Research from The Bank of New York Mellon and Kinetic Partners reveals a lack of consensus for regulatory enforcement of standards

LONDON, March 17, 2008 — Despite the ongoing 'credit crunch,' more than half the UK-based hedge fund managers have little or no awareness of the Alternative Investment Management Association's (AIMA) recommendations on hedge fund valuations, according to a new report conducted by Kinetic Partners on behalf of The Bank of New York Mellon.

The Bank of New York Mellon report, "Hedge fund valuation standards: evolution, not revolution," discovered that despite the lack of awareness of the report, there was general consensus (over 81%) that better governance of hedge fund valuation would be beneficial to improve the standing of alternative investments among institutional and private investors. Greater expectations about standards of operational risk controls from new classes of hedge fund investors and pressure by regulatory forces to protect private investors from exposure to complex alternative products are increasing the need for ever higher standards of risk management.

As a result, nearly two-thirds of respondents had already implemented one or more of AIMA's recommendations prior to their publication, albeit independently. Sixty per cent confirmed that they utilise a Valuation Policy Document (VPD), with the remaining 40% having a plan to introduce a VPD in the near future.

Industry participants were confused about AIMA's recommendations and it appears that many UK-based hedge fund managers feel that the recommendations haven't had a clear impact on the hedge fund industry. The respondents who were against further regulation in this area stated that AIMA does not have jurisdiction to set binding rules and that the cost of implementing these alongside the existing mandatory requirements, such as MiFID and ICAAP, could damage the attractiveness of the UK as a centre for investment managers.

The research established considerable confusion about existing standards. Numerous bodies have promulgated best practice recommendations on valuations, including IOSCO and the FSA, as well as AIMA and the Hedge Fund Working Group, established by 14 large European hedge funds in October 2007.

Whilst there was almost a 50/50 divide as to whether AIMA's recommendations should or should not be enforced by regulators, the results and analysis show that enforcing sound practice through regulation might not prevent the next market crisis. In spite of this, respondents in favour of regulation believed that enforcement would increase industry confidence and the net effect would be a more robust and better controlled alternative investment industry.

David Aldrich, managing director, The Bank of New York Mellon, said: "Our report highlights that it is not possible or practical to set rigid valuation standards that work for all parties given the different strategies and complex products that exist in the hedge fund industry. If self-regulation is to be effective, it is essential that best practice is understood and applied. As alternative investment products become available to new classes of investors, the reputational and financial risk to the industry of a valuation failure becomes more acute. It is essential that the industry continues to work hard to apply those best practice guidelines that have recently been published."

Julian Korek, a founder member of Kinetic Partners, said: "Valuation is a critical issue for hedge funds. Because many hedge funds invest in illiquid, hard-to-value and esoteric instruments, it is vital for investor confidence and protection that hedge funds implement robust standards for valuing their holdings. Many of the fund failures and frauds witnessed in recent years, particularly in the US, have had inflated or inaccurate valuations at their heart. Recent market volatility and the credit squeeze have caused fund failures and underperformance in many other funds, prompting some market observers to argue in favour of increased regulation. Others continue to believe that self-regulation via improved best practice standards is sufficient."

The research for The Bank of New York Mellon/Kinetic Partners report was conducted with leading UK-based hedge fund managers, with AUMs ranging from $10m to in excess of $10bn, in the six months following the release of the Sound Practices for Hedge Fund Valuation (The AIMA Guide) in March 2007. The purpose of the guide was to assist investors, fund managers, service providers and all interested parties in providing recommendations on covered governance, transparency, procedures and methodology.

The AIMA Guide to Sound Practices for Hedge Fund Valuation is available at: www.aima.org/uploads/ExecSummaryAIMAGuideSPforHFValuation2007.pdf.

The Bank of New York Mellon
The Bank of New York Mellon Corporation is a global financial services company focused on helping clients manage and service their financial assets, operating in 34 countries and serving more than 100 markets. The company is a leading provider of financial services for institutions, corporations and high-net-worth individuals, providing superior asset management and wealth management, asset servicing, issuer services, clearing services and treasury services through a worldwide client-focused team. It has more than $23 trillion in assets under custody and administration, more than $1.1 trillion in assets under management and services $11 trillion in outstanding debt. Additional information is available at bnymellon.com.

Kinetic Partners
Kinetic Partners is a global professional services firm providing audit and assurance, tax, regulatory risk and compliance, and forensic services to the investment management industry.

Launched in 2005 as a viable alternative to the 'Big Four' and a one stop shop for clients wanting in-depth industry expertise, we are a true global partnership structure offering a seamless and bespoke service. Kinetic Partners operates out of London, Dublin, the Cayman Islands, New York and Geneva.

www.kinetic-partners.com

This publication, which may be considered advertising, is provided with the understanding that it is for informational purposes only and does not constitute the rendering of legal, tax or accounting advice or other professional advice by The Bank of New York Mellon or its affiliates. Any discussion of tax matters contained in this publication is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code or promoting, marketing or recommending to another party any transaction or matter. This material may not be reproduced or disseminated in any form without the express written permission of The Bank of New York Mellon. The Bank of New York Mellon does not guarantee the accuracy of any information contained herein and cannot be held liable for any errors in or reliance upon this information. Prior results do not guarantee a similar outcome.