President's Working Group Sets Out Guidance for Hedge Funds
The President’s Working Group on Financial Markets has issued principles-based guidance for hedge funds and other private pools of capital. The principles are designed to guide U.S. financial regulators as they address public policy issues associated with the rapid growth of these alternative investment vehicles. They rely heavily on suitability and counterparty risk management. This is the Working Group’s first statement on these issues since 1999, which was in the wake of the Long Term Capital Management scandal.
A growing congressional concern has arisen over the fact that less sophisticated persons are exposed indirectly to hedge funds through the holdings of pension funds and fund of funds. The Working Group posits that these concerns can be addressed through sound practices on the part of the fiduciaries that manage the funds. They have a duty to perform due diligence to ensure that their investment decisions are prudent and conform to sound practices.
The Working Group urges fiduciaries to consider the suitability of an investment in a private pool within the context of the overall portfolio and in light of the investment objectives and risk tolerances. Fiduciary evaluation should include the investment objectives, strategies, risks, fees, liquidity, performance history, and other relevant characteristics of a private pool. Fiduciaries should also evaluate the pool’s manager and personnel, including experience and disciplinary history.
The Working Group also believes that hedge fund managers must devote sufficient resources to the creation and maintenance of risk management systems to ensure that material information can be delivered to creditors, counterparties, and investors in a timely fashion. Risk management and valuation policies employed by private pools of capital should comply with industry sound practices. These practices include protocols for completing trade confirmations, obtaining prior written consent for assignments, and using cash-settlement procedures for OTC credit derivatives following a credit event.