HedgeOp Compliance obtained a hard copy of the Obama Administration’s announcment for financial system regulatory reform (the “Proposal”) and wanted to note the following related to hedge funds:

(1) The Proposal calls for a requirement that advisers to hedge funds and other private pools of capital (such as private equity and venture capital) register as investment advisers with the SEC. The Proposal seems to be suggesting a standard SEC registration requirement (where certain information about the adviser will be publicly-available via the ADV Part 1).

(2) The Proposal calls for a requirement that all funds advised by registered investment advisers (including hedge funds, private equity and venture capital funds) to be subject to:

*record-keeping requirements
*investor, creditor and counterparty disclosure requirements
*regulatory reporting requirements

(3) The Proposal provides that regulatory reporting requirements should be done on a CONFIDENTIAL basis and that such reporting should include:

*AUM of private pool
*borrowings
*off-balance sheet exposure
*other information (see point (4) below)

(4) It should be noted that the Proposal provides that hedge funds and other private pools should also be required to report and confidentially file with the SEC “other information” to determine if “the fund or family of funds is so large, highly leveraged, or interconnected that it poses a threat to financial stability”. The Proposal specifically states that the SEC should be required to share such reports with the Federal Reserve so the Federal Reserve can determine whether the fund or family of funds meet certain criteria that would require them to be regulated by the Federal Reserve as “Tier 1 FHCs”. Under the proposal, “Tier 1 FHCs” (Financial Holding Companies) would be a new category of entities that are deemed to be in a position to pose a threat to financial stability if such entities were to fail (due to their size, use of leverage and interconnectedness).

This goes beyond traditional Bank Holding Companies. As such, under the Proposal Tier 1 FHCs would be subject to much higher regulatory and review standards to be determined and regulated by the Federal Reserve. There are no specifics as to what the size requirement should be in determining Tier 1 FHC status. Under the Proposal, that would be left to the Federal Reserve to determine. It should be noted that, under the Proposal, Tier 1 FHCs should be required to meet qualification requirements in the following areas:
*capital requirements
*prompt correction action
*liquidity standards
*overall risk management
*market discipline and disclosure
*restrictions on nonfinancial activities
*rapid resolution plans

(5) The Proposal calls for a requirement that the SEC be empowered to exam such funds to confirm that all requirements are being met (which may be different across the different types of private pools). Not clear in the Proposal if this audit/exam requirement will be part of exam/audit of adviser or in addition to that requirement.

The stated reason for these requirements is to allow US regulators to collect the data deemed necessary to assess the potential systematic implications of hedge funds and private pools. As we (at HedgeOp) have stated to clients and friends in the past, this seems to be the direction that regulators are going in on a number of fronts — confidentially gathering data in potentially problematic areas. This has already started in the area of short selling (per the weekly Form SH filing requirements). Now the same seems to be true for hedge funds and private pools. Next area – maybe use of leverage?

The Proposal does not contain any specific rule proposals. It seems as if the Administration will leave the details to Congress and the applicable regulators. We at HedgeOp will continue to monitor these developments very closely and update clients as needed.

Note from Editor
If you have any comments or contact requests for this or any other story, contact me at: alex@hedgeco.net