Spanish regulators reinforce hedge funds' exposure limits

Open-Ended ucits fund of funds forced to reduce holdings

Spain's regulator is forcing some open-ended Ucit fund of funds to eliminate or at least reduce their holdings in protected products as exposure to these vehicles is forcing some to overstep the legally allowed investments into hedge funds.

The problem is occurring because protected products are counted in Spain, along with pure hedge fund holdings, towards statutory limits on allocations by Ucit-approved funds to hedge funds.

Gracia Rubio de Cases, international partner with Spanish legal firm Baker & McKenzie, said the Spanish Security and Exchange Commission limited standard investment funds' investments to less than 5% in shares quotas or securities from other collective investment schemes, or at least 50% for fund of funds. Neither single strategy nor funds of funds can hold more than 10% in unlisted securities, and funds of funds cannot invest over 45% in shares issued by a sole collective investment scheme.

Rubio de Cases said some funds were overstepping these limits by investing in funds of funds, which themselves invested in structured products based on hedge funds. Both were used to calculate the fund's total exposure to hedge funds.

'The case of structured products is peculiar because, whenever an investment is made in a structured product, the regulator treats that not only as the investment in the structured product itself but also as an investment in the underlying situation.

'For purposes of calculating your consumption of (hedge fund asset) ratios, the hedge funds you own directly in your portfolio and the hedge funds that are the underlying assets of the structured product that you have in your portfolio will be counted.'

De Cases said that acquiring assets in excess of the established ratios may mean trouble for more participants than just the asset manager of the fund. 'Eventually it will be an infringement by the custodian who has overlooked the fact the management company was in infringement,' she said.

The funds approached by Spain's regulator have often been family-owned open-ended investment companies and de Cases said no other disciplinary measures had been taken when funds agreed to co-operate with their rulings.

Main limits for standard funds and funds of funds in Spain*

Standard fund

• 5% max in shares, quotas obligations or securities issued by other collective investment schemes (CIS)

• 5% max in securities issued or guaranteed by the same entity

• 15% max securities issued or guaranteed by entities of the same group

Fund of funds

• More than 50% in shares, quotas, or securities issued by other CIS

• 45% max in share issued by a sole CIS

• No investment in other CIS with investment policy that permits it to invest more than 10% of NAV in other CIS

Both

• 35% max in securities issued or secured by EEC member State

• 10% max in unlisted securities

• 17% max in securities not traded in OECD member States

Source: Baker & McKenzie

* Limits based on fund's NAV