Hong Kong and Singapore’s developed financial infrastructures coupled with the tax perks that both these financial hubs provide are among the reasons which have led to these centres dominating Asia’s hedge funds arena. Using data from Preqin’s Hedge Fund Analyst, the number of newly launched hedge fund managers in Asia has doubled from 22 in the year 2003 to 44 in 2013. Out of the 641 active Asia-based (excluding Australasia) hedge fund managers tracked by Preqin’s Hedge Fund Analyst, 478 were based in either Hong Kong or Singapore
In recent years, hedge fund managers around the world have faced a deluge of regulatory changes, which in turn has rapidly increased operational costs as fund managers change to comply with these regulations. Here, we take a look at how hedge fund managers based in Singapore and Hong Kong might be impacted by the recent introductions of Basel III, Foreign Account Tax Compliance Act (FATCA), the European Union’s (EU) Capital Requirements Directive IV and Alternative Investment Fund Managers Directive (AIFMD).
Basel III and its European equivalent Capital Requirements Directive IV were developed to strengthen banks in response to the 2008 financial crisis. It involves introducing additional capital buffers as well as decreasing bank leverage. This could mean increased financing costs for hedge funds, if for instance prime brokers decide to reduce their dependency on short-term funding lending. It could also impact investments into hedge funds, as solvency requirements for investors such as insurers will force these investors to re-evaluate their asset allocations to ensure higher levels of liquidity or lower levels of volatility.
However, fund managers in Singapore and Hong Kong would be less affected with the introduction of these regulations as compared to their foreign counterparts as many Asian financial institutions were already well positioned to meet the regulation’s capital and leverage requirements. Although hedge fund managers based in Singapore and Hong Kong may feel less of an impact in comparison to their peers in Europe and the US, there is still a chance of increased financing costs, especially for fund managers utilizing illiquid or highly leveraged strategies, and a risk of an impact on capital flow.
The EU’s AIFMD has an extremely wide scope and is aimed towards all EU fund managers managing alternative investment funds (AIFs), fund managers that manage AIFs established in the EU and other fund managers which market in the EU. Hedge fund managers in Asia hoping to raise funds from the EU will be affected by these directives, but there is some inertia in terms of the take-up rate among Asian fund managers. According to a survey of hedge fund managers conducted by Preqin in June 2014, just 13% of Asia and Rest of World-based fund managers are already AIFMD compliant. This may be as a result of the increased cost burdens; three quarters of Asia and Rest of World fund managers reported that AIFMD costs of compliance had been higher than expected. In addition the EU may not be a core fundraising region for many fund managers in Singapore and Hong Kong. Preqin’s Hedge Fund Investor Profiles shows that investors based in Europe only make up 16.7% of all investors looking to gain exposure to Asia, as compared to investors from North America, which makes up over 61.2% of the investor pool. These reasons are likely to make Hong Kong- and Singapore-based fund managers reconsider fundraising in the EU especially in light of the extra costs and burdens this will add to their business: 27% of Asia and Rest of World-based fund managers do not plan to actively market in the EU and 7% do not plan to be compliant at all.
FATCA is a regulation effected by the US with the purpose of identifying US persons who have invested in either non-US financial accounts or non-US entities. The intention behind FATCA is to keep US persons from hiding taxable income and assets overseas. Although there was some initial uncertainty about whether Asian fund managers need to comply with FATCA, it is now apparent that fund managers in Singapore and Hong Kong will be affected by it. Singapore has agreed to the reciprocal version of Model 1 (Intergovernmental Agreement) IGA which means that Singapore-based Foreign Financial Institutions (FFIs) will report FATCA required information directly to its national tax authorities who will then report to the Internal Revenue Service (IRS). The US is also required to provide certain information about Singapore’s residents to Singapore. Hong Kong, on the other hand, has agreed to Model 2 IGA where local reporters file directly to the IRS. The US will not have to provide any information to Hong Kong. Non-compliant FATCA institutions will be subject to a 30% withholding tax on US-sourced income. Hedge fund managers from both countries will be affected by FATCA with the size of the impact dependent on their exposure to US investors. Hedge fund managers in Singapore and Hong Kong are most likely to take notice of this regulation, due to the importance of US investors to their fundraising success.
Hong Kong and Singapore are poised to continue to dominate the hedge funds arena in Asia. Indeed, in the 6 months from January 2014 to June 2014, funds launched by managers based in these two countries made up two thirds of all fund launches in the region. In order to continue their dominance, there is no doubt that hedge fund managers in Hong Kong and Singapore will do well to prepare to ride the wave of global regulatory changes. However with compliance comes additional costs and barriers to entry for fund managers; we may see fund groups from these countries turn away from marketing within the EU to refocus their attentions on the US and locally where the chances of fundraising success may be higher.