Alternative investment funds' self-regulation is best for all stakeholders

Since the alternative investment funds regulations came into force there’s been no shortage of critics. Many have taken issue with several items.

A good example is the "one-size-fits-all" approach to all the different funds. How does lumping together hedge funds, property funds, infrastructure funds, distressed funds and private equity among others create a level playing field?

Demand for quarterly valuation reports, for instance, may prove unrealistic, especially for funds employing illiquid strategies. As is, such requirements will not only increase compliance costs but eventually could create a lopsided industry.

Further, the regulations make an implicit assumption for equity-debt structures whereas non-equity-debt arrangements such as digital assets, futures, and commodities among others could still apply.

Is it possible to row back on some of the regulations? Before we jump into that, there are more issues.

Some critics make the argument that if an alternative investment fund is theoretically capable of suffering losses far greater than the cash it manages, either by malinvesting or miscalculating bets, then the regulations do not avert losses. And therefore, the loser is the investor, the precise person the regulator is trying to protect.

In addition, some players argue that prospective fund managers may choose other jurisdictions where the rules are comparatively benign and where they can continue to invest without scrutiny.

Others do not see how the regulations are going to tackle any systemic risk issues.

Back to our question, I think it’s highly unlikely for the regulator to substantially alter anything now as the regulations are fairly recent. That said, the regulator should make one exception; allow AIFs to set up their own self-regulatory organisation (SRO) which sets standards, conducts examinations and enforces rules regarding its members.

Here’s why I say so, combining SRO principles with government oversight, allows the industry to evolve in its own terms. This way, (if the AIF industry agrees), it shall be able to realise that the benefits of self-regulation outweigh their costs, for a little additional cost, it can protect itself from unwelcome government regulations or intervention.

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The industry can therefore determine just how strict its regulation is, rather than have the Capital Markets Authority do it for them.

Conversely, the regulator equally benefits as this structure allows the market to dictate its own pace and keeps it from overreaching its authority. Plus, the average investor is protected.

Do SROs work? Yes. The Financial Services Authority in Japan is one good example exemplifying the evolution of SROs and their collaboration with government authorities in developing its financial industry. Britain and the United States are others. I must admit to be a later believer in SROs, but now I understand.

Asking the industry to self-regulate and put in place a code of conduct for its members is not only a great step forward, but it also helps the industry stay proactive in addressing any regulatory and legislative concerns touching them.

In other words, it prevents regulatory overreach. As they say, you either police yourself or you get policed.

Mwanyasi is MD, Canaan Capital.