Retail participation in hedge funds: assessing South African hedge fund regulation
Abstract
Hedge funds have been regulated more closely since the financial crisis of 2007-2009. This crisis prompted emotive debates amongst financial industry representatives, lawmakers and regulators to identify and evaluate gaps in the international financial architecture. Hedge funds, as an alternative type of investment, function within a highly complex financial system and through intricate investment strategies that require due oversight. The financial crisis exposed regulatory fault lines which, amongst the major contributors, included hedge funds. Hedge funds did not necessarily cause the crisis, but they did contribute to the severity thereof. Self-regulation within markets was absent and contributed, together with other factors, to global efforts to progressively coordinate regulatory efforts. The regulation of this type of alternative investment thus became more comprehensive. The global investment industry is experiencing a movement towards retailisation, which is not a recent trend. Non-qualified investors or retail investors invest in hedge funds as one of the investment structures available within the range of alternative investment opportunities. The protection of retail investors is a major element of financial regulation and needs to be affirmed, re-affirmed and re-visited. Continued assessment is required to ensure safeguarding within the dynamic, constantly changing and increasingly intricate global financial market system and complex investment landscape. In the latter half of 2015, hedge funds were designated as Collective Investment Schemes in South Africa. This study pursued the question of whether the enactment of legislative changes affecting hedge fund investment in South Africa measures up to international good practice. This interdisciplinary study more specifically aimed to assess whether retail investment in hedge funds in South Africa incorporates and adheres to international good practice in this regard. The re-search involved a comparative legal assessment of the global regulatory environment from an investor protection focus. Good practice regarding regulatory standards relevant to retail investment in hedge funds was identified from reports issued by the International Organisation of Securities Commissions (IOSCO), and an examination of the country jurisdictions with the most assets under management (the United States of America and United Kingdom) was conducted. As a political and economic union, the European Union's (EU) legislative provisions for hedge fund regulation influence all regions within the union and other major investment markets. There-fore, regulation regarding hedge funds in the EU was deemed important and included for the purposes of the study. From the good practices identified, a premise was established from which an assessment was performed of the regulatory landscape of retail hedge fund investment in South Africa and a benchmarking of local regulation to international good practice. Findings indicated that excessive regulation would disadvantage retail consumers. It removes flexibility and variety in the basket of available investment opportunities and services that are accessible in less regulated markets. Overregulation in one jurisdiction might lead to disinvestment from a tighter regulated market to less regulated ones resulting in regulatory arbitrage. On the other hand, underproduction or a lack of an effective regulatory framework exposes retail consumers to exploitation and would likely expose retail investors who find themselves in an alternative investment environment. Regulatory balance within a specific jurisdiction requires a sound approach and can be attained by combining the regulatory tools available in that jurisdiction, whether through direct or indirect measures. Economic circumstances must also be considered. For example, international best practice evolved from the integrated and sophisticated financial nature of the global financial architecture and, of course, risk. The current study endorses the structural reforms to the South African financial system, as well as the inclusion of hedge funds as collective investment schemes in accordance with the Collective Investment Schemes Control Act of 2002. This legal and regulatory framework provides a sound regulatory structure which measures up to international good practice on retail investor protection in hedge funds. The regulatory environment for hedge funds has seen a transference of assets into retail investor hedge funds, which can be ascribed to investor confidence growing as a result of this very same regulation. Unfortunately, risk cannot be removed entirely from in-vestments, and such risks are never stagnant. Thus, given the nature of hedge fund investment, South Africa's hedge fund regulatory framework requires continuous assessment. This should be done to determine the effect and impact of new direct regulation, and possible overregulation, which may turn out to become a barrier to growth within the market.