Handbook of Hedge Funds

3

Legal Environment

On average, the life span of a regulation is one-fifth as long as a chimpanzee’s, one-tenth as long as a human’s, and four times as long as the officials who created it.

In the past, the need for regulation and supervision of financial intermediaries dealing with the general public was rarely challenged. The regulators’ objective was threefold: (i) to protect small investors and depositors from abuse and default through licensing, registration, minimum disclosure requirements and increased transparency; (ii) to reduce systemic risks and ensure soundness and integrity of the financial system by imposing capital adequacy and margin requirements; and (iii) to ensure that customers were provided with quality service at competitive prices.

The regulatory situation of hedge funds, compared to that of traditional financial intermediaries such as banks, mutual funds, brokerage houses or insurance companies, has always been equivocal. On one hand, hedge funds operate in regulated markets, utilize the infrastructure of regulated financial centres and deal with regulated financial institutions (e.g. brokers and banks) to implement their investment strategies. They are therefore in a sense indirectly regulated. On the other hand, hedge funds tend to structure themselves in such a way as to avoid direct regulation oversight and escape the registration or licensing requirements generally applicable to investment companies. They want to operate with maximum flexibility, ...