09/16/2009

Cautious UK Taking Months to Okay Funds


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CORRECTION: An article on Sept. 16, "Cautious UK Taking Months to Okay Funds," misspelled the last name of Julian Korek, a founding partner of Kinetic Partners.

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Don't expect swift government permission to start marketing a hedge fund in the U.K., where the Financial Services Authority is taking months to give its go-ahead.

Since early this year, the London regulator has needed about four months and sometimes longer to complete background checks of key officials, conduct risk-management and operations reviews and take other approval steps. That's at least twice as long as the 6-8 weeks FSA had been taking in years past to give the go-ahead to funds.

The regulatory backlog worsened in April and May, when FSA was inundated with proposals from investment firms rushing to pursue what they view as post-crisis market opportunities.

Case in point: Only this week did two former Deephaven Capital professionals receive verbal approval to start marketing their planned event-driven hedge fund - nearly five months after applying to the FSA. And they are still waiting for written confirmation. In April, Tony Chedraoui and Mark Madden submitted their initial paperwork to FSA after setting up Tyrus Capital. Word has it they will launch with $750 million to $1 billion.

Their proposed vehicle would follow the same approach as Deephaven's $500 million European Event Fund. Chedraoui managed that vehicle for Deephaven until Stark Investments completed its acquisition of the Minnetonka, Minn., fund operator's flagship vehicle at the end of March. The St. Francis, Wis., investment firm didn't buy the Deephaven fund overseen by Chedraoui - those investors were given their remaining equity back. Chedraoui will serve as chief investment officer of the startup, and Madden will be the fund's chief operating officer.

Their experience is typical. And the delays are considerably longer for firms with principals who have worked in multiple foreign countries and those pursuing out-of-the-ordinary investment strategies.

FSA is returning around a quarter of all applications with questions. It is combing through qualifications of individuals, adding steps to what were already considered rigorous background checks before the Bernard Madoff fraud came to light last December. "It doesn't want a Madoff on its hands," said a lawyer familiar with the FSA's workings.

Non-U.K. managers seeking to set up hedge fund operations in the U.K. are attracting particularly close scrutiny. In those cases, FSA wants to ensure the compliance function is in the hands of trained professionals who understand risk management. FSA is taking great pains to understand the risks proposed funds intend to take.

More than ever before, FSA staffers are grilling all of the key individuals associated with parent companies, as well as staffers responsible for overseeing risk management.

"Earlier, the FSA had a far less onerous application process," said Julian Kroek, a founding partner at New York consulting firm Kinetic Partners. "Now, it's drilling down a lot more, demanding that people demonstrate they understand how to build its risk-based approach into their compliance."

However, the added thoroughness doesn't mean more applications are receiving a failing grade - they are just taking longer to win approval. The delay is seen as costly to some managers, who worry about an attractive market opportunity slipping away. A manager who applied earlier this summer said he's still waiting to be assigned an FSA case manager, the very first step in the approval process. The frustrated manager added: "We've lined up initial investors, but can't go ahead."

FSA chief executive Hector Sants has vowed to revamp the regulatory agency even as it attempts to overhaul the U.K.'s debilitated banking system.

FSA's backlog has grown over the summer as the volume of applications has jumped dramatically - partly fueled by entrepreneurial bankers and traders who are working to start investment firms after losing their jobs during the financial crisis.

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