/ Chilean pension funds are ready to invest in private equity and private debt: hedge fund rule clarified to remove obstacle for investment.

September 25, 2018

The Chilean pension regulator has recently released an important clarification (SP Official Ruling 18847 dated August 24, 2018 – “the Clarification”) to the hedge fund prohibition rule (SP NCG 220 – Hedge Fund Prohibition).

In previous newsletters we had been discussing the regulations issued by the Chilean pension regulator (Superintendencia de Pensiones – “SP”) to implement the amendment made by Law 20,956 to the pension fund statute (DL 3,500) that would allow direct investment of Chilean pension funds in foreign private equity funds and make co-investments (click here to see our earlier newsletters discussing the regulations and this statutory amendment) and the effects of the Hedge Fund Prohibition (click here to see our earlier newsletter discussing this prohibition).

The SP has been trying to ensure that by permitting Chilean pension fund (“AFP”) investment in alternative assets such as private equity, infrastructure, real estate and private debt, the door was not inadvertently opened for investment in hedge funds. The SP has long had a negative bias towards hedge funds and has stated that this would be supported by research that apparently concludes that the risk/return ratio of hedge funds as an asset class would not add value to the general performance of AFPs. While it is unclear why such research should lead to the banning of an entire asset class, it has been challenging for the SP to ban hedge funds without in turn inadvertently catching true private equity or private debt funds. This is in practice what had been happening for the past nine months.

Initially, in November 2017 the SP prohibited investment in any investment fund that used hedge fund investment strategies. This prohibition was so broad that it also caught highly regulated mutual funds.

In an attempt to narrow the ban, the SP, after public consultation, issued rule SP NCG 220, which on the one hand clarified that US 1940 Act Funds and UCITS would not be caught notwithstanding that they may have hedge fund sounding investment objectives such a macro, long/short, total return, etc., but on the other provided for three requirements that all private funds had to meet in order not to be considered hedge funds.

These three requirements were (1) that the fund not be registered as a hedge fund, (2) that the fund not self declare itself as being a hedge fund and (3) that the fund be registered for either public or private distribution in an Authorized Jurisdiction.

These three requirements raised all sorts of questions as to what they would mean. One item of concern was the “registration for distribution” requirement given private funds are typically not registered with any securities regulator. Another issue was whether reporting of the fund by the manager on US SEC ADV Form as a hedge fund would be tantamount to a self declaration as a hedge fund. The reason for this is that the definition of hedge fund on Form ADV captures many funds that are not hedge funds in the ordinary dictionary and commonly understood meaning of the term.

In response to these concerns the SP issued two official opinions. The first one clarifies that the term “registration for distribution” would mean any filing equivalent to a US SEC Form D filing, which is in line with industry practice in relation to private funds that are exempt from registration to be distributed in the US.

The second one, which we referred to in the introduction to this newsletter as the Clarification, states that Form ADV reporting shall not be taken into consideration for the purpose of determining when a fund is a hedge fund and therefore a prohibited investment for AFPs.

This is all good news for the purpose of improving future pensions, given it helps to remove obstacles for exposure to private equity as an asset class.

However, there are still issues to be ironed out in the regulations as well as in side letters to private fund limited partnership agreements concerning matters such as free transferability of limited partnership interests, quarterly reporting requirements imposed on GPs relating to fees and valuations and minimum 1% investment by GPs and related parties in the funds that the AFPs invest in.

Felipe Cousiño