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04 March 2024

DFSA issues code to ensure transparency

By Nitin Nambiar


Operators of hedge funds will need to develop systems and controls to mitigate risks related to trading such as price overrides and failed trades, according to the Code of Practice announced by the The Dubai Financial Services Authority (DFSA) yesterday. The code is the first-of-its-kind to be issued by a regulator and comes into effect from January 20.

The DFSA, which is the regulator of firms operating from the Dubai International Financial Centre (DIFC), has set out best practice standards for operators of hedge funds based in the financial free zone.

The DFSA’s initiative to issue a code comes in the wake of enhanced industry and regulatory focus on hedge funds.

The issuance of the code follows several months of consultation with industry professionals and international regulators, who were invited to comment on the proposed rules and offer their opinions on the code.

The DFSA said on its website that the regulatory authority has used a principles-based approach instead of rules in developing its best practices standards.

“We believe these best practice standards will promote certainty, while allowing participants a degree of flexibility to adapt these standards to suit their particular businesses,” it said.

The code contains nine high-level principles, which cover areas of key operational, management and market-related risks, particularly in the areas such as valuation of assets, back office functions and exposure to market risks.

The code lays down guidelines for ensuring objectivity and transparency in the risks taken by investors in the fund. “The code will provide investors and hedge fund managers with a backdrop for successful development of hedge funds in the DIFC,” said Chief Executive David Knott in a statement on the website. He said the regulator received a “highly positive feedback” throughout the consultation.

The standards under principles one to four of the code are designed to address management of operational risks that are associated with skills and resources, investment strategy and trading process and systems and controls, including back office functions of hedge fund operators by laying down guidelines for objectivity and transparency.

The standards under principle five are designed to address portfolio risk management, while principle six standards are designed to address issues of fund valuations. Principle seven deals with conflicts of interest between operators and investors. Principle eight lays down guidelines for systems and controls to deal with market sensitive information, while principle nine lays down conditions to be satisfied for hedge funds investing in an hedge fund.

The code can be found under “legislation” in the new section entitled “DFSA codes of Practice” on the DFSA’s website.

What does this code cover?

The Code of Practice sets out best practice standards for operators of Hedge Funds – both public and private domestic hedge funds – in the DIFC. These are designed to address risks inherent in the operation of hedge funds and are set out under nine principles.

Principle One – An operator of a hedge fund should have, or have access, to appropriate skills and resources to conduct the operations of the fund.

Principle Two – An operator of a hedge fund should develop and implement a robust and flexible investment process to suit the objectives and risk profile of its strategies.

Principle Three – An operator should have systems and controls to mitigate risks related to trading such as price overrides and failed trades.

Principle Four – An operator of a hedge fund should have adequate back-office systems and controls to avoid backlogs in trade confirmations.

Principle Five – An operator of a hedge fund should have appropriate measures to manage portfolio risks.

Principle Six – An operator fund should have adequate valuation policies and procedures to ensure integrity, accuracy and timeliness of the process.

Principle Seven – An operator of a hedge fund should not have arrangements under which any material benefits or concessions are provided to some investors, which could be unfair to others.

Principle Eight – An operator should have adequate systems and controls to deal with sensitive information.

Principle Nine – An operator should not invest in an underlying hedge fund without appropriate due diligence.