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Over the past several years, large U.S. institutions have become an increasingly large portion of hedge fund inflows. In fact, according to a recent Reuter’s article, pension funds, endowments and other large scale American money managers now account for up to three quarters of new money flows into the hedge fund sector. Accordingly, the importance of attracting American assets is growing for European, and even Asian, hedge funds, though significant challenges remain for those trying to enter the U.S. market.

U.S. Regulation Poses Significant Hurdle

One of the major barriers for foreign hedge funds in terms of accessing US investors is the complexity and cost of American regulation. One high-profile hedge fund executive from Europe told Reuters that, “(in terms of regulation) the worst in the U.S.” The requirement to register with both the Securities and Exchange Commission and the Commodity Futures Trading Commission is one such barrier. Many hedge fund managers view the multiple regulators as a hassle, and often face contradictory regulation.

Tax issues also weigh heavily on hedge fund managers looking for U.S. investment. The Foreign Account Tax Compliance Act, or FATCA, will compel all foreign financial institutions to turn over account details to the Internal Revenue Service for American taxpayers with accounts over $50,000. Since tax status is often complex and the penalties for non-compliance are significant, hedge fund views this new regulation as a significant source of regulatory risk.

Competition from U.S. Firms is Fierce as They Defend Their Turf

Foreign hedge funds don’t only have to worry about increasingly vigilant U.S. regulators, but also the fierce competition coming from domestic fund managers within the U.S.  Fund managers looking to crack into the market are having second thoughts about expending resources on what might be an unsuccessful venture.

“The U.S. is the largest market but is very competitive. All our largest competitors are based there. What sense does it make to deploy a tremendous effort with much less success?” Arie Assayag of UBP Alternative Investments, a European Fund Manager, told Reuters.

One of the largest fund managers in Europe, London-based Man Group, has had a similarly negative experience entering the United States market. Despite an intensive effort over several years, American investors still only account for 8 percent of its client base. In response, the company has hired the former head of an American hedge fund, John Rohal, in order to work on improving its attraction of U.S. clients.

This approach seems to be common across the industry and offers an opportunity for American hedge fund professionals looking for an international career. Their inside knowledge of the regulation system and what American clients are seeking can be of significant value to international firms.

And foreign hedge funds do have a competitive advantage, or at least a differentiating factor, when compared to their U.S. peers. Such funds can be viewed as having superior insight in the markets in which they are domiciled, providing potentially superior returns compared to American fund managers investing in the same market. Selling that competitive advantage could offer a significant opportunity for foreign funds in the United States.

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Hedge fund managers might want to begin to learn some Czech as the Eastern European nation becomes one of the latest countries attempting to kickstart a domestic financial industry. The opportunity to establish Prague as a financial center comes as a change in European Union regulation, coming into effect in July, gives preferential treatment to funds located within the borders of the Eurozone. While many of the thousands of hedge funds that will be seeking a local presence will look at the traditional hedge fund hubs such as Luxembourg, many other cities and countries are seeking the opportunity to host firms and the high paying jobs that they bring.

Perhaps surprisingly, the Czech Republic is well positioned as an attractive option for hedge funds, with relatively low local costs of office space and labor, close connections via air to major European centers and a relatively strong financial system. The country’s credit ratings are sound and, in fact, Czech government bonds are trading at a premium to higher rated French securities. That said, political risk remains elevated compared to other European nations, with one of the leading Socialist parties outwardly expressing a less than enthusiastic attitude towards business.

Capacity Issues Leave Luxembourg Stretched

The flood of hedge funds seeking European offices is beginning to have an impact on traditional centers such as Luxembourg. As prime office space and staff become scarcer, firms are finding it more difficult to establish a presence at an affordable price. This is where countries such as the Czech Republic come into play, offering firms the ability to establish a presence within the boundaries of the European Union, but at a very affordable price.

“There may be an issue of capacity backlog in Luxembourg and Ireland if tens of thousands of funds want to domicile,” Czech Deputy Finance Minister Radek Urban told Bloomberg, indicating his plans to draft legislation favorable to firms that wish to locate within his country.

This capacity issue has only been increased by financial turmoil in Cyprus, which has effectively eliminated one potential financial center from the list of hedge funds seeking European offices. While this reduced supply works in favor of countries such as the Czech Republic, it may also increase the important of financial and political stability in the finds of prospective companies.

The Czech Republic Not Only European Country Vying for Hedge Fund Offices

The Czechs are not alone in seeking out the tax revenues and highly skilled jobs that hedge fund offices bring to their economies. More traditional financial hubs such as Frankfurt and London are also expressing interest in making themselves more attractive to potential re-locators. While these jurisdictions certainly carry higher costs than Eastern European locales, they do offer more perceived stability politically and closer physical connections with important markets. While this additional stability will likely drive most of the hedge funds seeking European offices to setup in Western Europe, certainly many will be tempted by lower costs and consider the Czech option.

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Hedge Fund Regulation a Threat to the Industry

March 4, 2013

Across the financial industry, regulation has become the name of the game as officials attempt to reign in risk-taking activities that led to the financial crisis. Unfortunately for the financial industry, much of the regulation is being driven by politics and public opinion, which can be dangerous in a complex environment that is not always […]

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The Hedge Fund Industry Has an Ally in European Parliament

January 28, 2013

The growing pressure that the hedge fund industry is facing from regulators and the few individuals that have been willing to stand against the political tide were featured in a recent piece by the Financial News. Syed Kamall is a member of the European Parliament, representing London, one of the hedge fund centers of the […]

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Hedge Fund Industry Seeks Out Friendlier Jurisdictions

December 24, 2012

Throughout much of the Western world, the hedge fund industry has been targeted by governments that have been active in imposing additional regulations across the financial industry. After gaining a reputation as a source of some of the biggest bets and most reckless risk taking in the lead up to the financial crisis, hedge funds […]

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European Regulators Target Hedge Funds with Risky Rules

November 26, 2012

In what is becoming a fairly predictable trend, leading financial regulators are considering tightening regulations to limit global financial risk. However, recently proposed rules coming from the European Union may actually have a destabilizing impact on financial markets, despite the intention of the rules to decrease the risk that any specific institution may become too […]

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