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Hedgeweek Commentary: Behind the hedge fund news

Hard cases make bad law, the saying goes, and critics of the Financial Services Authority say the UK regulator is responding disproportionately to

Hard cases make bad law, the saying goes, and critics of the Financial Services Authority say the UK regulator is responding disproportionately to tricky market conditions in imposing new rules that increase transparency for various techniques and instruments used by hedge funds as well as other investors. Following the requirement last month that significant short positions in companies launching rights issues must be made public, the FSA has now announced that from next year contracts for difference will be included in the disclosure requirements for long positions.

Too much regulation can spoil the broth

Yesterday saw another new rule announced by the Financial Services Authority but, in contrast to its earlier clampdown on short selling, this time the UK financial watchdog has done a full consultation. In its second new rule announced in a month, the FSA has said that long positions that use contracts for difference must be included and made public when aggregate holdings reach 3 per cent or more.

The regulator will produce a policy statement in September and draft rules to implement the new position. It will accept technical comments on the rules to ensure they are workable and the final rules will be issued in February next year.

Last month the FSA issued new rules under which, at barely a week’s notice, hedge funds and other investors were required to reveal their positions when shorting the stock of companies that are in the process of raising capital through rights issues. The rule was imposed by the following accusations that speculative investors were responsible for the fall in share prices of several banks that had launched rights issues.

Now it’s the turn of long positions. CfDs can at present be used to build stakes and voting rights at companies without the disclosure that is required for direct shareholdings, allowing investors to build large positions anonymously. These instruments account for about 30 per cent of electronic trading on the London Stock Exchange.

Andrew Baker, deputy chief executive of the Alternative Investment Management Association, believes lighter regulation of CfDs is warranted. He says: "The FSA states that it found no compelling evidence of market failure in respect of inefficient price formation caused by a lack of transparency due to use of CFDs, and that excessive disclosure can cause market inefficiencies."

One consultant says: "[The new rules] make London a less attractive financial market. It gives hedge funds another reason to move to Geneva." Is this a case of unsystematically implementing regulatory measures when times are bad?

TCI and fellow activists may win through in Japan after all

Faced with sluggish growth and a backlash abroad against restrictive practices in its financial markets, Japan has set out plans to revitalise itself as a global financial centre. The world’s second-largest economy is desperate for foreign investment and is especially keen to woo hedge funds, which have been fleeing to centres such as Singapore to escape operating constraints and uncongenial tax rules.

Last week, the London-based Children’s Investment Fund saw all five of its proposals, including higher dividends and more outside directors, rejected by the annual general meeting of Tokyo-based electricity wholesaler J-Power, two months after the Japanese government blocked a bid by TCI, already the company’s largest shareholder, to double its stake in the firm, to 20 per cent.

The government took advantage of a new law that allows it to block foreign investment in sectors considered vital to national security, prompting EU trade commissioner Peter Mandelson to describe Japan as "the most closed investment market in the developed world."

Activist funds such as TCI and Steel Partners, a US hedge fund manager that has been campaigning for change at Japanese wig maker Aderans, have been pushing hard for higher returns and greater shareholder rights in Japan, but largely in vain up to now.

Now Takafumi Sato, head of Japan’s Financial Services Agency, the industry regulator, has insisted that Japan is not closed to foreign investors, including those campaigning for corporate change. At the Reuters Japan Investment Summit this week, Sato expressed support for the Tokyo Stock Exchange’s push to protect minority shareholders through rules on new share issues.

Japan has recently also amended its tax code to allow hedge funds to avoid dual taxation, allowing offshore funds run by Tokyo-based managers to avoid being classified as having a permanent establishment in Japan.

Perhaps the best news of all, Steel Partners, which in May helped to unseat president Takayoshi Okamoto and most of the Aderans board, has won a seat on the company’s board for its managing director Joshua Schechter. Clearly the cause is not lost.

Better times ahead

Sovereign wealth funds are increasingly seeking out investment opportunities with UK hedge funds, a trend that might signal better times ahead for the sector. According to the latest survey of administrators by Hedge Fund Manager Week, much of the fresh investment coming into the hedge fund sector, which now represents a total of USD2.9trn in single-manager fund assets, is coming from these state investment vehicles.

The survey says that much of their investment is being made through funds of hedge funds, whose assets have grown to USD1.4trn following a 10 per cent increase in the six months to the end of April, compared with 9 per cent for single-manager funds.

The sovereign wealth funds are said to be allocating more capital to alternative investments as they seek to maximise their investment returns on capital, and to have targeted an increase in their allocations to alternatives from 1 to 10 per cent.

Sovereign wealth funds have played an important rile in shoring up the capital base of leading US and European financial institutions over the past few months. Last week Barclays announced that the Singapore government investment corporation Temasek and China Development Bank would increase their investment in the bank, alongside fresh funds from Qatar’s royal family.

The increased interest in hedge fund investment by these state-run investment funds may be an indication of a brighter outlook for hedge funds, given the prestige of an endorsement by a sovereign investor.

Short selling of a different kind?

Last week, new rules from the UK’s Financial Services Authority came into force under which hedge funds and other investors must reveal their positions when shorting firms that are in the process of raising capital through rights issues. This rule was imposed by the FSA at short notice after hedge funds and other speculative investors were accused of being responsible for the fall in share prices of several banks that had launched rights issues.

But although hedge funds were forced to show their hand, there seemed to be limited impact on the share price of companies such as HBOS and Bradford & Bingley that were raising capital. In fact, their shares plunged further causing further worry for shareholders and underwriters.

Now it transpires that the GBP4.5bn capital increase launched by Barclays will be backed by several of the largest hedge fund managers in London and elsewhere. GLG Partners, Lansdowne Partners, CQS and Och-Ziff have all agreed to take up a sizable portion of Barclays shares as part of its GBP 1.7bn placing with institutional shareholders, according to the prospectus issued by the bank.

According to the Financial Times, some bankers believe that the hedge funds’ investment may have been undertaken as a way of covering short positions in Barclays. However, since the bank’s placing is not covered by the FSA rules on rights issues, the extent of short selling in Barclays is not known. What will the regulator do next?

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