Considerations By Managers Of Private Funds In Light Of Potential Eurozone Crises

Author:Mr Kevin Scanlan, Matthew K. Kerfoot, M. Holland West and Jeremy I. Senderowicz

European financial markets have experienced volatility and have been adversely affected by concerns regarding rising government debt levels, credit rating downgrades, and possible defaults on or restructuring of government debt of various countries, most notably Greece. These events have affected the value and exchange rate of the euro and have had varying impacts on fund strategy, performance, investments, operations, liquidity and counterparties.

This turmoil has fed speculation that one or more European Union Member States that have previously adopted the euro might choose or be forced to abandon the euro and return to a national currency. Further, there is great uncertainty as to whether the euro can con-tinue to exist as a single currency following a departure of one or more countries from the currency mechanism. Such events could have a dramatic impact on many aspects of fund management and investment, particularly for euro-denominated funds.

Managers of private funds (Managers) should consider how such events may affect their funds and evaluate what amendments, if any, may need to be made to fund documentation in order to provide them with sufficient tools and discretion to effectively manage the impact of any such developments.

Offering Document Disclosure: Investment Strategy and Risk Factors

Depending on a fund's investment strategy and restrictions, the fund may be adversely affected by a sovereign's rating downgrade, a country withdrawing from the euro and/or general market turmoil resulting from such events. A fund that is denominated in euros or that invests in instruments predominantly tied to Europe or the euro (whether directly or indirectly through derivatives) will be signifi-cantly exposed to the increasing volatility of the European financial markets. The sections of the fund's offering documentation discussing the fund's investment strategy, investment restrictions and investment objective should set forth important details regarding, among other topics: (i) the currency denomination of the fund or a particular class of shares; (ii) necessary and/or desired credit ratings of (the applicable portion of) the fund's invest-ments and counterparties; and (iii) Manager obligations upon a credit rating downgrade of an investment or counterparty (e.g., obligation to sell investment position, cancel position with a downgraded counterparty and/or notify investors). Managers should consider whether the current requirements or obligations set forth in these sections are applicable and reasonable in the current environment and whether it may be necessary to update any restrictions and/or provide the Manager with additional investment flexibility or discretion in the event of downgrades or other related matters.

Managers should also review and update the risk factors set forth in fund offering documentation as necessary to reflect risks associated with any current or potential eurozone crises. In addition to discussing recent events such as credit rating downgrades and financial market volatility, Managers should consider adding in-depth disclosures regarding the impact a breakup of the eurozone or abandonment of the euro by one or more countries could have on the fund, its investments, counterparties and service providers.

In conjunction with adding to or updating eurozone risk factors, Managers should also consider whether updates are required to other regulatory documenta-tion. For example, Managers that are U.S. registered investment advisers should update their...

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