Grey matters

The Conundrum of Hedge Fund Definition

Hossein Nabilou


Forthcoming available at

This article attempts to define hedge funds and to distinguish them from a variety of similar investment funds. After reviewing the hedge fund definition in the U.S. and the EU, this article argues that the current regulatory framework, which defines hedge funds by reference to what they are not rather than to what they are, is prone to regulatory arbitrage. Even in the presence of a statutory definition, due to the ineluctable indeterminacy of language and regulatory arbitrage problems, borderline issues will persist, which makes statutory definitions of hedge funds neither possible nor desirable. Therefore, regulators should avoid the temptation of proposing such statutory definitions. Instead, they should rely on regulatory discretion within a broad principles-based regulatory framework to do so. For such a principles-based regulatory regime to work, regulators should rely on a functional definition of hedge funds. Accordingly, this Article defines hedge funds as privately organized investment vehicles with a specific fee structure, not widely available to the public, aimed at generating absolute returns irrespective of market movements (Alpha) through active trading and making use of a variety of trading strategies. This functional definition is likely to help address regulatory problems that might originate from statutory definitions of hedge funds.

CFR Comment:
These two pieces by a professor from Luxembourg highlight issues in hedge fund regulation and reasons why regulators on both sides of the Atlantic may take up changes going forward.


How Countries Should Share Tax Information

Arthur J. Cockfield

(November 30, 2016) available at

There are increasing policy concerns that aggressive international tax avoidance and offshore tax evasion significantly reduce government revenues. In particular, for some low-income countries the amount of capital flight (where elites move and hide monies offshore in tax havens) exceeds foreign aid. Governments struggle to enforce their tax laws to constrain these actions, but are inhibited by a lack of information concerning international capital flows. The main international policy response to these developments has been to promote global financial transparency through heightened cross-border exchanges of tax information. The paper discusses elements of optimal cross-border tax information exchange laws and policies by focusing on three key challenges: information quality, taxpayer privacy, and enforcement. Relatedly, the paper discusses how the exchange of automatic ‘big tax data’ combined with data analytics can help address the challenges.

CFR Comment:
The remedy for the failure of information exchange to yield all the benefits claimed for it will surely be requirements of yet more information exchange. Here is an opening salvo in that battle.


Closing the Hedge Fund Loophole: The SEC as the Primary Regulator of Systemic Risk

Cary Martin Shelby

BOSTON COLLEGE LAW REVIEW, 58, forthcoming, available at

The 2008 financial crisis sparked a flurry of regulatory activity and enforcement in an attempt to reign in activity by banks, but other institutions have also been identified as potentially threatening to the stability of the financial markets. In particular, several empirical studies have revealed that systemic risk can be created and transmitted by hedge funds, which are private investment funds that have historically evaded regulation under the federal securities laws. In response to the risk created by hedge funds, Congress granted the Financial Stability Oversight Council (“FSOC”) authority under the Dodd-Frank Act of 2010 to designate hedge funds as Systemically Important Financial Institutions (“SIFIs”). Such a designation would automatically result in stringent capital constraints and limitations on liquidity risk on these nonbank institutions. However, in the over six years since FSOC has been granted this authority, it has failed to identify even one hedge fund as a SIFI. The council has encountered a variety of challenges such as criticisms to systemic risk studies sanctioned by FSOC, and massive resistance to the SIFI designation process by numerous industry participants. If this designation were applied to hedge funds it would severely limit the abilities of hedge fund advisers to pursue certain strategies. For these reasons, it is highly unlikely that FSOC will designate a hedge fund as a SIFI. The inability of FSOC to regulate systemically harmful funds is particularly troubling because several post-financial crisis studies have revealed that systemic risk can still be created and transmitted by hedge funds. Given FSOC’s inability to close this hedge fund loophole, this Article argues that Congress should explore appointing the SEC as the primary regulator of systemically harmful funds because; (1) the transparency framework inherent in the federal securities laws can supply a more effective means for mitigating systemic risk than the prudential framework currently mandated for SIFIs, and (2) appointing the SEC in this regard would reduce the fragmentation of our current regulatory structure which has been extended and complicated by the creation of FSOC. While the federal securities laws are typically used to promote investor protection, this Article posits that enhancing transparency to hedge fund counterparties and investors can decrease systemic risk by empowering such market participants to better protect themselves against risk. Enhancing protection in this manner could in-turn weed out systemically harmful funds from the marketplace, without imposing the severe capital constraints that would be mandated under FSOC’s model. With respect to reducing the fragmentation of our current regulatory structure, this Article argues that lawmakers should dedicate resources to reforming our existing agencies instead of creating additional layers of ineffective regulation that could lead to repeated failures, undue complexities, and wasted resources.

CFR Comment:
Sometimes it seems like the magic words to justify a new regulatory measure are “systematically important”. Here they are invoked to bring the SEC into the picture to remedy the FSOC’s failings. While a debate over whether the incoming Trump Administration will seek Dodd-Frank repeal is in the news, watching for things like this to sneak into any “repeal” or “reform” measure is worth doing.


