Hedge funds revise valuation policies

(April 2007) New mutual fund registration procedures will have an impact on hedge funds in Canada, says one expert. At the same time, an international industry body is promoting new valuation rules to deal with a rising phenomenon: illiquid investments.

The Canadian chapter of the Alternative Investment Management Association organized a workshop this week for the industry, regulators and the media to discuss these topics.

London-based AIMA released revised guidelines for valuing securities last week. Less than 23% of all hedge fund assets are hard to value, says Chris Pitts, a partner at PriceWaterhouseCoopers.

The guidelines cover four broad areas. Governing bodies for funds should have a valuation policy document that clarifies the role of the body, the investment manager and the valuation service provider. It should specify who is calculating the net asset value, whether the manager has a role in valuations, and what third-party sources are used. Prices should be based on a primary as well as a secondary source.

This can be crucial in valuing investments such as convertible securities. Since they are infrequently traded, there can be a wide spread between the bid and the ask price.

The new recommendation concerns side-pockets. This is a holding where illiquid investments are segregated until their value can be realized.

They pose a problem for investors because redeeming investors may not participate in the value realization while incoming subscribers may be getting exposure at a discount. Hence, AIMA recommends clearly communicating side-pocket policy to all investors.

The Canadian Securities Administrators registration reform project, National Instrument 31-103, will also impact Canadian hedge funds, says Michael Burns, AIMA Canada’s legal counsel and a partner at McMillan Binch Mendelsohn.

Among the key provisions are that companies that offer hedge funds will have to be registered. Investment advisors are already required to be registered. While the CSA doesn’t define “investment fund manager,” it is clear from other securities regulations that it refers to those who direct the business operations of a fund.

Hedge funds are frequently organized as limited partnerships. Burns says the new rule doesn’t make clear whether a series of limited partnerships that operate as one fund will have to have the same general partner registered multiple times.

Hedge funds have often been offered through limited market dealers in Ontario. The new national instrument extends this category across the country as an exempt market dealer. Exempt market dealers will also have to meet “fit and proper” proficiency requirements, generally by passing an exam.

Burns also wonders if a new capital requirement, a minimum of $100,000, will be a barrier for budding hedge fund managers.

Filed by Scot Blythe, Advisor.ca, scot.blythe@advisor.rogers.com.

(04/02/07)