Hedge funds must ensure independent oversight of their investment valuations to prevent managers inflating the returns that determine their pay, regulators said, opening a new line of scrutiny on the funds.
New guidelines for hedge funds, proposed by the International Organization of Securities Commissions, a Madrid-based group of authorities from countries including the U.S., U.K., France, Germany and Hong Kong, will depend on investors remaining vigilant over their stakes in the lightly regulated funds, the regulators said in a statement yesterday.
The so-called principles of asset valuation, issued after months of deliberation by regulators and industry representatives, come amid heightened attention on the $1.4 trillion hedge-fund industry amid concern from central bankers and politicians in the U.S. and Europe over industry regulation.
``The chief aim of the principles is to seek to ensure that the hedge funds' financial instruments are appropriately valued and, in particular, that these values aren't distorted to the disadvantage of fund investors,'' IOSCO said.
Many hedge funds invest in complex derivatives or other assets whose value is difficult to track in market trading. Outside administrators may depend on the opinion of fund managers to assess valuations. With managers earning 20 percent or more on profits, the potential exists for ``conflicts of interests,'' IOSCO said.
Influence on Value
``The manager may have both the incentive and the ability to influence the valuation of the financial instruments in the portfolio in ways that don't reflect their value,'' the regulators' paper said.
Hedge funds should have documented policies and methodologies for how investments are valued, IOSCO said. Independent boards should review those practices as well as relationships with third-party providers of prices for financial instruments.
The Alternative Investment Management Association, a London-based trade group representing hedge funds, praised the regulator organization for cooperating with the industry in setting the guidelines.
``We are pleased to see that IOSCO's proposed principles are along the same lines as our own recommendations,'' Emma Mugridge, a director of AIMA, said in a statement today.
Hedge funds are lightly regulated limited partnerships that typically take bigger bets than mainstream mutual funds. They cater to wealthy individuals with at least $1 million and institutions and endowments. They aim to make more money than mainstream mutual funds by taking bigger and riskier bets that move more capital faster in and out of markets.
Regulators who contributed to the report include officials of the U.S. Securities and Exchange Commission and Commodity Futures Trading Commission, the U.K. Financial Services Authority and France's Financial Markets Authority.
Industry representatives came from companies including Goldman Sachs Group Inc.; Ivy Asset Management, a hedge fund unit of Bank of New York Co.; Markit Group Ltd., a provider of price data; PricewaterhouseCoopers International Ltd.; and the hedge-fund administration unit of Bisys Group Inc.
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