Investment Funds Regulatory Update
September 30, 2009
White & Case's Investment Funds Regulatory Update provides a brief overview of some of the latest legislative, regulatory and judicial actions, policy statements and decisions affecting investment funds.
US, UK Seek Consensus on Financial, Fund Regulations
US Securities and Exchange Commission (SEC) Chairman Mary Schapiro and UK Financial Services Authority (FSA) Chief Executive Hector Sants said on September 16 that the agencies would seek common approaches to financial regulatory requirements and reporting, particularly for hedge funds and their advisers. The regulators announced that they had agreed to identify a common, coherent set of data to collect from hedge fund advisers/managers to help identify risks to their regulatory objectives and mandates.
The announcement resulted from a meeting of the SEC-FSA Strategic Dialogue, through which SEC and FSA leaders have met annually since 2006 to discuss areas of mutual interest. The other topics of discussion included over-the-counter derivatives markets and central clearing, accounting issues, regulatory reform, credit rating agency oversight, short selling, and corporate governance and compensation practices.
The regulators' announcement came ahead of the Group of 20 summit that convened on September 24 – 25 in Pittsburgh, Pennsylvania to discuss financial recovery, coordinating strategies and reforming the global financial system.
Garrett: Treasury OTC Derivatives Bill Likely to Form Basis for House Version; SEC, CFTC Chairmen Push for Stronger Bill
The US Treasury Department's legislative proposal to regulate the over-the-counter (OTC) derivatives market will likely be the starting point for the US House of Representatives bill that is expected to be released in the fall, said Rep. Scott Garrett (R-NJ), the ranking member of the Capital Markets, Insurance and Government Sponsored Enterprises Subcommittee, on September 15.
It appears that the Treasury's proposal, rather than the outline that House Financial Services Committee Chairman Barney Frank and House Agriculture Committee Chairman Collin Peterson agreed upon, will serve as the base document for the bill the House will be considering, said Garrett in his keynote address to the International Swaps and Derivatives Association (ISDA) Regional Member Conference.
SEC Chairman Mary Schapiro and Commodity Futures Trading Commission (CFTC) Chairman Gary Gensler presented their views of the Treasury proposal on September 22 at a House Agriculture Committee hearing. In their prepared testimony, both Gensler and Schapiro called the proposal an "important step" toward comprehensive regulation of the OTC derivatives markets, but also advocated certain revisions to it.
Gensler, echoing a letter he sent to lawmakers in August following the release of the Treasury draft, specifically called for eliminating the exceptions in the bill for certain OTC products and dealers, providing the SEC and CFTC with expanded enforcement and rulemaking authority, and imposing requirements that dealers and counterparties set aside money to back up trades.
White & Case's Investment Funds Regulatory Update provides a brief overview of some of the latest legislative, regulatory and judicial actions, policy statements and decisions affecting investment funds.
Schapiro repeated Gensler's most significant suggestions with approval, while also suggesting some additional "enhancements." These include regulating all OTC derivatives like their underlying "references" in order to minimize the potential for regulatory arbitrage, and raising the qualification standards for participation in the OTC derivatives markets.
The Treasury released the draft legislation on August 11 as part of the legislative regulatory reform package that the Obama administration promised to send to Congress. The proposed legislation's most significant provisions include the central clearing and trading of standardized derivatives, increased capital and margin requirements on customized derivatives, confidential reporting requirements on all derivative trades to a central repository and public access to aggregate data on open positions and trading volumes. The bill places joint enforcement authority in the hands of the SEC and the CFTC, generally according to their authority over the underlying assets.
- Garrett keynote address: available here
- Gensler prepared testimony: available here
- Schapiro prepared testimony: available here
- Proposed Treasury legislation: available here
- Peterson/Frank outline: available here
- Related client alert: available here
New York Bans Pension Fund "Pay-to-Play"
New York State Comptroller Thomas DiNapoli issued an executive order on September 23 that bans "pay-to-play" practices related to the US$116.5 billion New York State Common Retirement Fund.
