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Asia’s Cash-Poor Small Hedge Funds Vulnerable to U.S. Rules

Asia’s smaller hedge funds may be hardest hit by new rules in the U.S. making it costlier to raise and manage funds from the world’s biggest investment market.

Overseas hedge funds with more than 15 U.S. clients and investors managing more than $25 million for them will have to register for the first time with the Securities and Exchange Commission by July 21 as part of the Dodd-Frank regulatory overhaul. That means higher costs as managers have to keep the SEC up to date with assets and trading positions, and comply with U.S. securities laws.

For smaller managers, such as Solaris Asset Management, registration and monitoring costs are prohibitive. A decision not to register may shut the door on a region that contributes about 40 percent of assets for Asia’s hedge funds, exacerbating a capital shortage since the financial crisis.

“Asian hedge funds will not be able to avoid increased regulatory reforms from overseas,” said Andrew Hill, head of Citigroup Inc.’s prime finance sales in Singapore. “The encroaching regulatory globalization from the U.S. and Europe will undoubtedly increase the fixed costs of doing business in this industry and thereby will stack the cards further in favor of the larger funds.”

The average size of an Asia-based hedge fund is $97 million, less than half of the assets managed by counterparts in Europe and the U.S., according to Eurekahedge Pte. About 45 percent of the hedge funds in Asia manage less than $25 million, according to the Singapore-based industry data provider.

‘Too Expensive’

While Asia-focused hedge funds attracted more than $500 million in net new capital in the fourth quarter, the industry’s total assets of $83.4 billion remain 17 percent less than the second quarter of 2008, according to Chicago-based Hedge Fund Research Inc. About 40 percent of the assets of Asian hedge funds come from the U.S. and 50 percent from Europe, according to Eurekahedge.

Solaris, which started a hedge fund last year with money from investors in China, doesn’t plan to register with the SEC or raise money from U.S. investors. The cost of complying with U.S. rules would be “very high,” said Thomas Tey, managing partner of the firm in Singapore.

“There’s too much regulatory work for too little return,” Tey said. “Unless you get to some of the very big investors, like Calpers, state government money or some extremely wealthy individual, it’s not worth the hassle.” California Public Employees’ Retirement System, known as Calpers, is the largest U.S. public pension fund.

Meeting Compliance

Registration for smaller hedge funds will likely cost at least $40,000 as managers may need to hire an external consultant to help them get their documents and procedures in order, said Sree Vallipuram, chief operating officer of Iridium Asset Management, a Singapore-based firm which runs an Asian equity hedge fund that focuses on commodity-related industries.

To meet reporting requirements, managers may also need to hire a compliance officer, he said. Vallipuram declined to comment on whether the fund plans to register with the SEC.

“It’s the monitoring cost that will be recurring and it’s something that people will need to budget for,” said Ho Han Ming, a Singapore-based partner at law firm Clifford Chance LLP. “It could be a non-amount because you already do it anyway, but if you were a very lean outfit then it’s going to be an infrastructure you have to build.”

AIMA Request

The Dodd-Frank Act subjects financial companies including hedge funds to increased federal oversight following the 2008 credit crisis.

The London-based Alternative Investment Management Association in January provided a written submission to the SEC to raise the threshold for assets under management to at least $100 million, so that those sourcing less than that amount from clients and fund investors in the U.S. will be exempt from SEC registration, according to a submission filed by the group that was seen by Bloomberg News. The current proposed threshold of $25 million is “exceedingly low” and many of AIMA’s members wouldn’t be exempted from registration, according to the group.

“Some managers are taking a position that it’s all going to go away because the SEC is going to expand exemptions from registration,” said Ho, who heads Clifford Chance Singapore’s funds practice group, which advises managers on the structuring and registration of their funds. “Believe me - it’s not going to go away this time.”

New Rules

Registered hedge-fund managers will have to maintain and file with the SEC certain information including the amount of assets under management and trading positions. Asian managers would also be obliged to comply with U.S. securities laws, contributing to “high monitoring costs,” said Ho, who is also chairman of the Singapore chapter of AIMA.

“The biggest concern is probably the surrounding cost structure for compliance,” said Singapore-based Kemmy Koh, who heads the Asian unit of Pacific Alternative Asset Management Co., which invests in hedge funds. “This would obviously have a greater impact on the smaller hedge fund managers.”

Under the European Union’s Alternative Investment Fund Managers Directive, any fund manager who has clients in the EU will have to obtain a “passport” to operate across the 27- nation bloc from 2015. Managers will have to comply with transparency rules.

Overseas Dependence

Most managers in Asia are likely to register with the SEC as the U.S. has become a key source of capital for their funds, in particular institutional investors, Koh said. Paamco, based in Irvine, California, has generally required that Asian hedge fund firms it invests in register with the SEC, even before the Dodd-Frank Act, Koh said.

“The U.S. is still for the foreseeable future the largest and deepest capital pool globally for hedge funds,” said Dagmar Baeuerle, Hong Kong-based head of prime finance Asia-Pacific consulting services at Citigroup. “Until the large Asian capital owners start putting money to work in their own backyard, the Asian-based managers will need to go to the U.S. and Europe for capital.”

Some Asian hedge funds registered in late 2004 and 2005 during the SEC’s first attempt to gain regulatory oversight over the industry, Baeuerle said. A U.S. federal court threw out the SEC’s hedge fund registration rule in June 2006, just months after the requirement went live, calling it “arbitrary.”

Singapore Haven

This time it’s different as the new registration requirement is part of a broader financial-services regulatory reform package, said Baeuerle.

In contrast with the U.S., Singapore has made it easier for hedge funds to set up shop in the island-state than in other Asian cities such as Hong Kong, where hedge-fund managers face the same licensing requirements as mutual funds. While Singapore is introducing new rules to increase oversight of the industry, small funds can keep operating without a license.

New hedge funds in Asia raised $3.84 billion in assets last year, 48 percent more than 2009, according to the AsiaHedge New Funds Survey released today. A total of 95 funds started last year in the region compared with 78 in 2009, the survey said. Average new fund size increased to $40 million in 2010, it said.

Permal Asset Management Inc., a Legg Mason Inc. unit that invests clients’ money in hedge funds, prefers to allocate money to managers that are registered with the SEC, said Isaac Souede, New York-based chairman and chief executive officer of Permal.

“The cost of being in the business, especially for the small manager, has increased significantly because of what you need to do from the regulatory standpoint,” he said.

To contact the reporter on this story: Netty Ismail in Singapore nismail3@bloomberg.net.

To contact the editor responsible for this story: Andreea Papuc at apapuc1@bloomberg.net

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