A Code of Conduct for Hedge Fund Financial Services Providers (FSPs)
By Karin van Wyk
CEO
SAIFM

he Financial Services Board declared hedge funds and funds of hedge funds “financial products” for purposes of extending the licences of discretionary FSP to provide intermediary services for these funds and created a new category of FSP i.e. Category IIA with effect from 29 August 2007 in terms of the Financial Advisory and Intermediary Services Act, 2002.(FAIS Act)(i). A Hedge Fund FSP is defined as a FSP that renders intermediary services of a discretionary nature in relation to a specific hedge fund or fund of hedge funds in connection with a particular Financial Product (excluding, short term insurance products, health benefits and bank deposits) and acting for that purpose in accordance with the Codes, the FAIS Act and any other law(ii),

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

Other relevant definitions include:

  • A fund of hedge funds - a portfolio that, apart from liquid assets, consists of an interest, holding or investment in one or more other hedge funds.
  • Hedging - entering into transactions that protect against adverse price movements and limit exposures to specific risks.
  • Leverage - any position in which the delta factor would be less than -1 or more than +1, or a position in which the nominal exposures to assets in the portfolio is less than nil or more than 100% of the market value of the portfolio.
  • Net short position – a condition in which a portfolio has a greater nominal exposure to short positions than long positions in any asset class or in aggregate across the portfolio, meaning that more capital (including collateral) supports short positions than is invested in long positions and which may in certain cases require additional capital to be invested in the portfolio over and above the initial capital investment.
  • Short position - a position where an asset is sold by a seller for delivery at a future date or time, and the seller does not own such asset at the time of the sale; or in the case of a derivative instrument, a position where -
    • a decrease in the price of the underlying asset has a positive impact on the value of the of the derivative instrument; or
    • an increase in the price of the underlying asset has a negative impact on the price of the derivative instrument(iv).
The requirements of discretionary FSP’s (DFSPs) apply to Hedge Fund FSP’s, subject to the necessary changes, the provisions of section 8A in Part III of Chapter II of the Schedule to the Notice or any other law which may render a particular provision clearly inapplicable to hedge funds and their clients(v).

Duties of a Hedge Fund FSP

Before rendering intermediary services to a client in respect of a hedge fund, a Hedge Fund FSP must disclose in writing to the client –

  • that the requirements for discretionary FSP’s apply to the relationship between the Hedge Fund FSP and the client; and
  • the risks involved in investing in hedge funds.

The client must provide written confirmation of receipt of these written disclosures(vi).

Additional Mandates with regard to Hedge Funds and Fund of Hedge Funds Investments

A Hedge Fund FSP must have a specimen additional mandate approved by the Registrar, who may grant approval subject to such conditions as the Registrar may determine. The Registrar may also, subsequent to the initial approval, require amendments to the specimen additional mandate or require additional disclosures(vii).

Before rendering an intermediary service with regard to a hedge fund or fund of hedge fund, the Hedge Fund FSP must, over and above the signed mandate with regard to discretionary financial services, obtain an additional signed mandate from the client complying with the requirements relating to mandates generally insofar as they are applicable and in which the client must confirm –

  • the existence and contents of the first mandate;
  • the utilisation of a hedge fund portfolio for executing the intermediary services required by the client;
  • the approval by the client of the client’s objectives, guidelines and the trading philosophy of the Hedge Fund FSP, as disclosed in the mandate;
  • the approval by the client of the process to be implemented in the form of strategies or positions (including leverage and/or net short positions), borrowing limits and risk management principles to be applied to mitigate interest rate, credit and derivative risk, risk profile and risk management (for instance a sensitivity analysis) as disclosed in the mandate;
  • that the client has noted the FSP’s affirmation in the mandate that the establishment of the portfolio does not conflict with any law, and that the operation and managements thereof continuously comply with any law that may be applicable to it(viii).

(i) Section 2.1 Chapter II Notice on Codes of Conduct for Administrative and Discretionary FSP’s, 2003 as amended by the Notice on Codes of Conduct for Administrative and Discretionary FSP’s Amendment Notice, 2007 Government Notice 30228 dated 29 August 2007

(ii) Section 2.1, Chapter II Notice on Codes of Conduct for Administrative and Discretionary FSP’s, 2003 as amended by the Notice on Codes of Conduct for Administrative and Discretionary FSP’s Amendment Notice, 2007 Government Notice 30228 dated 29 August 2007

(iii) Section 2.1 Chapter II Notice on Codes of Conduct for Administrative and Discretionary FSP’s, 2003 as amended by the Notice on Codes of Conduct for Administrative and Discretionary FSP’s Amendment Notice, 2007 Government Notice 30228 dated 29 August 2007

(iv) Section 2.1 Chapter II Notice on Codes of Conduct for Administrative and Discretionary FSP’s, 2003 as amended by the Notice on Codes of Conduct for Administrative and Discretionary FSP’s Amendment Notice, 2007 Government Notice 30228 dated 29 August 2007

(v)Section 8A.1 Part III, Chapter II Notice on Codes of Conduct for Administrative and Discretionary FSP’s, 2003 as amended by the Notice on Codes of Conduct for Administrative and Discretionary FSP’s Amendment Notice, 2007 Government Notice 30228 dated 29 August 2007

(vi) Section 8A.3 read with section 5.2 of Chapter II Notice on Codes of Conduct for Administrative and Discretionary FSP’s, 2003 as amended by the Notice on Codes of Conduct for Administrative and Discretionary FSP’s Amendment Notice, 2007 Government Notice 30228 dated 29 August 2007

(vii) Section 8A.3 read with section 5.2 of Chapter II Notice on Codes of Conduct for Administrative and Discretionary FSP’s, 2003 as amended by the Notice on Codes of Conduct for Administrative and Discretionary FSP’s Amendment Notice, 2007 Government Notice 30228 dated 29 August 2007

(viii) Section 8A.3 and 8A.4 of Part III, Chapter II Notice on Codes of Conduct for Administrative and Discretionary FSP’s, 2003 as amended by the Notice on Codes of Conduct for Administrative and Discretionary FSP’s Amendment Notice, 2007 Government Notice 30228 dated 29 August 2007