The executive order prohibits the Fund from doing business with any investment adviser who has made a political contribution to the State Comptroller or a candidate for the State Comptroller. The ban parallels the proposed rule the SEC released on July 22 and similarly, will last two years from the date of the contribution. The executive order will expire on the effective date of the SEC's final rule.
The SEC final rule would also prohibit investment advisers from retaining placement agents to solicit government funds. DiNapoli instituted a ban on the involvement of placement agents with the Fund on April 22. The ban remains in effect.
SEC Chairman Mary Schapiro first mentioned the SEC proposal in late April, after New York Attorney General Andrew Cuomo unsealed indictments following a two-year investigation into alleged kickbacks related to the use of unregistered placement agents for the New York State Common Retirement Fund.
SEC Chairman: Hedge Fund Disclosure Must Be Balanced
The SEC will urge more public disclosure from hedge funds if Congress requires the investment pools to register with the agency, said Chairman Mary Schapiro on September 18.
During a conference at Georgetown University in Washington, DC, Schapiro said that the SEC will likely require "some level of public reporting," as it does for mutual funds. Schapiro did acknowledge, however, that the SEC is "very aware of the tension" involved in requiring more disclosure because hedge funds do not want competitors to "front-run" their strategies.
Singapore Considering Tighter Hedge Fund Rules
Singapore's central bank is consulting hedge fund executives on ways to tighten the regulatory regime of the nation's growing alternative investment industry. Industry executives believe the talks will lead to legislation governing the exempt sector, which accounts for the vast majority of Singapore's hedge funds.
Hedge fund executives expect any changes to the exempt regime to be manageable and are likely to oppose any regulatory changes that greatly increase costs of operations, which some hedge funds put at about half the level of Hong Kong or a third that of London. Options being mentioned in the talks include the introduction of minimum requirements for asset size, professionally qualified staff, working capital and professional indemnity arrangements.
Singapore's exempt regime allows entities with 30 or fewer financially sophisticated clients to avoid regulation required by a Singapore Securities and Futures Act license. Exempt funds are, however, subject to money laundering regulations and rules that require them to ensure they understand the level of financial awareness of their clients.
Although Singapore has previously defended the exempt option by maintaining that light regulation is appropriate for funds with financially sophisticated clients, the talks reflect the Monetary Authority of Singapore's response to political concerns in Europe and the US about the role of hedge funds in the global financial crisis.
IOSCO Publishes New Funds of Hedge Fund Standards
The International Organization of Securities Commissions (IOSCO) has published a new set of standards aimed at increasing the protection of investors in funds of hedge funds. The report focuses on the methods by which funds of hedge funds' managers deal with liquidity risk and the due diligence processes used by funds of hedge funds' managers prior to and during each investment.
The new report states that fund of hedge funds' managers should manage liquidity risks by, among other things: (i) making reasonable inquiries to be in a position to consider if the fund of hedge funds' liquidity is consistent with that of the underlying hedge funds, particularly in order to meet redemptions; (ii) prior to investing, and during the investments' lifetime, considering the liquidity of the types of the financial instruments held by the underlying hedge funds and (iii) before and during any investment, considering whether conflicts of interest may arise between any underlying hedge fund and any other relevant parties.
In addition, the new report suggests that fund of hedge funds' managers undergo a number of due diligence processes prior to any investment being entered into and on a continuous basis following the commitment, including: (i) establishing and implementing appropriate due diligence procedures for the purpose of investment into hedge funds, which are reviewed regularly; (ii) assessing the specific legal and regulatory requirements applicable in the hedge fund's jurisdiction; (iii) carrying out appropriate due diligence on the underlying hedge fund whenever it is considered necessary; (iv) regularly assessing if selection procedures for eligible underlying hedge funds have been properly met, or not met, and to explain any deviations and (v) maintaining adequate resources, procedures and organizational structures necessary for the purpose of carrying out a proper and robust due diligence.
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