Commentary

Asian Hedge Funds

1. Why are Asian hedge fund assets small relative to GDP and local savings rates?
Firstly, financial markets in Asia are less mature than their US or European equivalents. This results in a smaller range of securities and instruments that a hedge fund can access and utilize in the context of a hedge fund strategy. For example, access to borrow in the China A-share market is limited, cutting off a significant opportunity set/risk management tool for a large number of managers. While this type of exposure can be accessed elsewhere (i.e. H-shares, US-listed ADRs), the regulatory environment in the A-share market effectively limits the amount of AUM that China-focused L/S managers can optimally run in this space. Furthermore, credit markets in Asia are less developed than their US and European counterparts where CMBS, RMBS, ABS and corporate loans and bonds are all of significant breadth and depth. All in all, financial markets in Asia do not offer the same broad range of building blocks as peers in the US and Europe, restricting the range of hedge fund strategies that can be operated at meaningful size (more than $1bn).

Editor’s Letter - Issue 126

AIMA are fielding more member queries about MiFID II (unbundling, call taping, best execution etc.) than anything else, says Deputy CEO Jiri Krol, but there are other important items on the European regulatory agenda. To “strengthen the powers of ESMA to promote the effectiveness of consistent supervision across the EU and beyond” is now priority action #1 of the EU’s CMU mid-term review. ESMA opinions are now focusing on differences between countries’ authorisation and delegation arrangements. These must meet minimum standards, but many regulations, including MiFID II, allow for different application. Some regulators complain about perceived lighter standards applied by others. The UK has historically “gold plated” MiFID whereas other countries stuck to its minimums.

Any shift from a “lowest common denominator” to a “highest common denominator” philosophy for harmonising European regulation could threaten the delegation model that provides the foundation for Europe’s globally competitive asset management industry. “Delegation is vital for the EU asset management industry to survive as a single market that can benefit from specialisation. It encourages member states to group service providers within a single jurisdiction. This lets asset managers inside and outside the EU outsource activities such as the depositary function. The model has worked well and has not caused any issues in terms of financial stability or investor protection,” reflects Krol. “Though some additional conditions are imposed on third countries, delegation criteria are broadly similar for countries inside, and outside, the EU. So a Brazilian fund manager can act as adviser for a UCITS.” AIMA is reiterating the importance of delegation in discussions with ESMA and European Commission officials.

National Exam Program Risk Alert

This Risk Alert provides a summary of observations from OCIE’s examinations of registered broker-dealers, investment advisers, and investment companies conducted pursuant to the Cybersecurity Examination Initiative announced on September 15, 2015.

I. Introduction
In OCIE’s Cybersecurity 2 Initiative, National Examination Program staff examined 75 firms, including broker-dealers, investment advisers, and investment companies (“funds”) registered with the SEC to assess industry practices and legal and compliance issues associated with cybersecurity preparedness.2  The Cybersecurity 2 Initiative built upon prior cybersecurity examinations, particularly OCIE’s 2014 Cybersecurity 1 Initiative.3 However, the Cybersecurity 2 Initiative examinations involved more validation and testing of procedures and controls surrounding cybersecurity preparedness than was previously performed.

The examinations focused on the firms’ written policies and procedures regarding cybersecurity, including validating and testing that such policies and procedures were implemented and followed.  In addition, the staff sought to better understand how firms managed their cybersecurity preparedness by focusing on the following areas: (1) governance and risk assessment; (2) access rights and controls; (3) data loss prevention; (4) vendor management; (5) training; and (6) incident response.

Shifting Priorities

Before buying any product or service, consumers will typically run through a list of key criteria. A car, for example, needs to be affordable, reliable, safe and easy to drive, but changing circumstances may alter the importance of those factors. New driving regulations might make speed controls more important, while a rise in road traffic accidents could shift the focus on to safety features.

Foreign exchange prime brokerage has been through a similar renaissance in recent years. The combined effects of post-crisis banking reforms and the fall-out from the Swiss National Bank (SNB) de-pegging of the Swiss franc in 2015 have driven major shifts in focus on the part of prime brokerage providers and their institutional clients.

One of the first considerations for clients should be the creditworthiness of the prime broker, as there is a significant range of entities offering the service, from the largest investment banks to smaller boutique providers. In the wake of the SNB decision, when many institutions lost money on the sudden one-way currency move, safety of funds has become ever more important. Firms now recognise that they need to scrutinise the balance sheet and capital base of their chosen counterparties to make sure they have the necessary resources to withstand future market stresses.

Credit quality follows close behind, as the provision of credit lies at the core of the prime brokerage business model. If a prime broker is dealing with a large number of trading platforms, liquidity providers and clients, it needs a strong and plentiful supply of credit. Before entering into a new relationship with a prime broker, clients need to be sure that credit will be available when they need it.

Minimizing Risk

Investors who wish to gain exposure to commodities can do so directly through futures, options and other derivatives; or indirectly, and perhaps unintentionally, through the currencies of commodity exporting nations. The Australian dollar (AUD), Canadian dollar (CAD), Brazilian real (BRL), Mexican peso (MXN), Russian ruble (RUB) and the South African rand (ZAR) demonstrate positive and, at times, reasonably strong correlations to a large basket of commodities (Fig.1).

These correlations offer opportunities for investors who have exposure to either currencies or commodities. For example, one could take a position in a commodity and potentially reduce portfolio risk by taking an opposite position in a positively-correlated currency (Fig.2–5).

