Traversing the Regulatory Landscape for Hedge Funds
As new regulatory changes emerge, your relationship with your fund administrator will become critical.
Co-Chief Operating Officer, Northern Trust Hedge Fund Services
With new regulations on the horizon for 2023 and beyond, hedge fund managers are bracing for what could be some of the biggest regulatory changes since the Dodd-Frank Act of 2010.
Facing new proposals and rules from the U.S. Securities and Exchange Commission and emerging global ESG regulations, managers can prepare now for upcoming modifications.
Upcoming changes range from a transition to a T+1 standard settlement cycle in the U.S. to enhanced private fund reporting regulations to tightening ESG standards in the U.S. and the EU. Organizations with a robust framework for compliance and an experienced fund administration partner can more thoroughly navigate a rapidly changing landscape.
One change from the Securities and Exchange Commission (SEC) is compressing the trade lifecycle from T+2 standard settlement to T+1 standard settlement. Why is the SEC doing this just five years after the move from T+3 to T+2 was implemented? It believes that the shift will address the market vulnerabilities that can weaken the infrastructure, such as volatility from the pandemic and meme stocks. The SEC also believes the shortened settlement timeframe will reduce market exposure to systemic risk related to trade lifecycle.
The modification adds complexity for market participants, who will face a compressed timeline to complete trade confirmations, allocations and affirmations. And for regulatory requirements, the new, shorter timeframes mean they must have data ready more quickly. When the T+1 standard settlement takes effect, clients may need to rethink their operational support models to accommodate the shortened timeframes.
Due to rapid growth in the number of private funds in the U.S. since 2011 and the constantly evolving industry, the SEC is proposing amended requirements for Form PF. The changes would mandate that hedge fund and private equity advisors disclose information via Form PF within one business day of major market events (for example, massive investment losses, significant margin defaults or operations events)1. The SEC also proposed lowering the Form PF reporting threshold for large private equity funds to $1.5 billion AUM from $2 billion AUM.
In addition, the SEC and Commodity Futures Trading Commission (CFTC) have partnered to jointly propose sweeping changes to the Form PF framework for hedge funds. The proposal contains amendments to many questions that have been included on the form since its inception. The changes would provide regulators with better information to assess activities that pose systemic risks, as well as collect data on certain investment strategies that have evolved since the initial ruling went into effect.
With these proposed changes, federal regulators aim to enhance oversight of large funds, ultimately hoping to improve market stability and protection for investors. Many private fund advisors already complete Form PF, but with these new requirements, advisors will need to accommodate faster turnaround times or additional data requirements. Funds that have not filed a Form PF prior to the amendment going into effect must assess what is required and determine their own obligations. If this is a new requirement, a firm can work with an administrator who can guide them through the process.
As ESG investment strategies and principles gain a greater foothold, ESG regulations are also emerging across the globe. In the U.S., the SEC has proposed new climate-related disclosures for investors. Investors would be required to disclose “climate-related risks that are reasonably likely to have a material impact on their business, results of operations, or financial condition, and certain climate-related financial statement metrics in a note to their audited financial statements2.” Under the Enhancement and Standardization of Climate-Related Disclosures for Investors, firms would be required to disclose climate-related risks, including direct and indirect greenhouse gas emissions.
The EU has also addressed their ESG-related regulations. In November 2022, the European Parliament approved The Corporate Sustainability Reporting Directive (CSRD), which requires large firms to disclose data on how their business practices impact humans and the environment plus any climate-related risks3. Slated to take effect in 2024, the requirements apply to all EU-based companies plus large corporations with a significant presence in the EU.
As ESG regulations evolve in the coming years, firms will want to monitor the developments and take steps to address their compliance needs.
In the rapidly evolving global regulatory landscape, hedge funds need to be prepared for change with access to information. An administrator can help determine how to support changing data needs as well as accelerated turnaround times for ad hoc filings, plus provide an informational resource on future regulations.
3 Sustainable economy: Parliament adopts new reporting rules for multinationals | News | European Parliament (europa.eu)