats to retail investors,” said Olwyn Alexander, Head of Alternatives, PwC Ireland.
“There are many strategies that fit very neatly into the UCITS framework such as long / short equity or absolute return type strategies. It is great to see such products being offered to the retail investor to allow for better protection in falling markets and diversification. However, if some managers push at the boundaries too hard, there will undoubtedly be a reaction from regulators, which could act as a trigger for UCITS V,” she added.
“Hedge-fund managers should be aware that this is a fragile and formative period, in which the regulators are setting rules that will govern the sector for many years to come. Consequently, where there is flexibility it is vital that managers be seen to act within the spirit of the rules,” cautioned Robert Mellor, UK financial services tax leader, PwC.
Read the PwC report on Newcits in full