CAIA L2 - 2.3 - Global Regulation

Question 1

Explain

2 Theories
of Regulation

2.3 - Global Regulation

Answer 1

1. Public interest theory of regulation
   is the idea that regulation should benefit society and reduce the collateral damage caused by free markets to competition and the environment, for example.
2. Private interest theories of regulation
   consider that legislators, businesses, and industry groups may protect self-interests through regulation (e.g., limiting competition, limiting imports).

2.3 - Global Regulation

Question 2

Explain

How increased regulation
can be viewed as a
positive or a negative

2.3 - Global Regulation

Answer 2

Negative:
* Restricts the activities of a business.

Positive:
* Creates new activities that are less regulated.

For example, the increase in commercial lending regulations in the U.S. paved the way for the development of the shadow banking system, which is not as regulated as the traditional banking system. Additionally, the former is more efficient in providing its services.

2.3 - Global Regulation

Question 3

Define

Qualified opportunity zones

2.3 - Global Regulation

Answer 3

tax cuts
that are offered to investors for private equity and real estate investments
in certain areas of the U.S.

As a result, there was a surge in such investments after the legislative change.

2.3 - Global Regulation

Question 4

List

4 Main US regulatory bodies
and their jurisdictions

2.3 - Global Regulation

Answer 4

1. SEC => Securities, markets, investors
   Securities and Exchange Commission - has the main oversight and regulatory authority in the U.S. securities markets. The SEC’s responsibilities consist of safeguarding investors’ interests, promoting capital investment, and ensuring the smooth functioning of markets. The SEC has principles-based disclosure requirements, which means investors must be provided with crucial information about securities prior to investing.
2. FINRA => broker-dealers (self-regulated - SRO)
   Financial Industry Regulatory Authority - is managed by the SEC. FINRA oversees the activities of broker-dealers (both individuals and firms) to ensure that they conduct business ethically and within the stated rules. FINRA is also responsible for developing those rules.
3. CFTC => Commodities Derivatives
   U.S. Commodity Futures Trading Commission - is the oversight body for the commodity derivatives market (both individuals and firms) to prevent any participants from suffering harm caused by fraud and other unethical behavior.
4. NFA => Derivatives (self-regulated - SRO)
   National Futures Association (NFA) is a self-regulating body that oversees individuals and firms involved in trading futures.

Blue-sky laws - State Laws
50 State securities commissions - act jointly with SEC

2.3 - Global Regulation

Question 5

List

5 important
US regulatory frameworks
(Acts)

2.3 - Global Regulation

Answer 5

1. Securities Act of 1933 (Securities Act)
   Regulates => Securities offerings
   mandates securities (including private funds) registration with the SEC, subject to any relevant exemption(s). The objective is for investors to be provided with critical information about the securities traded to allow them to make informed investment decisions.
2. Securities Exchange Act of 1934 (Exchange Act)
   Regulates => Exchange transactions / broker dealers
   oversees the trading activity in the secondary market with regulations for exchanges and broker-dealers.
3. Investment Advisers Act of 1940 (Advisers Act)
   Regulates => Investment Advisers
   deals with registering and regulating those who offer investment advice on securities. An investment adviser is a paid individual or entity who provides investment advice and/or publishes analyst reports on securities.
4. Investment Company Act of 1940 (1940 Act)
   Regulates => Investment funds
   covers companies that invest and trade in securities and whose own securities are publicly traded. The 1940 Act includes mutual funds.
5. Dodd-Frank Act came into effect in 2010
   Regulates => Systemic risk to promote financial stability
   after the major financial crisis. The objective was to shield customers from predatory practices by financial institutions, as well as disallowing taxpayer-funded bailouts for financial firms that were formerly deemed too large to fail.

2.3 - Global Regulation

Question 6

List

Conditions that requires
Investment Adviser registration
(SEC / State)

2.3 - Global Regulation

Answer 6

SEC registration exemptions:
* VC adviser - The adviser advises on venture capital funds.
* Private fund < $150m adviser - The adviser advises on private funds with under $150 million in AUM.

Others
* AUM < $25m: usually no need to register with state or SEC
* AUM $25-100m and has a permanent establishment in a state that requires registration: registration with state
* AUM $25-100m and has a permanent establishment in a state that does not require registration: registration with SEC
* AUM $25-100m and has a permanent establishment in state that does not require examination by the state securities commissioner: registration with SEC
* AUM > 100m and has managed accounts: registration with SEC
* AUM > 150m and no managed accounts: registration with SEC

SEC registration: 2 specific situations
* The fund manager operates a registered investment or business development company.
* (Non US HF) + (> 15 US clients) + (AUM > $25m) - A non-U.S. hedge fund has more than 15 U.S. clients and investors with AUM exceeding $25 million (SEC registration requirements for non-U.S. hedge funds).

