Quarterly Newsletter – Q1 2009
Posted on 11 Apr 2009
Laven Partners Operational Due Diligence Services
As the G20 closes the Financial Times reported that a new regulatory regime had been promoted by the EU Commission which would seek to have more disclosures from investing parties, including hedge funds, and that this disclosure would be expected from the regulated managers in the EU. Laven Partners strongly supports this position and would again reiterate that all the regulation in the world will come to nothing if it is not also monitored and enforced.
Further, over time the real use of a new regulatory system will become apparent only if it strengthens investors’ confidence in a system that has previously failed them. Such confidence will also come from specialists who can advise their clients on how to select investments with an understanding of all the forms of risks that pertain to such decisions.
Investigative Due Diligence
Laven Partners has always argued for a different approach to investments’ selection, notably in the alternative sector where there is no common ground between most managers and their strategy. Our unique form of investigative due diligence has helped uncover many weaknesses with certain managers who then ended up failing a few years later. We are proud of what we have achieved and it deserves further explanation.
A Unique and Broad Coverage
The reason why our Independent Process of Operational Due Diligence (IPODD) is unique is because our view of operational risk is not simply limited to checking the accounts of the fund or checking the degree of front office, middle office and back office reliability in a management company. Our coverage is much broader and we aim to include risk management and actual compliance controls, including those that pertain to good corporate governance. We believe this is the best way to catch any weaknesses and make our clients aware of the risk they buy into. The IPODD has helped our clients avoid pitfalls or reduce their allocation in line with the new uncovered operational risks. Our unique approach is backed up by a robust system that checks and cross checks all forms of information discovered through the investigative process. These are then compared to statistical data analysis to determine any changes in strategy or inconsistencies as well as for further corroboration of any information shared with us, so that in effect any misrepresentations or inconsistencies can, as much as possible, be picked up and reported upon.
Strictly Independent of Managers
Above all, we have always opposed being paid by anyone but the investor, insisting on a proper degree of independence even if this means that the costs of investments will suffer some due diligence costs. This means that we do not seek to certify managers but only to report on their organisations and work. As the last few months have proven, useful advice on operational risks actually helps generate profits by avoiding losses otherwise incurred when investing with unreliable managers and suffering the consequences in terms of loss of clients and reputational risks. As we recently said in the Economist, we believe that to date there has been a degree of complacency and laxness about how people choose investments.
The first quarter of 2009 was dominated by news on the busted Bernard Madoff which has further contributed to the global misconception that hedge funds are the root of all evil and that more regulations are needed to control hedge funds. Managing Director of Laven Partners, Jerome Lussan, appeared on Bloomberg TV in relation to the Madoff scandal discussing the changes that could be made in the industry as a result of the scandal. To watch the interview, follow the links below:
G20 gang up against hedge funds
In February French Finance Minister Christine Lagarde called for tighter regulations of hedge funds and higher capital requirements for banks with ‘risky’ hedge fund clients. Lagarde, who presented her plans to the G7 finance ministers, would like the EU to exert more control over hedge funds via prime brokers.
Laven Partners commented in the media:
“The financial crisis started with the banks and while we acknowledge the need to look at the financial industry in its entirety, new regulations for hedge funds are not the answer. There are also plenty of internal hedge fund/proprietary trading activities in banks which appear to be ignored by the new proposals. There are a large number of hedge funds regulated by the Autorité des Marchés Financiers (AMF) in France and hedge fund management companies regulated by the FSA in the UK. Regulation can and will work well where it is applied. In the EU there is a strong regulatory framework, but it needs to be applied with more diligence and greater effort.”
“Rather than introduce new rules, governments need to ensure better understanding of and implementation of existing regulations. They should use whatever budgets are available to call for more internal and external audits of compliance rather than put tax payers’ money into more legislation. There are one or two simple solutions, notably better enforcement, which will help clean up all abusive practices, whether in banks or hedge funds. This would increase confidence rather than simply create more legal and economic uncertainty for our financial systems.”
The regulatory framework for hedge funds is sufficient but regulators are failing to fully enforce it. Laven Partners comments on the recent AIMA initiative.
The Alternative Investment Management Association (AIMA) announced in February a new initiative to support the regulatory reporting of significant positions and risk exposures by hedge funds to national regulators. AIMA claims the initiative is a bid to pre-empt possible G20 measures aimed at imposing bank-like regulation of the sector.
