1. EU and UK Regulatory Perspective: Proposed hedge fund legislation The International Funds Conference 2010 Stephen Ball, Partner

2. 2 A year of turmoil… 2008 -2009 1471 hedge funds closed. $582 billion in assets lost. Equal to the world’s annual spending on prescription drugs.

3. 3 …hedge fund assets growing again - up 9% year-to-date as of Q3 2009 Hedge fund industry assets reach $2 trillion - back to 2006 levels.

4. 4 On track to return their best year this decade having returned over 19% $40 billion of inflows in Q4 2009

5. 5 Risk appetite has returned Hedge fund managers’ gross exposure is back to pre-Lehman levels Source: Bank of America Merrill Lynch Hedge Fund Monitor, Quarterly Market Analysis, November 30th 2009. Bank of America Merrill Lynch research is available at www.mlx.ml.com

6. 6 New fund activity is resuming 2009 Quiet Q1 and Q2 Q3 and Q4: –203 new hedge funds launched. –$12 billion assets raised. –Most new launches from existing managers launching new products. Source: Hedge Fund Research, Third Quarter 2009 Industry Report, Inc. © HFR, Inc. 2009,

7. 7 Top 10 US fund launches 2009 Launched Assets by Strategy Source: * As of November 2009 - Absolute Return, November 2009 database.

8. 8 Top 10 European fund launches 2009 Launched Assets by Strategy Source: * As of November 2009 - EuroHedge, November 2009 database

9. 9 Top 10 Asian fund launches 2009 Launched Assets by Strategy Source: * As of November 2009 – AsiaHedge and EurekaHedge, November 2009 databases.

10. 10 Pensions increase share of global hedge fund assets 2013 hedge fund assets will reach $2.6 trillion 2005 – 2013 pension fund weighting increases from 15-30% Source: The Bank of New York Mellon and Casey Quirk Analysis 2009: The Hedge Fund of Tomorrow: Building an Enduring Firm, April 2009.

11. 11 Largest funds still account for a significant proportion of assets Top 10 fund of hedge funds manage $221 billion assets and control $36% of the industry. Top 5 fund of hedge funds manage $147 billion assets and control 21% of the industry. Source: InvestHedge, September 2009 issue (data as of June 2009) – N.B. The InvestHedge Billion Dollar Club List is published every 6 months.

12. 12 Investor concerns drive structural changes Alignment of interests A focus on greater transparency Liquidity remains a key issue for investors Managed accounts and UCITS III A call for a new and stricter regulation

13. 13 Regulation: where are we? UK Financial Services Authority – 60 consultation and discussion papers, 32 policy statements UK Treasury – 35 consultation papers EU – 27 consultation papers European Commission Draft Directive on Alternative Investment Fund Managers (AIFM) published on 30 April 2009 Highly controversial both in and outside European Union 12 November 2009, Swedish Presidency of the European Council published revised draft Directive 25 November 2009 Gauzes report published Huge rise in operational and regulatory compliance costs Consequential industry consolidation

14. 14 Risk to investors Risk to counterparties Risk to creditors Stability of European financial markets Integrity of European financial markets Cross-border nature of risks Alternative Investment Fund Managers Directive - Rationale

15. 15 AIFM Directive - Objectives Ensure that all AIFM are subject to appropriate authorisation and registration requirements. Provide a framework for the enhanced monitoring of macro- prudential risks. Improve risk management and organisational safeguards to mitigate micro-prudential risks. Enhance investor protection. Improve public accountability for AIF holding controlling stakes in companies. Develop the single market for AIFM.

16. 16 Timeline

17. 17 Response to the draft Directive Cost - $25 billion? 2% of investors in favour, 46% against. Major barriers on investing with EU fund managers who use offshore funds 32% increase in hedge fund compliance costs. 10% of hedge funds surveyed had delayed launch of a fund. Detrimental impact on tax revenues. Loss of choice for investors and resulting reduction in returns. Managers more likely to move their funds offshore.

