Hedge funds were regulated for the first time in South Africa in 2015 under the Collective Investment Schemes Control Act 45 of 2002 (“CISCA”). Prior to this, it was the hedge fund investment managers who were regulated under the Financial Advisory and Intermediary Services Act 37 of 2002 (“FAIS”). The regulation of hedge funds brought the hedge fund FSPs into the regulated environment of CISCA.
Many hoped that the regulation of hedge funds would see a flow of new assets into the industry but unfortunately this is not what has transpired. The regulatory burden has also been onerous and costly for many without the compensation of additional asset flows. This has also been compounded by the reluctance of the Financial Services Board (“FSB”) to relax certain provisions that were in place to protect investors prior to the regulation of hedge funds.
The separate category IIA FSP licence under FAIS for hedge fund financial services providers (“FSPs”) was implemented to regulate hedge fund FSPs when hedge funds were not regulated. But arguably the need for this separate licence category has fallen away with the regulation of hedge funds. In the draft proposed amendments to the determination of fit and proper requirements for FSPs (2016), the FSB chose to retain the category IIA FSP licence and all of the additional requirements that apply to hedge fund FSPs. Thus, despite hedge funds being regulated under CISCA, the FSB has kept previous restrictions that applied to a hedge fund FSP before hedge funds were regulated. These requirements include additional capital adequacy restrictions and marketing disclosures that apply to hedge fund FSPs only and not to other asset managers.
This approach appears to ignore the shift in responsibility to the end investor from the hedge fund FSP under FAIS to the management company (or “Manco”) under CISCA. It is the Manco and the custodian of the hedge fund scheme who are now ultimately responsible to the investor. This approach by the FSB could also be viewed as applying double regulation to the hedge fund industry by regulating both the hedge fund FSP with extraordinary requirements and also regulating the hedge fund product. This is an inconsistent approach with every other financial product in FAIS and serves to create the perception that a hedge fund is an extremely risky investment product.
The FSB should therefore add a sub-category for hedge funds under FAIS category II licence and scrap the category IIA FSP licence for hedge funds only. This should be as a matter of priority to close the regulatory inconsistencies that have arisen as a result of retaining the category IIA FSP licence. This is also particularly necessary in light of the impending further layer of regulatory oversight that will be added to the financial services industry including hedge funds. There needs to be a fine balance in the regulatory regime between protecting the investor and encouraging the growth and sustainable development of the hedge fund industry.