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Singapore's Failed Attempt at Hedge Fund Regulation

Recently Singapore announced a major change in its approach to hedge fund regulation - and thehedge fund community celebrated.

Previously in Singapore hedge funds were not required to be licensed as long as they were classifiedas exempt fund managers. As long as they only marketed themselves to so-called qualified investorsand met some other basic criteria, there wasn't much oversight or regulation of their activities. Allhedge fund managers had to do was provide notification to the Monetary Authority of Singapore("MAS") of their choice as to whether to be licensed or not - and most chose the latter.

This fast and loose approach to hedge fund regulation was originally utilized as a marketing tool tolure fund managers to Singapore, and as a 2010 Bloomberg article stated , "put the city back on themap " as an Asian hedge fund destination.

For the past two years, the MAS has been studying ways to increase regulation of hedge funds. Aftertwo years of study, and seemingly taking cues from the U.S.'s Dodd-Frank legislation and recent SECregistration requirements, the MAS decided to effectively require all hedge fund managers aboveS$250 million to register.

Specifically, under the Securities and Futures (Licensing and Conduct of Business) (Amendment No2) Regulations (2012), hedge funds will now be classified into two different categories: FundManagement Companies ("FMC") and Registered Fund Management Companies ("RFMC") . RFMCreplaces the old Exempt Fund Manager ("EFM") classification.RFMCs can serve up to 30 qualified investors and manage up to $250 million in Singapore dollars,(commonly written as S$). RFMCs do not need a license but FMC's will need a license.

According to the MAS press release regarding these new regulations, FMCs will subject to " enhancedbusiness conduct and capital requirements. These include rules requiring independent custody andvaluation of investor assets, as well as requirements for FMCs to undergo independent annualaudits by external auditors and having an adequate risk management framework commensuratewith the type and size of investments managed by the FMCs."

Let us analyze each of these items individually:

Requirements for independent custody

Does anyone remember Bernard Madoff? The potential for manipulation in self-custody relationshipsis too great. While it is commendable that the Singapore financial regulators now require

independent custody for FCMs- investors should avoid self-custodied managers, such relationshipsare generally not worth the potential risk to investors.

Additionally, it could be asked, why does the MSA only require independent custody it for largermanagers? Perhaps a custody related fraud below S$250 million does not outweigh the burden andcosts of hiring a third-party custodian placed on smaller fund managers in the mind of the MSA,however such considerations would likely hold little recompense for the investors who could losecapital in such a situation.

http://www.bloomberg.com/news/2010-07-28/singapore-hedge-fund-regulations-lure-managers-put-city-back-on-the-map-.htmlhttp://www.bloomberg.com/news/2010-07-28/singapore-hedge-fund-regulations-lure-managers-put-city-back-on-the-map-.htmlhttp://www.bloomberg.com/news/2010-07-28/singapore-hedge-fund-regulations-lure-managers-put-city-back-on-the-map-.htmlhttp://www.mas.gov.sg/~/media/MAS/Regulations%20and%20Financial%20Stability/Regulations%20Guidance%20and%20Licensing/Securities%20Futures%20and%20Fund%20Management/Amended%20Regs/Securities%20and%20Futures%20Licensing%20and%20Conduct%20of%20Business%20Amenhttp://www.mas.gov.sg/~/media/MAS/Regulations%20and%20Financial%20Stability/Regulations%20Guidance%20and%20Licensing/Securities%20Futures%20and%20Fund%20Management/Amended%20Regs/Securities%20and%20Futures%20Licensing%20and%20Conduct%20of%20Business%20Amenhttp://www.mas.gov.sg/~/media/MAS/Regulations%20and%20Financial%20Stability/Regulations%20Guidance%20and%20Licensing/Securities%20Futures%20and%20Fund%20Management/Amended%20Regs/Securities%20and%20Futures%20Licensing%20and%20Conduct%20of%20Business%20Amenhttp://www.mas.gov.sg/News-and-Publications/Press-Releases/2012/MAS-Implements-Enhanced-Regulatory-Regime-for-Fund-Management-Companies.aspxhttp://www.mas.gov.sg/News-and-Publications/Press-Releases/2012/MAS-Implements-Enhanced-Regulatory-Regime-for-Fund-Management-Companies.aspxhttp://www.mas.gov.sg/News-and-Publications/Press-Releases/2012/MAS-Implements-Enhanced-Regulatory-Regime-for-Fund-Management-Companies.aspxhttp://www.mas.gov.sg/News-and-Publications/Press-Releases/2012/MAS-Implements-Enhanced-Regulatory-Regime-for-Fund-Management-Companies.aspxhttp://www.mas.gov.sg/~/media/MAS/Regulations%20and%20Financial%20Stability/Regulations%20Guidance%20and%20Licensing/Securities%20Futures%20and%20Fund%20Management/Amended%20Regs/Securities%20and%20Futures%20Licensing%20and%20Conduct%20of%20Business%20Amenhttp://www.mas.gov.sg/~/media/MAS/Regulations%20and%20Financial%20Stability/Regulations%20Guidance%20and%20Licensing/Securities%20Futures%20and%20Fund%20Management/Amended%20Regs/Securities%20and%20Futures%20Licensing%20and%20Conduct%20of%20Business%20Amenhttp://www.bloomberg.com/news/2010-07-28/singapore-hedge-fund-regulations-lure-managers-put-city-back-on-the-map-.htmlhttp://www.corgentum.com/

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Requirements for independent valuation of investor assets

"Independent" is a vague term at best. Does this mean that a hedge fund that trades highly liquidpositions such as equities, and is able to price such positions from a third-party source such as

Bloomberg, has satisfied this requirement? Or instead is the work of a third-party firm engaged bythe hedge fund manager, such as a fund administrator, required? Does this mean that it is now aviolation of the Singapore regulations for FCM's to self-administer?

What about situations where positions are thinly traded or initially manager marked? Would thehedge fund manager hiring a third-party administrator, who may not have the competency toindependently price such thinly traded positions, still satisfy this requirement?

An overarching concern relating to the use of such third-party administrators is that administratorsthemselves are hired by the fund managers. While they work for the fund, there are legitimatequestions about the true independence of such relationships.

Requirement for FCMs to undergo independent annual audit by external advisors

Would this requirement be satisfied by a hedge fund managers regular annual financial statementaudit.Does this "new" requirement mean that it was previously fine for a manager not to be audited?

Once again, it seems the MSA is finally catching up to what is common sense to investors. Whileinvestors should in no way outsource their operational due diligence responsibilities to a third-partyauditor, the work of an auditor and the subsequent financial

statements are extremely valuable to investors during due diligence. If a hedge fund manager is notaudited - investors should move on.

If on the other hand the "independent annual audit" language does not imply that a financialstatement audit will not encompass the "independent annual audit" language of the MSA, will FCMhedge funds now be required to have a separate audit performed in addition to the financialstatement audit?

Requirement to have an adequate risk management framework commensurate with the type andsize of investments managed by the FMCs

Once again, this is perhaps so vague as to be useless. Many logical well-intentioned hedge fundsmay take different approaches, some less conservative than others, in regards to the definition of the word adequate. Certainly, it would be considered adequate to have an independent dedicatedrisk manager, but other fund managers may feel that non-dedicated oversight is sufficient. How willthe MSA regulate this?

Conclusion:

On the surface investors init ial reactions to such enhanced regulatory reforms may be that moreregulation is better for investors. However, it is important that investors take measures to not onlyunderstand the technical requirements of new regulatory requirements but also whether theseadditional requirements will be effective.

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