18. 18 Reaction to the draft Directive “…badly thought out or thought out with malign intent.” Boris Johnson, Mayor of London “…a very dodgy directive that’s been poorly constructed. It’s a process that makes those who support the European Union embarrassed.” Treasury Minister Lord Myners “It really doesn’t work.” Eddy Wymeersch, Chairman of the Committee of European Securities Regulators “Regulatory overreaction.” Richard McIndoe, Head of Pensions, Strathclyde Pension Fund “Ill-conceived and badly drafted.” George Osborne, Shadow Chancellor of the Exchequer, UK Conservative Party “…the French dressing on what was already a dog’s breakfast of a directive.” The Economist

19. 19 AIFM Directive - Key provisions 1.Application 2.Authorisation 3.Capital Requirements 4.Marketing Provisions 5.Limitations on leverage 6.Depositaries 7.Valuators 8.Delegation 9.Reporting and disclosure 10.Third Country Provisions

20. 20 Application Introduces a legally binding authorisation and supervisory regime for all AIFMs managing AIFs in the European Union. Covers hedge funds, private equity funds, commodity funds, real estate funds, infrastructure funds. AIFM directive does not apply to: –AIFMs managing AIF portfolios that have total assets of less than €100 million –AIFMs managing AIF portfolios that have total assets of less than €500 million subject to the AIFs not being leveraged and which do not grant investors redemption rights during a period of five years following the date each AIF is constituted AIFM directive does not apply to UCITS, Credit Institutions covered by the Capital Requirements Directive, Pensions funds.

21. 21 Authorisation AIFM requires authorisation from Home Member State regulator. Must demonstrate suitability and provide information on: –Identities of the AIFM’s shareholders –Arrangements of governance, risk management and valuation –Proposed delegation functions –Liquidity management, short selling, custody arrangements AIFM directive gives member state regulators the power to withdraw authorisation from AIFMs.

22. 22 Capital Requirements As a minimum AIFMs shall have own funds of at least €125,000. Where the AIF portfolios managed by the AIFM exceed €125,000, the AIFM will need to have an additional amount of own funds. The amount will be equal to 0.02% of the amount by which the values of the portfolios in the AIFM exceeds €250 million. Irrespective of the above provisions AIFMs shall not hold an amount of own funds which is less than that required under the Capital Requirements Directive.

23. 23 Marketing Provision An AIFM authorised in its Home Member State will be entitled to market its funds to professional investors (as defined in the Markets in Financial Instruments Directive) in any member state. The cross-border marketing of the AIF is subject only to a notification procedure, under which the relevant information is provided to the Host Member State. The AIFM Directive does not provide rights in relation to marketing AIFs to retail investors. “Passporting” of management services into another member state also permitted subject to notification procedure.

24. 24 Limits on Leverage The AIFM directive sets out specific obligations for AIFMs managing leveraged AIFs. The provisions apply where an AIFM manages one or more AIFs that employ “high levels of leverage on a systematic basis”. “High leverage” is defined as the combined leverage from all sources which exceeds the value of the equity capital of the AIF. AIF’s employing systematically high leverage must make certain disclosures to the AIF investors and also to its Home Member State Regulator.

25. 25 Appointment of Depository The Directive provides for the appointment of a depository which shall be a credit institution. Must be EU domiciled, authorised and supervised credit institution. Must act independently and solely in the interests of the AIF investors. The depositary’s task shall include receiving payments made by investors, safe keeping any financial instruments belonging to the AIF and verifying whether the AIF has obtained ownership of all other assets the AIF invests in –Depositaries may delegate their tasks to other depositaries –Depositary will be liable to the AIFM and the AIF’s investors for any losses suffered

26. 26 Appointment of Valuator Under the directive AIFMs will appoint for each AIF they manage an independent “valuator”. Valuation of assets, shares and units should occur at least once a year. AIFM must ensure that the valuator has appropriate and consistent procedure to value AIF assets. Rules applicable to the valuation of assets and the calculation of net asset value per unit or share of the AIF shall be laid down in the law of the country where the AIF is domiciled or in the AIF is domiciled or in the AIF’s rules or incorporation documents.

27. 27 Delegation of AIFM functions Delegation to third parties is provided for in the directive. Before an AIFM can delegate any functions it first needs prior authorisation from its Home Member State Regulator and certain conditions need to be complied with. An AIFM may not delegate to the depositary, valuator or to any other undertaking whose interests may conflict with the AIF or its investors. Third parties may not sub delegate any functions that have been delegated to them. AIFMs are not allowed to delegate their functions to such an extent that, in essence, they could no longer be considered to be the manager of the AIF.

28. 28 Reporting and Disclosure An AIFM must make an annual report available for each AIF it manages. The Report should contain at the very least: –a balance sheet or statement of assets and liabilities –an income and expenditure account for the financial year and a report on the activities of the financial year The annual report will be made available to investors and regulators no later than 4 months following the end of the financial year.

