To be successful, hedge fund managers must to be able to concentrate on what they do best. It is essential that they delegate as many peripheral functions as possible in order to focus on the core-investment responsibilities of running a portfolio. This means that they either need to create an infrastructure within their organisation to handle all of these functions or they have to keep their business more lean and outsource these roles. Building a hedge fund operation is largely an issue of taking standard industry components, and putting them together in an integrated fashion to create a business.
The key requirement is to have a perspective on how these pieces fit together. Operational areas such as accounting, tax, compliance and even IT all interface with one another. In this way a ‘good’ decision taken in one area can have a negative impact elsewhere in the firm if the implications of the original decision are not fully considered. Hedge fund managers therefore need to have a holistic perspective on all of their operations, not just a viewpoint on a series of silos. Developing cross-disciplinary expertise that allows hedge funds to understand issues in the context of the whole business as opposed to a single, narrow discipline is critical.
For example, part of our accounting offering is that we also understand the regulatory requirements. There are synergies between tax, accounting and compliance that can be leveraged by integration and there is a requirement for checks and balances to be built into these operational processes at a more strategic level. A lot of UK hedge fund managers are structured as LLPs due to the commercial and tax benefits that historically could be derived. Mooted changes to the tax rules mean that these structures will need to be carefully considered in conjunction with accounting and regulatory rules so that managers can make the right strategic decisions for their business.
The introduction of AIFMD is a good example of where accounting interfaces with compliance – in this case where the new rules have imposed different capital requirements. Understanding the impact of this regulation beyond the mere compliance aspects, to the extent of how much capital an AIFM may need to tie up, can also affect some key strategic decisions especially for a small firm.
The service we undertake for most start-ups is the FCA application, closely followed by various elements of tax structuring. However in undertaking this initial consulting we also have to be mindful of how a client might want to develop the business as well as the constantly changing tax and regulatory environment. We advise our clients to run fairly flexible business models, so if the regulatory landscape changes they can adapt to fit in.
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The pursuit of capital is becoming increasingly challenging for many new hedge fund managers so it has become critical that operational risk is demonstrably understood and robustly managed. This allows potential investors to gain comfort in the businesses they will be backing by investing in funds.
Adrian Johnson, partner, HedgeStart