Financial Times Guide to Investing in Funds

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Compliance

any financial business and its customers. Regulations provide a structure

that managers can conform to. In effect regulations provide a free guide

on how to run a financial services business. Where regulation is prin-

ciples based and not prescriptive, as in the UK, it is unfortunately not

adhered to enough as we shall see below.

To understand funds, investors must look at the regulatory envi-

ronment of both the fund and the manager, as well as the advisor

where there is one. An offshore fund tends to have little regulation

to comply with, especially in the traditional fund jurisdictions such

as the Cayman Islands. In comparison, the manager (or the advisor)

is normally in a jurisdiction with higher regulatory standards and

therefore needs to implement and follow procedures and report to the

regulator accordingly.

Compliance is important therefore on many levels including the fact

that a breach of certain rules could lead to a ban from the regulator.

This could leave your money without a manager, which would create

an immediate operational risk even in the context of an orderly liq-

uidation. So let me explain where I think you need to start with

compliance, what insights it can give you with little investigative

effort, and what to conclude about the various managers you might

come across in relation to their approach to compliance.

Compliance status

There are as many regulators as there are countries, at least in the

developed world. This does not make anything uniform and is not

easy for investors to follow. However, since regulation is largely a

matter of good business practice and common sense, the spirit of com-

pliance flows from state to state. Note that despite the harmonised

approach to regulation in the EU, European directives continue to be

implemented by each country as it sees fit, occasionally leading to

material differences.

Overall though you can work with the principles of good compliance

and it is lucky that there are only a few countries that host the major-

ity of funds and managers. Most commonly, regulated managers or

advisors are found in the following countries:

Compliance status 159

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France (regulatory authority: Autorité des Marchés Financières

(AMF));

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Luxembourg (regulatory authority: Commission de Surveillance du

Secteur Financier (CSSF));

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Switzerland (several independent regulators, including the Swiss

Financial Market Supervisory Authority (FINMA));

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UK (regulatory authority: Financial Services Authority (FSA));

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US (several independent regulators, including the Securities and

Exchange Commission (SEC), Financial Industry Regulatory

Authority (FINRA), National Futures Association (NFA) or the

Commodity Futures Trading Commission (CFTC)).

Note also that there are no hedge funds in the UK, only regulated

funds (although that may be in the process of changing), and that

in the US until recently most managers did not have to be regulated.

Therefore, when you are told of a hedge fund in the UK, that is simply

a misnomer and such funds do not exist. It is the manager or the advi-

sor that is regulated and that is in the UK. The fund’s relationship

to the manager as we saw before is one of delegation of responsibili-

ties notably in relation to asset management. I say this at the risk of

sounding obvious, because if you are going to find out about a regu-

lated company you need to know which one you are looking for.

You should consider the jurisdiction of the manager therefore and

whether the laws in that country require the manager to be authorised

and regulated. This is the case for the UK, as we have noted, but not

necessarily for Switzerland where regulation, other than anti-money

laundering provisions, generally only applies to managers that are

involved in managing Swiss domiciled funds.

In the US it is not always easy for foreigners to understand which

manager should be registered with which authority: for example, if a

manager offers and sells foreign futures contracts to customers located

in the US, then the manager must either register or apply for an

exemption to registration. However, for your purposes as an investor,

you should note that if a fund is trading futures its manager should be

registered with the NFA and CFTC (unless it qualifies for an exemp-

tion). So, it might be worth your time verifying any registration with