2.3 - Global Regulation

Question 7

Identify

Investment advisor
obligations
within private fund regulations

2.3 - Global Regulation

Answer 7

• Comply with 12 matters regulated under the Advisers Act
  1. Adviser agreement terms
  1. Performance fees
  1. Client solicitation
  1. Political contributions
  1. Trading practices
  1. Advertising
  1. Recordkeeping
  1. Personal securities reporting
  1. Custody
  1. Proxy voting
  1. Compliance program
  1. Gifts and entertainment
• Fill out and file Form ADV with the SEC
  Part 1 => fund admin details + staff.
  Part 2 => range of services provided, fees, and conflicts of interest
• Deliver Form ADV Part 2 to clients (part of adviser’s legal obligation)
  D0 (beggining)
  Annually
  when it changes
• Deliver Form CRS to clients
  When? => before investing
  What? fees + conflicts of interest + firm’s disciplinary history
• Cybersecurity - Policies and procedures in place for cybersecurity threats

2.3 - Global Regulation

Question 8

List

Private Placements conditions
(Rule 506 of Securities Act)

2.3 - Global Regulation

Answer 8

Registration of securities = onerous process

• No general advertising => (< 35 nonaccredited investors + nonaccredited have enough skills to assess their suitability)
  or
• General advertising => All investors are accredited

’–
Accredited investors:
* Net worth > $1m (ex residence)
or
* Last 3 years: income > $200k (300k if with spouse)

2.3 - Global Regulation

Question 9

List

2 Tests (conditions)
for the Private Investment Fund
Exemption

2.3 - Global Regulation

Answer 9

• < 100 beneficial owners
• No Public Offerings
• Only Qualified Purchasers

’–
Qualified purchaser:
* Individual > $ 5m in investments
* Institution > $25m in investments

2.3 - Global Regulation

Question 10

List
CCO activities
(Chief Compliance Officer)

Answer 10

CCO PPP MM
1. Policies & Procedures Periodic testing - Perform periodic testing of policies and procedures
2. Review marketing materials
3. Test recordkeeping at least annually

The CCO has the following key duties:
* Establish compliance - Establish the tone from the top, in terms of the firm’s commitment to compliance from senior management down to the employees
* Compliance testing (e.g., testing effectiveness of policies and procedures)
* Report to senior management
* Review documents that provide investment information to investors to ensure nothing is false or misleading
* Ensure all supervisors know their responsibilities for maintaining books and records and testing such policies and procedures at least annually

Question 11

Define

Access persons
and
their obligation (according to code of ethics)

2.3 - Global Regulation

Answer 11

Persons who have access in MNPI

• firm’s directors
• officers
• partners
• other persons

who would be privy to material nonpublic information on securities
‘–
Obligation
- Get approval to invest + report personal securities frequently
Report personal securities transactions and holdings at fixed intervals and to receive approval from the firm prior to investing in reportable securities like IPOs

2.3 - Global Regulation

Question 12

Define

SEC exams

2.3 - Global Regulation

Answer 12

SEC exams

Who?
* done by the Office of Compliance, Inspections and Examinations (OCIE), most commonly on an announced basis

When?
* Normal periodic inspections focus on the marketing materials and the Form ADV to check for any false or misleading statements.
* Cause exams arise from specific tips and complaints.
* Sweep exams arise because of a compliance problem that the SEC has noted in numerous firms.

2.3 - Global Regulation

Question 13

List

7 situations that
Requires Reporting
(by US private funds)

2.3 - Global Regulation

Answer 13

1. > 5% public equity
   Significant acquisition and ownership positions (Section 13(d) of the Exchange Act). Ownership of more than 5% of a class of public equity securities with voting rights may need to provide details on the acquisition—source and amount of funds, purpose.
2. > $100m public equity
   Discretion over $100 million in public equity (Section 13(f) of the Exchange Act). Disclosure of holdings and voting power held by manager.
3. > $150m private fund + details => Form PF
   Form PF. AUM in private funds greater than $150 million must file Form PF with the SEC with details such as fund size, leverage, investor types, liquidity, and performance. Additional information is required for hedge funds, such as strategy and risk.
4. CTA or CPO => Form CPO-PQR
   Form CPO-PQR. Filed with the CFTC by commodity pool operators or commodity trading advisers.
5. Regulation D and blue-sky renewal filings. For private funds with private offerings greater than one year.
6. Pay-to-play and lobbyist registration laws. For private fund advisers who lobby U.S. state or local governments.
7. Short selling reporting. Required in some countries for short positions in specific investments.

