This is a guide for those managers who want to start a forex hedge fund. It provides information on forex hedge fund structures, an overview of the registration requirements, and a discussion of the process of forming a forex hedge fund. For the purpose of this article we are focusing on spot forex transactions, but much of this information also applies to those managers who trade foreign currency futures and forwards contracts.
Background – Growth of Forex Hedge Funds
While there are no statistics on the number of forex hedge funds or the amount of assets under management, anecdotal evidence suggests a rather large influx of capital into forex hedge funds and certainly managers are deciding to start forex hedge funds in record numbers. It is not hard to understand why. Spot forex has been a popular investment choice for both the retail and instiutional investor who are looking to generate investment returns which do not mirror the stock markets. Many of these managers have been managing their own accounts, prop accounts, or the accounts of their friends and family and now these same managers are starting their own forex hedge funds (also known as forex commodity pools) to bring their strategy to a larger group of investors.
Structural Considerations for Forex Funds
Forex hedge funds or commodity pools are a little bit different than traditional hedge funds because of the extreme liquidity which is a characteristic of the off-exchange foreign currency markets. Because of the liquidity and ease of getting into and out of positions without moving the markets, the structure is typically more flexible and “investor friendly” then other funds.
Specifically, some of the central structural characteristics of forex funds include:
- generally no lock-up (although some managers may have very short lock-ups of 3 or 6 months)
- generally monthly liquidity with notice as short as a week (HFLB note: while many managers would have the ability to allow more frequent redemptions, we do not recommend this practice unless the manager has a good back office which can efficiently handle redemption requests)
- generally monthly performance reporting and some managers even provide more frequent performance reporting
- usually management fees of 1% to 2% and performance fees of 20% or some other sort of “tiered” or “graduated” performance fee structure
Risk Management for Forex Hedge Funds
It is imperative that forex managers have robust risk management procedures. Because of the highly leveraged nature of spot forex transactions, there are unique risks which a manager must be aware of and which the manager must address. Managers will need to discuss their risk management programs with their attorneys. Instiutional investors, especially, will make sure that hedge fund management companies have strict risk management structures in place – this is likely to be a hot topic during the hedge fund due diligence process.
Registration Requirements for Forex Funds
Until this year the CFTC and the NFA had no authority to regulate managers who only traded in the spot forex markets. Congress passed the Farm Bill which provided the CFTC and the NFA with a mandate to register forex managers and associated persons. While final rules have not yet been promulgated, they will likely require all active owners and associated persons to have both a Series 3 exam license and a Series 34 exam license (there may be a grandfathering provision for those persons who were registered as APs prior to the passage of the Farm Bill).
Forex managers will also need to have their disclosure documents approved by the NFA – this requirement will apply to both managers who have separately managed account programs as well as Forex commodity pools. It is also likely that Forex managers will need to institute some sort of NFA compliance program and the manager’s lawyer or compliance firm can help design a Forex compliance program based on the firm’s specific structure.
Because of the registration requirements and the disclosure document submission procedures, the time it takes to establish a Forex fund going forward is likely to be at least a couple of months from the date the manager passes the Series 34 exam. Additionally, based on the manager’s situation the timeline may be longer or shorter – the manager’s Forex lawyer or compliance firm will be able to provide more in depth guidance once the facts of the fund have been determined.
Forex Hedge Fund Prices
Like other hedge fund strategies, forex hedge fund pricing will be similar to other types of futures programs. For many managers, the best choice will be to go with a boutique law firm who will be able to draft the Forex offering documents as well as guide the manager though the Forex registration process. Depending on the law firm and the investment program the cost for establishing the Forex hedge fund will be anywhere from $15,000 to $20,000 or more. These costs may or may not include the registration process. If a manager chooses to go with a larger national law firm the costs will likely start at $25,000 or higher.
Offshore Forex Hedge Funds
Because of the worldwide popularity of off-exchange foreign currency trading, there are many Forex managers which are located in offshore jurisdictions and many non-U.S. investors who would like to invest in these programs. Many managers would like to create programs which are available for both U.S. and non-U.S. investors. Depending on the facts of the situation the manager may or may not need to go through the Forex registration process.
Contact us to get started with your forex hedge fund today. Our experienced attorneys and staff can help you to get registered as quickly as possible. We will also be able to help you navigate the regulatory maze and make sure you know the rules so that you stay out of trouble with the NFA or CFTC.
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