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The hedge fund industry in South Africa has grown significantly over the last few years

Hedge fund schemes as such are not formally regulated, but collective investment schemes are regulated in terms of the Collective Investment Schemes Control Act 45 of 2002 (CISCA).

Therefore, if a hedge fund complies with the definition of a collective investment scheme, CISCA must be complied with, since no person may perform any act or enter into any agreement or transaction for the purpose of administering a collective investment scheme, unless such person is registered as a manager or is an authorised agent in terms of CISCA.

A collective investment scheme is a scheme, in whatever form, including an open-ended investment company, in pursuance of which members of the public are invited or permitted to invest money or other assets in a portfolio, and in terms of which two or more investors contribute money or other assets to and hold a participatory interest in a portfolio of the scheme through shares, units or any other form of participatory interest; and the investors share the risk and the benefit of investment in proportion to their participatory interest in a portfolio of a scheme or on any other basis determined in the deed.

Foreign collective investment schemes carried on outside, but promoted in South Africa have to be approved in terms of section 65 of CISCA.

The conditions for such approval have been set out in Notice 2076 of 2003.

The approach of the Financial Services Board ('FSB') has been to ensure that there is parity of regulatory standard between the foreign regulatory environment and South Africa, and that the products offered are of a similar structure and risk profile to those offered by a South African collective investment scheme.

The FSB is a regulatory body established by statute to oversee the South African non-banking financial services industry.

Nevertheless, hedge funds are routinely structured in such a way that they are not regulated by CISCA, and to this end, trusts, partnerships and companies have been established to provide investors with investment products.

In 2007, the FSB introduced regulations in terms of the Financial Advisory and Intermediary Services Act 37 of 2002, to govern the conduct and registration of managers and persons providing intermediary services to hedge funds and fund of hedge funds.

These were introduced to protect investors and to require various disclosures from financial services providers (FSP's), so that investors are better informed.

In the Notice on Codes of Conduct for Administrative and Discretionary FSP's Amendment Notice, 2007 (Board Notice 89 of 2007 published in GG No 30228 of 29 August 2007) various definitions were introduced.

The purpose of the definitions was to clarify the position of the hedge fund FSP and not to regulate the products.

Briefly, a hedge fund FSP is a financial services provider that renders intermediary services of a discretionary nature in relation to a particular hedge fund or fund of hedge funds.

A 'hedge fund' is defined as a portfolio which uses any strategy or takes any position which could result in the portfolio incurring losses greater than its aggregate market value at any point in time, and which strategies or positions include but are not limited to leverage or net short positions.

A 'fund of hedge funds' is defined as a portfolio that, apart from assets in liquid form, consists of an interest, holding or investment in one or more other hedge funds.

The hedge fund FSP must act in accordance with the prescribed Codes of Conduct.

The relevant requirements for discretionary FSP's apply to hedge fund FSP's and their clients, subject to necessary changes.

Hedge fund FSP's must, before rendering any intermediary services to a client, provide a written disclosure to the client of the applicability of the requirements for discretionary FSP's to their relationship, and in a prescribed format, on risks involved in hedge funds.

This prescribed format has not yet been made available, and may include cautions that the valuation of unlisted securities is more difficult to calculate than the valuation of listed securities and that where leverage is employed, it may amplify a fund's volatility. 

The hedge fund FSP must also obtain a written confirmation from the client of receipt of such written disclosures.

Before rendering any intermediary service, the hedge fund FSP must obtain a signed mandate from the client, containing certain provisions, as prescribed for discretionary FSP's, and which apply with the necessary changes.

An additional signed mandate must be obtained, confirming the existence and content of the first mandate, and in particular the utilization of a hedge fund portfolio for purposes of executing the intermediary services required by the client.

It must also contain an express confirmation by the client that the client approves of the investment objectives, guidelines, trading philosophy, and the utilization of strategies or positions (including leverage and/or net short positions, borrowing limits and risk management principles to be applied to mitigate interest rate, liquidity, and credit and derivative risk), risk profile and risk management (for instance a sensitivity analysis), as disclosed and stated in the mandate.

The mandate must also contain an express confirmation by the client that the client takes note of the FSP's affirmation that the establishment of the relevant portfolio does not conflict with any law, and that the operation and management thereof continuously comply with any law that may be applicable.

The FSB also issued a Determination of Fit and Proper Requirements for Financial Services Providers Amendment Determination, 2006 (see Board Notice 87 of 2007 in GG No 30228 of 29 August 2007) which comes into operation on 29 April 2008 ('the Determination').

The Determination establishes a Category IIA FSP, which includes all persons who require licenses as hedge fund FSP's.

In order to obtain a Category IIA license, an applicant must have a track-record of managing particular hedge fund strategies, and be able to adequately demonstrate knowledge, skill and competency in managing all instruments and asset classes comprising a hedge fund portfolio as optimized by and in conjunction with the requisite hedge fund strategies employed from time to time.

The applicant will also be required to have achieved certain minimum academic standard, qualifications or professional status as may be applicable.

After licensing, applicant may also be subject to further conditions or restrictions in respect of the required qualifications.

The FSB also issued a Determination of Forms of Application for Authorisation as Financial Services Providers, 2003 (see Board Notice 88 of 2007 in GG No 30228 of 29 August 2007).

This prescribes the forms which must be completed by an applicant for a license as a hedge fund FSP and be submitted to the FSB.

Hedge fund managers are advised to complete their applications as soon as possible.

Note that in terms of section 36 of FAIS, any person who acts as an FSP, while not licensed do so, or  who carries on business by rendering financial services to clients for or on behalf of any person who is not authorised as an FSP; or in any application, deliberately makes a misleading, false or deceptive statement, or conceals any material fact, is guilty of an offence and is on conviction liable to a fine not exceeding R1 000 000 or to imprisonment for a period not exceeding 10 years, or to both such fine and such imprisonment.

Ina Meiring is a Director at Werksmans Advisory Services