2.3 - Global Regulation

Question 14

List

4 European Regulatory Bodies
and
state who is responsible for the stability of financial system

2.3 - Global Regulation

Answer 14

oversight and convergence objectives within EU member countries
* ESMA - stability of the financial system. European Securities and Markets Authority (ESMA): focused on maintaining the stability of the financial system
* EBA European Banking Authority (EBA)
* EIOPA - European Insurance and Occupational Pensions Authority (EIOPA)

-
* ESRB - financial system macro - European Systemic Risk Board (ESRB): focused on macroeconomic aspects of the financial system

2.3 - Global Regulation

Question 15

Contrast

UCITS
x
AIF
characteristics
(in european vehicles / funds)

2.3 - Global Regulation

Answer 15

UCITS - Undertakings for Collective Investments in Transferable Securities
* Retail investors
* Leverage limit
* open-ended
* liquid
* public traded investments

AIF - Alternative Investment Fund
* Larger investors
* leverage is limited by manager (AIFM)
* compensation cap for managers

2.3 - Global Regulation

Question 16

List

2 ways
of Marketing of AIFs by AIFMs
in the EU

2.3 - Global Regulation

Answer 16

1. Marketing passport - All EU to prof investors
   allows marketing of AIFs to professional investors throughout the EU, subject to only one set of rules
   Usually: domiciled in Luxembourg and Ireland
2. Respecting the country’s private placement rules - marketing in certain EU member countries under the country’s private placement rules.

2.3 - Global Regulation

Question 17

Define

Asset stripping rules
(in EU regulation on AIF)

2.3 - Global Regulation

Answer 17

Prohibition:
Acquiring control in a nonlisted company
take debt
distribute dividend
(in 2y after controlling)

2.3 - Global Regulation

Question 18

Differentiate

Home member state
x
Host state
(in EU AIF regulation)

2.3 - Global Regulation

Answer 18

Home member state
is the country in which the AIFM is authorized,

Host state
is the country where the AIF is marketed

2.3 - Global Regulation

Question 19

List

Hong Kong
regulatory requirements
and frameworks

2.3 - Global Regulation

Answer 19

main laws regarding asset management regulation - SFO - Securities and Futures Ordinance
Securities and Futures Commission (SFC) enforce
‘–

AIF private placement (to bypass registration)
1. < 50 persons
2. > HKD 500,000 / person
3. < HKD 5 million
4. Professional investor, which would be financial institutions and intermediaries but not individuals or holding companies controlled by individuals

2.3 - Global Regulation

Question 20

List

Singapore
regulatory requirements
and frameworks

2.3 - Global Regulation

Answer 20

• Main laws regarding asset management regulation - SFA - Securities and Futures Act
• Monetary Authority of Singapore (MAS) enforce
• Fund = collective investment scheme (CIS)
• Variable Capital Company (VCC) = umbrella fund structure
  ‘–

Exemption from CMS licensing
1. < 30 qualified investors / < 15 funds+LP - There is a maximum 30 qualified investors (maximum of 15 of them being funds or limited partnerships)
2. AUM < 250m - Total AUM does not exceed $250 million (per SFA)
3. Registration as a RFMC with the MAS

2.3 - Global Regulation

Question 21

List

South Korea
regulatory requirements
and frameworks

2.3 - Global Regulation

Answer 21

• Main laws regarding asset management regulation - FSCMA (SC SK South Korea) - Financial Investment Services and Capital Markets Act
• Financial Services Commission (FSC) enforce
• All foreign funds offered to Korean investors must be registered with the FSC
• Less stringent registration requirements apply to funds targeted to qualified professional investors
• All advertising must be done locally by Korean firm

2.3 - Global Regulation

Question 22

List

Japan
regulatory requirements
and frameworks

2.3 - Global Regulation

Answer 22

• Main laws regarding asset management regulation - FIEA + ITIC - Financial Instruments and Exchange Act (FIEA) and the Act on Investment Trust and Investment Corporation (ITIC)
• Kanto Local Finance Bureau of Ministry of Finance Japan (KLFB) enforce
• All entities selling funds to Japanese investors must be registered with the Financial Services Agency of Japan (not obligated if not for JP investor)

2.3 - Global Regulation