Lack of detail relating to private pools of capital

The US financial reform white paper released by the US Treasury had a section on private pools of capital. The headlines read:

All advisers to hedge funds (and other private pools of capital, including private equity funds and venture capital funds) whose assets under management exceed some modest threshold should be required to register with the SEC under the Investment Advisers Act. The advisers should be required to report information on the funds they manage that is sufficient to assess whether any fund poses a threat to financial stability.

But what about the detail? Almost all of these firms have more than one corporate structure and those structures are most incorporated in more than one country. Managers will incorporate in the US, UK, Hong Kong, Singapore, Japan, Australia, Dubai, Europe etc, while funds / pools of capital can be incorporated out the US, Cayman, BVI, Luxembourg, Ireland, Hong Kong, Singapore and the list goes on. Larger hedge fund management groups will have many structures in place. Private equity firms have even more due to the way that they raise and apply capital.

Treasury was short on detail. This is what they said in explaining the headline above:

In recent years, the United States has seen explosive growth in a variety of privately owned investment funds, including hedge funds, private equity funds, and venture capital funds. Although some private investment funds that trade commodity derivatives must register with the CFTC, and many funds register voluntarily with the SEC, U.S. law generally does not require such funds to register with a federal financial regulator. At various points in the financial crisis, de-leveraging by hedge funds contributed to the strain on financial markets. Since these funds were not required to register with regulators, however, the government lacked reliable, comprehensive data with which to assess this sort of market activity. In addition to the need to gather information in order to assess potential systemic implications of the activity of hedge funds and other private pools of capital, it has also become clear that there is a compelling investor protection rationale to fill the gaps in the regulation of investment advisors and the funds that they manage.

Requiring the SEC registration of investment advisers to hedge funds and other private pools of capital would allow data to be collected that would permit an informed assessment of how such funds are changing over time and whether any such funds have become so large, leveraged, or interconnected that they require regulation for financial stability purposes.

We further propose that all investment funds advised by an SEC-registered investment adviser should be subject to recordkeeping requirements; requirements with respect to disclosures to investors, creditors, and counterparties; and regulatory reporting requirements. The SEC should conduct regular, periodic examinations of such funds to monitor compliance with these requirements. Some of those requirements may vary across the different types of private pools. The regulatory reporting requirements for such funds should require reporting on a confidential basis of the amount of assets under management, borrowings, off-balance sheet exposures, and other information necessary to assess whether the fund or fund family is so large, highly leveraged, or interconnected that it poses a threat to financial stability. The SEC should share the reports that it receives from the funds with the Federal Reserve. The Federal Reserve should determine whether any of the funds or fund families meets the Tier 1 FHC criteria. If so, those funds should be supervised and regulated as Tier 1 FHCs.

That was it.

So the key question on the minds of managers and advisors to these pools of capital that operate outside of the United States remains, how will this affect me?  At present we need to wait and see.

Those firms who have already registered with the SEC voluntarily will note that they can expect new federal provisions regarding record keeping and disclosures to be put in place and that the SEC will conduct inspections of the funds.  This is a big job and the SEC will need to expand its supervisory resource base to do this.  We suspect that more onus will be put on auditors to report compliance with the SEC directives in order for the SEC to delegate down some of this additional supervisory burden.

The big question that is still out there relates to those firms that have a US investor somewhere in their structure and have not thus far sought to register with the SEC.  Will one investor trigger a registration requirement, will firms with only minor US investor participation kick out those investors to minimise compliance costs for the benefit of the other investors?

Of course there remains two pieces of legislation before the US Congress respectively dealing with registration of hedge funds and advisors.  The US Treasury white paper did not refer to these existing bills and we can only guess that there is politics behind this deliberate oversight.

So, watch this space, more info to come, lets hope that whoever drafts the materials listens carefully to the MFA and the respective private equity industry groups.