Analysis: Singapore hedge fund sector set to shrink

HONG KONG/SINGAPORE Thu Dec 1, 2011 11:45pm EST

HONG KONG/SINGAPORE (Reuters) - Singapore's $53 billion hedge fund industry is set for a shakeout as the city-state's planned new regulations are expected to raise costs for scores of already stretched smaller funds, threatening their survival.

The move would represent a partial reversal of Singapore's light-touch regulatory policy that has so far succeeded in drawing hundreds of hedge funds and spawning Asia's second-biggest hedge fund centre.

And while the changes will bring Singapore's rules on par with other major financial centres and are meant to ensure the fund industry's long-term stability, it will mean hedge funds will face more challenges in Asia as they try to grow collective assets to levels attained before the 2008 financial crisis.

The tightening grip of the Monetary Authority of Singapore (MAS), the industry regulator, would mean that many smaller hedge funds will be forced to close or merge or return outside money and convert themselves into a family office to avoid being regulated, industry executives say.

"You will get an initial wave of consolidation when people realize that they are just not going to make it," said Peter Douglas, founder of Singapore-based hedge fund consultancy GFIA.

The MAS wants fund management companies (FMCs) with more than S$250 million ($192.44 million) in assets to obtain a license, while the smaller funds will have to register with the regulator before they can start operating.

All funds will have to be independently audited.

The MAS is asking all such companies to have systems to manage and monitor risks. It will also be mandatory for fund management companies, many of which are organized as hedge funds, to have at least two investment professionals.

The regulator has consulted the industry on the new rules and intends to implement them in early 2012. The move will "achieve long-term sustainability of the fund management industry," the MAS has said.

In the near term though, as much as 15 percent of the nearly 400 hedge funds in Singapore might decide to shut as the rules come into force, said GFIA's Douglas.

Many funds are already not a picture of health. A hedge fund needs to manage at least $30 million in assets to be commercially viable and attract institutional money, according to Douglas. But four in every 10 funds in Singapore run less than $25 million, data from industry tracker Eurekahedge showed.

Operating costs have surged as well. Since the 2009 bottom in rents, office rents have gone up by 38 percent, according to Petra Blazkova, the head of research for Southeast Asia at CBRE. Property prices and transportation costs are also up in the city-state.

The new regulations could be the tipping point for several of the funds. A risk management system alone would cost at least $25,000 a year, with the cost going up depending on reporting and monitoring requirements.

Additional manpower and an independent auditor would mean tens of thousands of dollars more. While the big funds already meet the requirements, the one or two-man teams could effectively see their costs double as they will need at least one more staff member and an auditor.

"For the famous guys, it's not such an issue as they raise a lot of money at the beginning, but for the not-so-famous ones it's a big struggle," said a manager who set-up his own fund three years ago, asking not to be named. "My costs have gone way up. If they get unmanageable then I will have to move or shut down," the fund manager added.

WINNERS AND LOSERS

The shake-up could bring more business for law and auditing firms as hedge funds scramble to ensure compliance with the regulations. Businesses that offer investments from multiple managers may also benefit as portfolio managers join them to stay afloat.

For service providers such as prime brokers and fund administrators, who have expanded aiming to tap start-ups in the city-state, the new rules would pose challenges as fund launches slow, at least immediately after the rules come into effect.

The head of one fund management firm said the city-state was now imposing an expensive box-ticking exercise on the industry, which was unlikely to reduce the risk of a Madoff-type scandal from happening and would discourage people from starting up.

Wall Street fraudster Bernard Madoff's multi-billion dollar Ponzi scheme trapped many hedge funds.

Philippa Allen, chief executive of consultancy firm Compliance Asia, said some of the hedge funds that have offices in Singapore and Hong Kong will likely close one centre.

To skirt the regulations, funds may also return money to external investors, like prominent hedge fund managers George Soros, Stanley Druckenmiller and Chris Shumway have done.

SILVER LINING

Singapore is not alone, even in Asia, to lay a heavier hand on hedge funds.

Fund managers in Hong Kong, Asia's top hedge fund centre, are required to obtain a license. And under the new Dodd-Frank Act in the United States, hedge funds will be forced to register with financial regulators, giving them fresh insight into exactly how these generally secretive portfolios make money.

Some analysts believe a stamp of approval from MAS will help funds raise capital and create a stronger industry. Other rules, such as requiring an independent fund administrator, will give investors the confidence to trust reporting by a hedge fund manager.

The steps could help draw money from institutions and aid a recovery of the Asian hedge fund industry, which now manages about $47 billion less than peak assets of $192 billion in December 2007, according to industry tracker AsiaHedge.

Han Ming Ho, head of Clifford Chance's fund practice in Singapore, does not see an exodus of hedge funds from the city-state due to the new rules and says some of them could actually be beneficial to the industry.

"Now managers can say to the market they are registered by the MAS, which exempt managers under the old regime couldn't do," he said.

(Writing by Muralikumar Anantharaman; Editing by Matt Driskill)

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