The Dublin Funds Industry Association (DFIA) and the Irish regulators have agreed changes to the regulatory regime that applies to hedge funds and prime brokers domiciled in Ireland. According to Dublin lawyers Dillon Eustace, the proposed changes will increase counterparty exposure limits and speed up the approval process for prime brokerage appointments.
First, the Irish Financial Services Regulatory Association (IFSRA) will no longer formally review prime brokerage documentation, subject to agreement with the hedge fund industry on a form of robust confirmation from legal advisers that the documentation complies with conditions set down in a new draft “Guidance Note.”
Secondly, the amount of a hedge fund’s assets, which are available to a prime broker for appropriation or rehypothecation is to be increased from the current limit of 100% to 140% of its indebtedness to the prime broker. The daily monitoring of this limit is to be discussed with the industry. Otherwise, existing rules will continue to apply. These include the appointment of the prime broker as sub-custodian by the Irish custodian bank, minimum capital adequacy and quality requirements (rating and shareholders’ funds), positions must be marked to market daily, the prime broker must agree to return the same or equivalent securities to the scheme and the arrangement must incorporate a legally enforceable right of set-off for the fund.
Thirdly, the current limitation (up to 100% of the fund’s indebtedness to the prime broker) on the right of a prime broker to appropriate and use assets of a hedge fund will be disapplied in full, but the extent to which assets are available will have to be disclosed in full in the fund’s prospectus.
Fourthly, an exposure of up to 20% of NAV (or 30% in the case of European Union (EU) or equivalent credit institutions) will apply to primer brokers. There will be an additional exception of up to 40% of investment in one or more “regulated collective investment undertakings.” Assets passed as collateral in these transactions will not be subject to daily monitoring by trustees, but eligible counterparty criteria will apply (i.e. minimum credit rating of A2/P2). All existing quantitative investment restrictions (with the exception of permitted 40% investment in one or more regulated collective investment undertakings, which remains) will be replaced by a single exposure limit of 20% of Net Asset Value, which can be raised to 30% in the case of an EU or equivalent credit institutions. The definition of exposure will encompass all exposures to an issuer or entity.
Fifthly, the current limitations on a hedge fund to pass assets outside of its custody network to support trades it enters into with any over-the-counter counterparty will be disapplied in full, though OTC counterparties must now have a minimum credit rating of A2/P2. IFSRA have suggested that where the fund proposes to use a single counterparty, the rules applicable to funds which appoint a prime broker will apply. (Dillon Eustace says this presumably means the quality requirement, an enforceable right of set-off in favour of the fund and daily marking to market, but further discussions with IFSRA will be necessary to clarify this point.) Details will have to be disclosed in the prospectus.
Sixthly, hedge funds structured as investment companies are required under Irish company law to spread their risk, so IFSRA will reserve the right to comment on specific proposals, especially when it detects what it considers excessive exposure to counterparties. Details will have to be disclosed in the prospectus.
Seventhly, IFSRA wants the role of trustee to be maintained, including the appointment of prime brokers as sub-custodian, but daily monitoring of compliance with conditions applied to the appointment of prime brokers can be discussed with it, based on precedent, and restriction to a number of trustee firms.
“Once agreement on the above points has been reached between the Industry and the IFSC and Funds Supervision department, the proposals will be presented to the Board of Management of IFSRA for approval, and a revised Guidance Note will be issued,” explains Dillon Eustace. “It is important to note that these proposals are subject to comment from the Industry and further Irish Financial Services Association clarification. However, they can be viewed as a very positive development and in some cases go beyond the recent requests from industry.”