Remarks at the Economic Club of New York

Thank you, Terry [Lundgren], for that kind introduction. I am delighted to speak to you here at the Economic Club of New York. The Club has established itself as an esteemed, non-partisan forum for economic discourse. It is an ideal place to discuss policy of the U.S. Securities and Exchange Commission (“SEC” or “the Commission” or “the agency”) and its effects on the U.S. economy and the American people. I intend to do just that in this, my first public speech as Chairman of the SEC.1

Nearly six months ago, my predecessor Mary Jo White gave her last public address as SEC Chair in this same forum. In her remarks, she stated “I am confident in reporting that the agency is today a stronger protector of investors than ever before and much better equipped to meet the challenges of the fast-paced, complex, and interconnected securities markets of 2017.”2 I am pleased — and thankful — to say that I agree with Chair White. When I arrived at the Commission, I made it a priority to meet with staff across the agency. With each meeting, I became more impressed by the breadth of issues my 4,600 colleagues cover, and even more, by their dedication.

The Dodd-Frank Act of 20103 required the SEC to complete an unprecedented array of congressionally mandated rulemakings — all on top of the agency’s usual work. Under Chair White’s leadership, the Commission made great strides, adopting a number of the rules with which it was charged. Admittedly, there are still Dodd-Frank mandates to be completed. But I have inherited an agency with considerably more discretion over its agenda.

MiFID II In Focus

The Dechert speakers were:

Mikhaelle Schiappacasse, Senior Associate (MS)
Matthew Duxbury, Associate (MD)
Dick Frase, Partner (DF)

MS Good morning everyone and welcome to this new session on MiFID In Focus, Unlocking Organisational Requirements. I’m joined by my colleague, Matt Duxbury. I’m Mikhaelle Schiappacasse, and we’re both associates here in the financial services group in London.

We will be joined later by our colleague Dick Frase who will be speaking about product development, and provide some additional updates since the last seminar that covered that topic.

So, without further ado, I’ll hand it over to Matt to start us off.

Man FRM Early View

Conversations about volatility sometimes feel like conversations about gold. There are people who seem to have a bottomless pit full of opaque, conspiratorial and technical knowledge out of which they cook up a witches’ brew of the most terrifying forecasts which infect the imagination and wake you up at night. They aren’t often right, so it is easy to resent the loss of sleep, and they are making a lot of noise right now.

Calls for higher volatility were commonplace in the annual outlook documents at the beginning of the year. Back then, politics and the end to a decade of flooded liquidity were the triggers. With perfect foresight on these issues, we doubt many of these pundits would have changed their volatility forecasts. But they all seem to have been wrong so far and at the half way mark, short volatility strategies are performing well.

Growth numbers are better than we might have expected; global and solid, without being worryingly strong in our view. And the weaker dollar – historically a benign influence on global liquidity – seems to have surprised many. And any good news out of European politics (Macron and the French election) has been beneficial. This has made it possible to listen to the Central Bankers’ warnings about the end of the party in a state of preternatural calm.

Editor’s Letter - Issue 125

The global hedge fund industry has made new highs in assets and performance, as have several of the managers profiled in this issue. HFR and Evestment both place industry assets at $3.1 trillion while Preqin put the figure at $3.3 trillion and BarclayHedge is in the middle at $3.2 trillion. Performance in 2017 to July ranges between about 4.5% to 7.5% depending on index providers and strategies. Equity and event-driven managers are generally performing best, and there is a wide spread of performance within the relative value, CTA and macro spaces.

The asset split by strategy varies much more than do assets and performance, according to how managers are defined and categorised by themselves (and/or by database providers). For instance, relative value is largest at $827 billion per HFR whereas Preqin’s relative value tally is just $341 billion. Preqin ranks macro biggest at $955 billion while HFR’s macro total is $579 billion.

Newer and smaller managers are punching above their weight. The fact that HFR’s equal-weighted indices are outperforming its asset-weighted indices shows smaller managers outperforming, in absolute terms. Some 1,006 new funds launched in 2016, according to Preqin. And in terms of numbers, the industry is dominated by smaller funds. Nearly half of hedge funds (and fund of funds) – or close to 5,000 of them – run below $100 million.

What’s New In Washington

On June 30, Congress gaveled out for the July 4 recess after postponing a critical vote to begin debate on an Affordable Care Act (ACA) repeal-and-replace bill. Senate Majority Leader Mitch McConnell (R-KY) and the GOP caucus have worked for the last two months in countless hours of behind-the-scenes meetings on what many believe to be a long-shot effort to unite 50 of the 52 Republican senators.Senators from both sides of the aisle have taken issue with the manner in which the bill has been written and the lack of opportunities to voice concerns and offer amendments through the traditional committee markup process. GOP leadership has countered by noting that the upcoming Senate floor debate will allow several dozen bipartisan amendments to be offered and voted upon.

Substantive concerns have been expressed by a handful of moderate Republican senators over cuts to Medicaid, while more conservative Republican senators have voiced their concern that the legislation does not go far enough in the direction of a complete repeal. The debate on this issue will continue when the Senate gavels back in on July 10, and it awaits a new score from the Congressional Budget Office on a revised bill. In the meantime, calls to cancel or shorten Congress’ annual August recess have begun to grow louder. After celebrating the Independence Day holiday in Washington, D.C., President Trump headed to Poland and then Germany for the G-20 summit. Mr. Trump is expected to meet some critics who are concerned with his administration’s maneuvering on the international stage so early into his presidency. A topic of conversation among the world leaders: steel and aluminum trade.

Here are some things that we believe are worth focusing on since our last article:

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