29. 29 Third Country Provisions Marketing of third country funds (e.g. Cayman domiciled) in EU territory will be permitted 3 years after the AIFM Directive comes into force (expected 2015). Third country AIF only marketable after the third country has: –Signed a tax information exchange agreement with the relevant member state; –Complies with stringent regulatory, supervisory and tax equivalence and information requirements; and –Allow EU AIF equivalent market access Until the three year period has elapsed AIFMs domiciled in a Member State will be permitted to continue to market AIFs domiciled in a third country in other Member States under the existing domestic private placement rules currently in force in those Member States.

30. 30 Implications for Cayman and other offshore jurisdictions Hedge fund managers will move offshore. Non EU funds prohibited unless AIF’s domicile complies with OECD Tax and Exchange of Information rules. Three year delay on access to passport. Marketing Restrictions. Estimated Fund Domicile Registration Source: Charles River Associates Impact of the proposed AIFM Directive across Europe

31. 31 Current Position - Original Draft Who is covered by the directive Grants exemptions to managers of less than €100m of funds or unleveraged private equity funds of less than €500m. EU-based managers of offshore funds are exempt, as are credit institutions, pension funds, insurers and supranational institutions. Limits on leverage The Commission will have the power to set pan-European limits on the amount of leverage that different fund types and strategies may take. Marketing Restrictions outside the EU EU-domiciled fund managers “approved” by national regulators may sell EU-domiciled funds in the EU. Offshore funds run by EU-domiciled managers must comply with OECD tax treaties and may be “passported” after a three-year transition period. Non-EU fund managers will gain a passport only if their country has equivalent legislation to the EU. Pay Limits and Disclosure Requirements Does not mention pay. Depositories: new custodians Funds must use an EU credit institution as a depository and it would be liable for the actions of any subdepositories. This was a direct reaction to the Bernard Madoff “Ponzi” scheme, in which it turned out that many of the feeder funds had delegated custodial responsibilities to Mr Madoff.

32. 32 Proposals for the new rules: Swedish Version Who is covered by the directive Smaller managers must still be subject to national regulation. Removes exemptions for credit institutions, pension funds, insurers and supranational institutions. Partly scraps the exemption for EU-based managers of offshore funds. Limits on leverageLeverage caps will be decided by national regulators, not the Commission, and applied on a temporary basis only under exceptional circumstances. Marketing Restrictions outside the EU Approved fund managers can market EU funds across the EU. Offshore funds or EU-domiciled funds that feed into offshore funds can seek approval on a state-by-state basis. Pay Limits and Disclosure Requirements Mandatory deferral of at least 40 per cent of variable pay over a three-year period. Managers would be banned from using money from profitable businesses to subsidise poorer performers and total remuneration and carried interest paid would have to be disclosed. Depositories: new custodians The depository may be an EU credit institution or an investment firm. Firms with no redemption rights in the first five years may also use a third party that is subject to prudential supervision, such as a US bank. The liability rules are less strict than those in the original draft.

33. 33 Proposals for the new rules: Gauzès Parliamentary Version Who is covered by the directive Removes all size thresholds and scraps exemption for EU-based managers of offshore funds. Limits the exemption for credit institutions, pension funds, insurers and supranational institutions to those investing only for their own account. Limits on leverageFund managers themselves will set their own in-house leverage limits for each of their funds. The Commission will have the power to impose temporary leverage limits on specific funds in an emergency. Marketing Restrictions outside the EU EU-domiciled funds eligible to be sold across the EU. Non-EU funds cannot raise money from investors in the EU unless the fund’s home authorities have an information-sharing and co-operation agreement with the country of the investor. Pay Limits and Disclosure Requirements Pay policies must be consistent with principles laid down by the Group of 20 nations and similar to rules applicable to credit institutions. Pay should be linked to risk and manager interests should be aligned with those of shareholders. Total remuneration and carried interest paid would have to be disclosed. Depositories: new custodians The depository can be a credit institution or an investment firm. If it is located outside the EU, the Commission would agree that the depository is subject to equivalent regulation and investor-protection rules.

34. 34 “Governments’ response the financial crisis has been compared to that of rowdy drinkers in a bar brawl: ‘You wait until a fight breaks out and then take a swing at the guy you have always wanted to hit. Whether or not he had anything to do with starting the fight is not the point.’ In Europe that is a pretty accurate description of how policymakers are treating hedge funds and private equity funds.” The Financial Times