Investment firms such as pension funds and insurance companies have increasingly turned to private, alternative investments in search of yield they can’t find in the stock and bond markets. Interest rates have remained too low for too long to support long-term investment strategies, even as the Federal Reserve targets rate increases.
With that as a backdrop, the U.S.Securities and Exchange Commission (SEC) in early 2022 proposed a batch of new regulations meant to scrutinise how private fund advisers charge fees to investors, measure fund performance, speed up and enhance their reporting mechanisms and shorten the trade settlement cycle from two days to one.
These potential new requirements amplify the growing need among hedge fund and private fund managers to implement technologies that arm them with a greater ability to measure and report on their holdings in real time, which, in turn, better equip managers to meet any future requirements and maintain transparency.
We further explore what this means for regulatory compliance within the private equity and hedge fund sectors.
In an attempt to increase transparency, the proposed SEC rules would mandate large hedge funds and private equity funds to:
- Report “extraordinary” investment losses or significant margin and counterparty default events within one day
- Enhance the information used for risk assessment and the SEC’s regulatory programs
- Increase the number of advisers submitting information by reducing the reporting threshold from USD2 billion AUM to USD1.5 billion
In the 1970s, the disclosure rules were originally put in place to protect a company’s management from hostile market participants. However, the new rules indicate that the SEC is seeking greater oversight over the private financial markets.
What do these changes mean for hedge funds and asset managers?
The proposals would require registered private fund advisers to share quarterly statements with investors including detailed records of all fees and expenses — a point of contention in the industry — as well as performance.
The changes would also force funds to reveal a stake of 5 per cent or more and to amend that disclosure more quickly if the holding changed materially. The intention here is to create greater visibility on what big private investors are doing and will make it harder for activists to profit from secret market manoeuvres.
What would be required of businesses if these proposals are confirmed?
- Private fund managers would be expected to prepare quarterly statements including certain information regarding fund performance, fees, expenses, as well as manager compensation and distribute it to their investors within 45 days after each calendar quarter-end.
- Private funds would have to undergo annual, independent audits in an effort by the SEC to place a check on asset-valuation estimates often used to calculate fund managers’ fees.
- Private equity and hedge fund advisers, including those not registered with the SEC, would be prohibited from engaging in certain sales practices, conflicts of interest and compensation schemes that the SEC perceives as contrary to the public interest and the protection of investors.
- The new disclosures proposed wouldn’t have to be filed with the SEC or made public, private funds would be required to maintain books and records to allow regulators to assess their compliance with the rules.
The growing critical need for data management and reporting technology
The demand for complete, and consumable data and timely, accurate reporting of that data has become both a necessity and a concern for asset managers. In many cases, managers with billions in AUM are still operating with data stacks that are built from spreadsheets or are over-reliant on manual processes that are prone to human error. This causes errors in data and ultimately leads to untimely delivery of what is essentially an incorrect or incomplete snapshot of risk.
One of the more challenging issues is gathering data from across the organization and third parties to arrive at the correct input for regulatory reporting. In addition, asset managers will need prompt access to data to meet their compliance requirements with the right data management tools.
The regulatory standards landscape is changing at an uncompromising speed. The updated SEC disclosure rules are an example of this shift.