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The capital raising environment for hedge funds is as challenging as ever, and hedge funds that are looking to attract institutional investors (currently the largest source of investor dollars) will have to develop the institutional qualities that institutional investors are looking for. The regulatory environment is also more onerous than ever, and a hedge fund that is of institutional quality will be in a better position to successfully navigate the ever increasing regulatory burdens.

The term “institutional quality” is used to describe a hedge fund (and the hedge fund manager (“HFM”) that manages the hedge fund) that has a mix of characteristics that institutional investors require before making an allocation. These characteristics include: (i) a well-developed investment management infrastructure; (ii) a robust compliance regime; (iii) a robust operational platform that meets international standards; (iv) top service providers; and (v) a strong risk management program.

Investors will use the operational due diligence (“ODD”) process at the beginning (and during the life of the relationship) to determine whether a hedge fund is of institutional quality.  Similarly, regulators will use the exam process to determine whether a HFM has the correct processes and controls in place to manage the associated risks in running their business and to ensure that the hedge fund is compliant with the relevant regulatory rules of the jurisdictions in which they are domiciled and transact in.[1] Investment The failure to pass either of these tests will significantly inhibit the HFM’s ability to raise capital. Thus, one of the most important responsibilities of the HFM is to ensure that it can effectively and efficiently meet the requirements imposed on it by investors (the continuing ODD process) and regulators (the inevitable exam process).

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