Laven Partners comments:
“The reality is that the existing regulatory framework is broadly sufficient if only it were properly enforced. Compliance and operational risks are misunderstood or not taken seriously by some financial institutions, and without proper enforcement regulators allow for reckless investment practices and potential fraud. To add new regulations may not help if the industry is not yet capable of dealing with existing regulations. The regulator needs to dedicate more resources to enforcement.
Of course, improvements can be made to the regulations. For example, we believe that banks, which act as prime brokers and know the positions of their hedge fund clients, should report significant short and long stock positions on an aggregate basis. This would give the regulator more control and prevent hedge funds from having to divulge individual positions, which could put them at a competitive disadvantage. We have also been campaigning for the industry to adopt a new standard valuation agreement to limit problems with pricing for certain strategies, which applies to all financial institutions, not just hedge funds. We are pushing for the FSA to better enforce its handbook in the UK, across all asset management companies and banks, for example by making annual external compliance audits compulsory. This would quickly help ensure stronger risk controls were put in place. If we want to come out of the crisis stronger we must evaluate our existing system and improve where relevant, but resist a knee jerk reaction to over regulate. The whole financial industry needs to cooperate to re-establish trust with investors, and there is no doubt that it will be rewarded for making the right efforts.”
Laven Partners holds breakfast meetings
Over February and March, Laven Partners held breakfast meetings in London, Geneva and Zurich, discussing operational due diligence. We helped our clients to achieve positive performance in 2008, advising them on their portfolio or through our Laven Funds SPC – Multi Strategy SPC and Laven Funds SPC – Global Systematic ST SPC.
In difficult market conditions the breakfast meetings were an opportunity to share our perspectives for 2009 and how we expect to continue delivering performance with decorrelated liquid strategies based on our risk driven, bottom up approach.
FSA introduces telephone recording rules
On 6 March 2009, the FSA’s new rules on recording telephone conversations and electronic communications came into force.
The rules were introduced as a preventative measure against market abuse. Although it is already common practice in many firms for telephone conversations to be recorded (particularly in relation to trade execution) it is important to understand the application of the new rules as from 6 March 2009, the FSA will be able to take disciplinary action against any firms not fully complying with the rules.
The rules are contained in the Conduct of Business Sourcebook of the FSA handbook at COBS 11.8. Authorised firms must record relevant telephone conversations and keep a copy of the relevant electronic communications. Firms are expected to record communications or conversations which cover specific activities and investments.
Where firms already recorded telephone lines prior to the rules, they should still need to review their existing arrangements to ensure that they comply with the new rules, notably in relationto record keeping.
If you require any further information or advice on the application of the rules please contact the compliance consultancy team at Laven Partners.
Lussan Ltd announces opening of Luxembourg office
Specialist investment law firm, Lussan Ltd, an affiliate of Laven Partners, continued its expansion in February with the opening of a representative office in Luxembourg.
Director Jerome de Lavenère Lussan says: “We have opened this office following increased interest from clients in setting up Luxembourg-based funds. We have seen a strong interest for UCITS III funds and the implementation of the Specialised Investment Fund (“SIF”) law in 2007 means that Luxembourg also offers the flexibility of an offshore centre such as the Cayman Islands with the benefit of the rigorous EU legal and regulatory framework.”
Alexandra Tzalla, a solicitor and avocat in Luxembourg with Lussan says: “We have been looking forward to this new expansion and have already received many enquiries from both existing and prospective clients. Our Luxembourg office will operate with both the help of local lawyers and our colleagues in London. This new addition will provide our clients a complete solution in the investment management industry.”
MLRO in the Cayman Islands
Firms in the Cayman Islands are required to appoint a Money Laundering Reporting Officer (the “MLRO”). The MLRO should be a senior member of staff carrying out a compliance, audit or legal role within the firm. Where a firm has no employees in the Cayman Islands, such as a fund, the firm may appoint someone else as the MLRO. The MLRO should receive any suspicious activity reports made by staff and reports them to the Cayman Islands Monetary Authority if the MLRO deems that the information contained in the report supports suspicion. Firms are also required to maintain registers of reports submitted to the Cayman Islands Monetary Authority.
Our Caribbean based company, Laven Financial Services, which offers compliance and management support services can assist you with any further queries. Our corporate services provide companies with access to highly experienced directors that have been specially selected on their extensive experience, skills, reputation and according to our strict criteria. Our expertise stems from extensive knowledge of reviewing funds and management companies from a regulatory and legal point of view. Please speak to your contact at Laven Partners for further information.