Wednesday, January 26, 2011

SEC and CFTC Propose Joint Form for Hedge Fund Advisers and CPOs to Report Systemic Risk Information

Advisers to hedge funds and other private funds would be required to report information for use by the Financial Stability Oversight Council in monitoring risk to the financial system under rules jointly proposed by the SEC and CFTC. The proposed rules would implement Sections 404 and 406 of the Dodd-Frank Act by creating a new Form PF to be filed periodically by SEC-registered investment advisers who manage one or more private funds. Information reported on Form PF would remain confidential, although the SEC may use Form PF information in an enforcement action.

The SEC believes that proposed Form PF has two principal benefits. First, the information collected through Form PF is expected to facilitate FSOC’s monitoring of the systemic risks that private funds may pose and to assist FSOC in carrying out its other duties under the Dodd-Frank Act with respect to hedge funds ad other nonbank financial companies. Second, this information may enhance the ability of the SEC to evaluate and form regulatory policies and improve the efficiency and effectiveness of the Commission’s monitoring of markets for investor protection and market vitality.

Form PF is a joint form between the SEC and the CFTC only with respect to sections 1 and 2 of the form. Section 3 of the form, which would require more specific reporting regarding liquidity funds, would only be required by the SEC. The information that Form PF would require would be filed through an electronic filing system expected to be operated by an entity designated by the SEC.

The proposed CFTC rules would require commodity pool operators (CPOs) and commodity trading advisors (CTAs) registered with the CFTC to satisfy proposed CFTC filing requirements by filing Form PF with the SEC, but only if those CPOs and CTAs are also registered with the SEC as investment advisers and advise one or more private funds

The coordination with the CFTC would result in significant efficiencies for private fund advisers that are also registered as a CPO or CTA with the CFTC because, under the proposed rules, these advisers would satisfy certain reporting obligations under both proposed Advisers Act rule 204(b)-1 and proposed CEA rule 4.27(d) with respect to commodity pools that satisfy the definition of private fund by filing Form PF.

Under the proposed reporting requirements, private fund advisers are divided by size into two broad groups: large advisers and smaller advisers. The amount of information reported and the frequency of reporting would depend on the group to which the adviser belongs.

Smaller private fund advisers would file Form PF only once a year and would report only basic information regarding the private funds they advise. This would include information regarding leverage, credit providers, investor concentration and fund performance. Smaller advisers managing hedge funds would also report information about fund strategy, counterparty credit risk and use of trading and clearing mechanisms.

Large private fund advisers would file Form PF on a quarterly basis and would provide more detailed information than smaller advisers. The focus of the reporting would depend on the type of private fund that the adviser manages. Large hedge fund advisers would report on an aggregated basis information regarding exposures by asset class, geographical concentration and turnover. In addition, for each managed hedge fund having a net asset value of at least $500 million, these advisers would report certain information relating to that fund's investments, leverage, risk profile and liquidity.

Proposed Form PF would include questions about large hedge funds’ investments, use of leverage and collateral practices, counterparty exposures, and market positions that are designed to assist FSOC in monitoring and assessing the extent to which stresses at those hedge funds could have systemic implications by spreading to prime brokers, credit or trading counterparties, or financial markets. This information also is designed to help FSOC observe how hedge funds behave in response to certain stresses in the markets or economy

Large liquidity fund advisers would provide information on the types of assets in each of their liquidity fund's portfolios, certain information relevant to the risk profile of the fund, and the extent to which the fund has a policy of complying with all or aspects of the Investment Company Act's Rule 2a-7 concerning registered money market funds (Rule 2a-7).

Large private equity fund advisers would respond to questions focusing primarily on the extent of leverage incurred by their funds' portfolio companies, the use of bridge financing, and their funds' investments in financial institutions.
Under the proposal, larger private fund advisers managing hedge funds, liquidity funds such as unregistered money market funds, and private equity funds would be subject to the heightened reporting requirements. Large private fund advisers would include any adviser with $1 billion or more assets under management. All other private fund advisers would be regarded as smaller private fund advisers and would not be subject to the heightened reporting requirements.

The SEC estimates that approximately 4,450 advisers would be required to file all or part of Form PF, with approximately 3,920 being smaller private fund advisers not meeting the thresholds for reporting as Large Private Fund Advisers. Although this heightened reporting threshold would apply to only about 200 U.S.-based hedge fund advisers, these advisers manage more than 80 percent of the assets under management.

The proposed Form PF would define a liquidity fund as a private fund that seeks to generate income by investing in a portfolio of short-term obligations in order to maintain a stable net asset value per unit or minimize principal volatility for investors. Liquidity funds thus can resemble money market funds, which are registered under the Investment Company Act and seek to maintain a stable net asset value per share, typically $1, through the use of the amortized cost method of valuation. Reporting by advisers to liquidity funds is designed to allow FSOC to assess liquidity funds’ susceptibility to runs and ability to otherwise pose systemic risk.

For purposes of determining whether an adviser is a Large Private Fund Adviser for purposes of Form PF, each adviser would have to aggregate together: assets of managed accounts advised by the firm that pursue substantially the same investment objective and strategy and invest in substantially the same positions as the private fund and assets of that type of private fund advised by any of the adviser’s related persons. The aggregation requirements are designed to prevent an adviser from avoiding the proposed Large Private Fund Adviser reporting requirements by restructuring the manner of providing private fund advice internally

Proposed Form PF is the result of extensive consultation and collaboration between SEC staff and other FSOC members. Also, in formulating this proposal, the Commission collaborated with the U.K.'s Financial Services Authority and other members of the International Organization of Securities Commissions. The types of information that IOSCO recommended regulators gather from hedge fund advisers is consistent with and comparable to the types of information the SEC proposes to collect from hedge funds through Form PF.

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