The Hedge Fund Journal - FinServ releases White Paper on regulation preparation
The paper, Preparing for Alternative Asset Management Regulation: A Roadmap for Planning Cost-Effective, Asset-Building Infrastructures to Meet the Coming Regulatory Requirements, highlights the key areas where alternative asset managers can expect scrutiny from regulators – including their leverage positions, asset class concentrations and off-balance sheet holdings – as well as heightened demands from investors for an accurate, transparent picture of holdings and counterparty exposures. The paper argues that hedge funds, private equity firms and third-party fund administrators must approach compliance preparations tactically, to avoid erroneous spending. It also maintains that funds must make compliance decisions with an eye toward attracting new assets once investors return to the market over the next 18 months.
The paper contends that the vast majority of hedge funds are not prepared for more stringent regulation, and the new breed of investor they will be faced with when asset flows resume.
“A case in point is last year’s Lehman crisis, when many fund managers took days, if not longer, to assess their exposures to the firm. This revealed critical deficiencies in hedge funds’ counterparty risk management and caused a major crisis in confidence,” said Howard Weinstein, Managing Partner of FinServ Consulting. “To comply with new rules, and to attract assets, hedge funds must be prepared to identify, aggregate and report on counterparty risk exposures, across all funds and lines of business.”
The paper also identifies and addresses fundamental deficiencies in the ability of many third-party fund administrators (TPAs) to service complex, multi-fund asset managers.
“Most TPAs have a really hard time supporting operationally intensive funds such as multi-strategy, multi-fund asset management firms and their unique asset blends. Much of the work is still done manually, which leads to data integrity issues and the inability of managers to respond quickly to regulator and investor requests,” said Weinstein. “TPAs that want to be more than a shadow organization will have to improve their ability to deliver robust, customized services.”
The paper draws key lessons on compliance spending from the experiences many corporations had in complying with Sarbanes Oxley.
“Firms doing the compliance minimum spent the same amount as firms that approached compliance as an opportunity to improve their enterprise-wide processes and operations. Similarly, alternative asset management firms that embrace the new rules as a catalyst for change will be the ones best equipped to thrive and attract assets,” said Weinstein.
Investors will also put increasing pressure on the government for more reporting and controls on the hedge fund industry.
“Further regulation of the hedge fund industry is our new reality,” said John Torell, CFO of Tudor Investments, and a contributor to the paper. “It is likely that any new regulation will require enhanced financial disclosure. Improved transparency, in the form of increased information flow, will need to be both well thought out and sufficiently targeted to help the regulators perform their responsibilities.”