A Catharsis for U.S. Trust Law: American Reflections on the Panama Papers

Reid K. Weisbord

COLUMBIA LAW REVIEW ONLINE, 116: 93-107 (2016) available at

In April 2016, a massive leak of confidential legal documents, now known as the “Panama Papers,” attracted international scrutiny and condemnation of offshore asset protection trust arrangements. Such trusts are legal to create but notoriously susceptible to abuse by wrongdoers seeking to hide assets from the peering eyes of tax collectors and creditors. The Panama Papers offer compelling evidence of something long suspected but difficult to prove for lack of transparency ‒ even though asset-offshoring techniques may be used for legitimate purposes, they are, in fact, too often abused as a cover for criminal activity and tax evasion. In response to the leak, the U.S. Department of Justice and several foreign law enforcement agencies opened investigations into the financial improprieties uncovered by the Panama Papers. However, before criticizing offshore trust havens for capitalizing on fraudulent behavior at the expense of nonresident claimants, U.S. state lawmakers should first reflect upon the recent wave of domestic trust legislation authorizing similar conduct here at home. This article is a patriotic catharsis lamenting the recent trend of U.S. trust law to sanitize some of the most controversial and widely abused offshore trust practices and urges lawmakers to take steps toward its reversal. Three aspects of U.S. trust law, in particular, have authorized asset protection techniques similar to those permitted in offshore trust havens: (1) self-settled asset protection trusts, (2) nonresident tax shelters, and (3) trust secrecy. The article concludes with a discussion of existing federal law protections against domestic trust abuse and recommendations for reform.

CFR Comment:
An interesting call for changes in U.S. trust law to block use of offshore trusts to avoid U.S. taxes.


Global Developments in Trust Arbitration

S.I. Strong


Over the last few decades, arbitration has become increasingly popular in a wide variety of contexts and jurisdictions. However, up until recently, one field ‒ trust law ‒ has stood apart and resisted the pull toward arbitration. Over the last few years, this tradition has begun to change. Indeed, an increasing number of jurisdictions have begun to embrace the arbitration of internal trust disputes, meaning disputes involving trustees and beneficiaries and relating to the inner workings of the trust. Although trust arbitration has received support from numerous courts, legislatures and commentators, the procedure is still in its infancy, and numerous questions exist about the use, scope and validity of arbitration provisions found in trusts. This chapter describes the key issues in the area of trust arbitration as a matter of both national and international law and introduces the work of other contributors to a new volume of collected essays on trust arbitration. Both the chapter and the book in which it is found consider trust arbitration from both a trust law and arbitration law perspective, which is critical to a proper understanding of the issues at stake. The chapter and the book also discuss trust arbitration as a matter of domestic and international law, thereby recognizing the differences in national approaches to trust arbitration while also respecting the importance of offshore jurisdictions in trust law and practice. Trust arbitration is a new and exciting area of law, practice and scholarship, and one that will be growing rapidly in the coming years. This chapter provides an important introduction to the comparative, international and interdisciplinary issues that arise when settlors seek to require arbitration of trust-related disputes through inclusion of an arbitration provision in a trust.

CFR Comment:
An introduction to an important trend. Jurisdictions that focus on trusts need to be thinking ahead to how they will adjust.


Culprits or Bystanders? Offshore Jurisdictions and the Global Financial Crisis

Daniel Haberly & Dariusz Wojcik

(November 21, 2016) available at

Questions have been raised regarding the role of low-tax offshore jurisdictions in the global financial crisis, based largely on evidence that many problematic asset-backed securities were issued from or listed in the Cayman Islands, Jersey, Ireland, and other ‘offshore’ sites. However, there has not been a systematic investigation of the offshore geography of crisis-implicated securitization. Here the authors fill this gap by constructing the first comprehensive jurisdictional map of the largest pre-crisis Asset-Backed Commercial Paper (ABCP) programs, and examining the rationale for and impacts of this geography in detail. They show that offshore jurisdictions were disproportionately involved in producing the most unstable ABCP classes. However, this is difficult to explain in terms of the traditional role of offshore banking centers as sites for direct avoidance of onshore regulation and transparency. Rather, they propose a Minskian model of pre-crisis offshore ABCP production, wherein these jurisdictions specialized in alleviating incidental institutional frictions (e.g. double taxation) hindering onshore financial innovation. In this context, they could sometimes be legitimately described as improving the institutional ‘efficiency’ of financial markets; however, by facilitating the endogenous evolutionary instability of these markets, this apparently innocuous service had profoundly negative effects. This normative disconnect poses a conundrum for offshore reform.

CFR Comment:
Useful data and some great visualizations, although some tough sledding in the text for those not up on Hyman Minksy’s theoretical frameworks.


Finally, two papers look at the impact of moving transactions offshore.


Offshoring and Audit Reviewer Effectiveness

Frank D. Hodge & Kim Ikuta

(November 3, 2016) available at

In order to reduce costs, audit firms have begun transferring audit tasks to offshore locations in countries such as India. Consequently, new audit associates no longer perform these tasks. They are, however, asked to review them. If gaining experience completing audit tasks is an important building block to effectively reviewing those tasks, then offshoring may negatively impact future audits. Using an experiment, the authors investigate this concern and find that auditors who lack experience completing relatively complex audit tasks are less effective during the review phase of an audit than are auditors who have experience completing the tasks. They also find that a simple training exercise does not eliminate this problem. The results highlight a potentially hidden cost of offshoring, one with important implications for audit firm training if offshoring trends continue.

CFR Comment:
This brief paper raises an important question, one which accounting regulators might want to consider in thinking about who should be able to sign off on audits.


Domestic Financial Markets and Offshore Bond Financing

José María Serena & Ramon Moreno

BIS QUARTERLY REVIEW (September 2016) available at

Firms in emerging market economies markedly increased their issuance of bonds in offshore markets after the great financial crisis. By contrast, increases in offshore bond issuance by firms in advanced economies were more muted. An empirical analysis suggests that the less developed state of financial markets in emerging economies may have encouraged firms there to step up their offshore bond issuance as external financing costs fell. Firms appear to use the proceeds of offshore bonds to boost their holdings of short-term assets. This may raise financial stability concerns.

CFR Comment:
An excellent empirical investigation of the impact of multijurisdictional financing.



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