Today’s Top 5 Compliance Issues For Hedge Funds

By Martin Herriot, Managing Director at Newgate Compliance


It has been a challenging few years for the European hedge fund industry following the financial crisis and the European regulators attempts to revolutionise the regulatory regime for supervising the industry. From a UK compliance perspective we see the top issues falling under two headings – the AIFMD and thematic scrutiny. These are the issues affecting the industry and causing the most angst amongst our clients:


Alternative Investment Fund Managers Directive


No comment on the European Hedge Fund industry would be complete without mentioning the effort which firms have had to expend in order to get ready for the implementation of the AIFMD. The time to file the application to become an AIFM has been and gone.  Firms by now have provided a combination of self-certification, narrative and commentary to demonstrate to the regulator how they are to comply with the onerous requirements of the AIFMD. Now that the AIFMD has been transposed into law in each EEA state the hard work begins as AIFMs have to implement on a practical basis the requirements of the directive with no previous precedents to rely on.  Particular challenges will be:


Proportionate segregation: firms will have set out to the FCA how they intend to structure themselves internally to demonstrate they meet the requirements, on a proportionate basis, to operate their risk, valuation and compliance functions with sufficient independence away from the portfolio management function to mitigate conflicts of interest. Particular challenges will present themselves where the Chief Investment Officer is also a majority owner of the business. The non-trading functions will have to demonstrate that they are able to perform their roles with sufficient authority and get their voices heard at the highest level. Certainly in the UK, the FCA will expect that minutes of key governing committees show that challenge from all areas of the business is occurring and that dominance of one individual, or group of individuals, does not lead to failings in standards, governance and culture in firms.


AIFMD Reporting: Firms will need to ensure readiness for the complexities around the how, where, what and when of the AIFMD reporting regime. The reporting template is large with complex data required from a potentially large range of sources. It is unclear whether all firms subject to reporting obligations have truly got their heads around the full nature of the requirements in order to submit their first reports. If AIFMs are relying on fund service providers to compile reports then they should make sure that arrangements are in place and the costs agreed.


Marketing: From the date of authorisation EEA managers will have a passport to distribute EEA AIFs across all EEA member states. Subject to certain conditions managers of non-EEA funds can sell via National Private Placement Rules (NPPR) or on a reverse solicitation basis. Challenges are faced by managers of Non-EEA funds on how to actually go about marketing under the various NPPRs and the risk that such avenues may be closed off or made more restrictive over time. Indeed, many managers may have opted in their application to say they do not intend to market in the EEA for the foreseeable future and rely on reverse solicitation. There is, however, uncertainty as to what this means in practice and therefore there is a risk of a firm inadvertently breaching marketing restrictions.


Thematic Scrutiny


Whist the European regulators will all doubtless be keeping an eye of the implementation of the AIFMD in their territories each member state will also have their own supervisory priorities.  From a UK perspective whilst the FCA is keen to ensure an orderly implementation of the AIFMD in the UK it has also made it clear to the hedge fund industry that it has other key priorities which it will scrutinise as per its business plan for the year. Challenges for UK managers will be to demonstrate that systems and controls are in place cover the key areas of interest as follows:


Conflicts of interest management: Focus will continue to be placed on how hedge funds managers manage potential conflicts between their interests and those of their clients and ensuring that firms act as good agents on behalf of clients. The FCA will continue to look at dealing commission arrangements that firms have in place to ensure only eligible goods and services relating to research and execution are being paid for. MiFID II is likely to introduce a restriction for firms to receive only ‘minor non-monetary benefits’ from third parties linked to their services to clients which will continue to keep commission sharing arrangements in the spotlight.


Market Abuse controls: The FCA continues to take enforcement action against firms whose behaviour does not comply with the code of market conduct. Firms need to monitor publications from the regulator in relation to these issues and carry out regular reviews of their systems and controls to ensure compliance market conduct regulations.



Newgate Compliance Limited is a consultancy specialising in regulatory and governance issues for the asset manager, investment advisory and broking sectors. It services the compliance and governance requirements of alternative investment fund managers with assets under management currently ranging from £1 million to £18 billion. Its three directors boast over 30 years of experience at the UK regulator.