(May 7): China tightened rules for hedge funds, raising the minimum-asset threshold of the 5.5 trillion yuan (RM3.61 billion) industry while imposing restrictions on the use of derivatives and leverage.
Private securities investment funds need to raise at least 10 million yuan initially to set up and maintain a minimum of 5 million yuan in assets or face liquidation, according to new rules published by the Asset Management Association of China on April 30, after toning down a draft version that fueled concerns about the impact on small players.
The so-called “operational guidelines” which will take effect on Aug 1, are expected to weed out weaker and less compliant hedge fund firms. The rules cap both total leverage and borrowing through equity-related total return swaps at 100%, while also limiting exposure to derivatives like “snowballs” to 25% of a fund’s net assets.
The finalised rules came after regulators curbed some trading by quantitative hedge funds in a market meltdown earlier this year and punished a few players in an escalated clampdown on violations by the less-regulated industry. The market is still “pretty polarised” with the 2,000 smallest players — out of a total of about 8,300 — running only 0.15% of the total assets. Some managers have been found to lack discipline and have harmed investors’ rights, according to the association, which is supervised by the securities regulator.
“It’s necessary that regulation and management are strengthened to promote the stable and healthy development of the industry,” AMAC, as the group is known, said in the April 30 statement.
The final rules halved the minimum asset requirement for a hedge fund to sustain operations from 10 million yuan in the draft. The earlier version raised concerns that more than a third of the existing products could be forced to liquidate, according to estimates by Shanghai Suntime Information Technology Co, which tracks hedge funds.
After “fully assessing” industry feedback, the association lowered the threshold and allowed a 120 trading-day grace period before liquidation, the association said. Funds with less than 5 million yuan, which include many “shell” products that are no longer operational, accounted for a “very small” part of the industry as of March 31, according to a statement. Small players that “lack the ability to sustain operations” have less than 10 billion yuan in combined assets; hence, the impact is “relatively small”, it added.
The new guidelines capped the leverage that hedge funds can borrow from brokerages through swaps at 100%, formalising earlier window guidance that restricted a highly leveraged strategy known as direct market access (DMA). The rules also require investments in over-the-counter options products like snowballs to be no more than 25% of fund assets, with the exception that all clients are professional investors who each put in at least 10 million yuan.
While funds that fail to meet requirements on OTC derivatives will be barred from raising new money or extending maturities, existing contracts can continue till they mature, the association said, limiting the market impact.
Regulators have been tightening the reins on brokers’ derivatives businesses after the DMA products and snowballs helped fuel the selloff earlier in the year. Officials last month told some of the biggest brokerages to suspend any increase in their net exposure to OTC derivatives involving domestic A shares, including snowballs, Bloomberg News reported then.
The final rules also cut the minimum six-month lockup period in the draft to three months and allow more frequent redemptions.
