Suitability of Investment Managers Redefined by "Irish Stock Exchange"

The following article, which was written by Dermot S L Butler, Chairman of Custom House Group,
was originally published in the special supplement to the September 1998 edition of the AIMA Newsletter

The Code

The listing requirements and procedures of the Irish Stock Exchange (known as "The Code") requires that the investment manager of a fund applying for a listing on the Irish Stock Exchange (the "Exchange") must have adequate and appropriate expertise and experience in the management of investments (Paragraph 2.22 of The Code).

The 100 Million Dollar Rule

An investment manager, who had "appropriate expertise and experience", had been, until the 13th August, defined, in broad brush terms, as an investment manager who was managing a minimum of US$100m in third party funds on a discretionary basis, (although the Exchange has proven to be flexible with regard to permitting funds to be listed where the investment manager could demonstrate that he had both experience and expertise but not necessarily US$100m discretionary funds under management).

Prima Facie Compliance

This changed on 13th August last, when the Exchange issued "Practice Note 1/98", in which the Exchange outlined other circumstances in which the investment manager would normally be accepted as having demonstrated prima facie compliance with Paragraph 2.22. In addition to the existing demonstration of prima facie compliance, achieved by way of managing US$100 million, of third party funds on a discretionary basis, other prima facie demonstrations of compliance include the following situations:

* Where the investment manager is regulated in the conduct of investment management business by a recognised regulatory authority, the Exchange will normally accept this fact as prima facie demonstration of compliance with Paragraph 2.22. At this time "recognised regulatory authorities" are limited to any regulatory authority which is charged with the regulation and supervision of investment managers under the law of:

•   a) any EU Member State
•   b) Australia
•   c) Canada
•   d) Hong Kong
•   e) Japan
•   f) Singapore
•   g) Switzerland
•   h) United States.

* An investment manager would normally be deemed to have complied with Paragraph 2.22 where the applicant fund is only open to and has only ever been open to:

•   a) investors subscribing a minimum of US$1m;
•   b) investors who are professional investors; or
•   c) investors equivalent to professional investors as defined in the jurisdiction of the fund, subscribing a minimum of US$100, 000, (however the Exchange should be consulted in advance as to what will be considered "equivalent").

In the context of b), a "professional investor" is any investor which is a sophisticated investor, (which, in general terms, means an investor who subscribes a minimum of US$100,000, or currency equivalent, to any single fund), and which warrants, at the time of making the investment, that its ordinary business or professional activities include the buying and selling of investments whether as principal or agent; or, in the case of a natural person, their individual net worth, or joint net worth with the individual's spouse exceeds US$ 1m; or it is an institution with a minimum amount of assets under discretionary management of US$5m. Furthermore, the investor must warrant expressly to the applicant fund that they have sufficient knowledge, expertise and experience in financial matters to enable them to evaluate the risk of investing in the fund and are aware of the risks inherent in investing in securities and the method by which the assets of the fund are held and/or traded and can bear the risk of loss of their entire investment.

* The Exchange accepts that, where a major internationally reputable investment or securities house has its own labelled fund, or is the named Manager of the fund, delegating to the investment manager, it may be appropriate for the Exchange to rely significantly on the due diligence and assessment of experience and expertise carried out by such major institutions when determining compliance with Paragraph 2.22. However in all cases the Exchange should be consulted in advance.

Rulings in Principle

Even though the Exchange has broadened the base of qualification for prima facie compliance with Paragraph 2.22, the Exchange is nevertheless prepared to consider applications by funds where the investment manager does not meet the particular tests shown above. However the Exchange will have to be satisfied, prior to submission of any listing particulars, that the investment manager has adequate and appropriate expertise and experience. In order to get a ruling in principal on this, the applicant must submit to the Exchange a written submission demonstrating the experience of the investment manager.

Primary Focus of the Exchange

The primary focus of the Exchange, when assessing the suitability of such an investment manager, will be on the prior fund management expertise of the principals of the said investment manager and as such will take into account, inter aria:

•   a) the amount of funds previously managed on a discretionary basis;
•   b) the length of experience;
•   c) the relevance of such experience;
•   d) how recent such experience has been; and
•   e) the size and reputation of previous employers.

The amount of funds previously managed by the principals may include proprietary funds of the principals' employers, together with third party funds which have been managed on a discretionary basis, although the proprietary element must exclude personal and family monies, or monies in which the principal has, or has had, a beneficial interest.

The "relevant" fund management experience should be in the same geographical markets, industry sectors and security types as those in which the applicant fund will invest.

Furthermore, the Exchange would normally expect at least one principal of the investment manager to have a minimum of five years of such relevant investment management experience, with discretionary management over at least US$100m during the most recent experience. Such experience should be in a directly relevant area of investment to the applicant fund.

Other Factors to be Considered

In addition to the factors that the Exchange will consider as their primary focus when assessing suitability, the Exchange will also give due consideration to other factors relevant to the experience of the principals of the investment manager and to the particular circumstances of the applicant fund when considering suitability. Examples (this list is not exhaustive) of other relevant factors include, inter aria:

•   a) level of current funds under administration;
•   b) the applicant fund's minimum subscription;
•   c) level of involvement and expertise of investment advisors to the fund;
•   d) the expertise and reputation of the sponsor or arranger of the fund;
•   e) the level of proprietary funds managed;
•   f) the gross assets and notional funds under management;
•   g) prior relevant trading experience;
•   h) prior relevant investment advisory experience; and
•   i) the size and reputation of current clients of the investment manager.

It is important that the Exchange is supplied with all information which the Fund and its advisors consider relevant and to provide that information in a comprehensive and clear form so as to enable an informed assessment on suitability to be made.

Comment

The broadening of the definitions of appropriate expertise and experience with regard to investment managers will be welcomed with open arms. The previous somewhat arbitrary definition of a minimum of US$100m of discretionary monies under management precluded many investment managers, who undoubtedly had suitable and appropriate expertise and experience, but insufficient assets under management. This necessitated applying for a ruling in principle, which requirement, to a large extent, has now been avoided.

Perhaps the most important change is the acceptance of suitability of an investment manager who is properly regulated by a recognised regulatory authority. In today's regulatory environment, almost all CTAs and other investment managers, including hedge fund managers, are regulated by the CFTC, SFA or by their domestic regulatory authority and, providing the regulatory authority is from the list of recognised countries, then this aspect of an application for listing of a fund on the Exchange can be seen to have been enormously simplified.

Dermot S.L. Butler is Chairman of Dublin-based Custom House Administration & Corporate Services Limited ("Custom House"), a company that specialises in assisting clients in the organisation, establishment and administration of alternative investment and hedge funds. Custom House is authorised by the Financial Regulator, (formerly the Central Bank of Ireland), under the Investment Intermediaries Act, 1995.