Alternative Investment Management Association
The ever-changing hedge fund regulatory environment together with the continued rise of institutional investors in the hedge fund space has significantly increased the reporting burden on investment managers to both regulators and investors. In this environment, driven by regulators and investors, managers are increasingly turning to fund administrators to assist them in meeting their regulatory and investor reporting requirements. Fund administrators in turn must expand their service offerings and develop sophisticated data management and reporting capabilities to properly service their clients.
There is no doubt that the regulatory burden on hedge fund managers is more onerous than ever. In the US for example, the SEC’s Office of Compliance Inspections and Examinations (OCIE) recently sent a letter to senior management of newly-registered investment advisers alerting them to upcoming OCIE examinations of newly-registered advisers to be conducted within the next two years. Earlier this year, the Commodity Futures Trading Commission (CFTC) amended the CFTC Rules to rescind an exemption from commodity pool operator (CPO) registration heavily relied upon by hedge fund managers which development will require many hedge fund managers to register as CPOs and operate their funds in compliance with various disclosure, recordkeeping and periodic reporting obligations set forth in the CFTC Rules. All this means managers who register as CPOs and with the SEC face up to 40 filings annually in the US alone! Coupled with the ever-changing filing rules relating to trading activity such as Form 13F filings in the U.S. and short sale reporting in certain mainly European markets, the cost of compliance for hedge fund managers is undoubtedly significantly more than ever before.
Form PF/ Form CPO-PQR
It is not surprising that managers are therefore looking to fund administrators to assist where administrators have access to the data required by regulators. Designed to assist the Financial Stability Oversight Council in monitoring systemic risk, Form PF is the most recent new burdensome filing requirement which requires SEC registered advisers to provide portfolio, performance and risk information about their funds.
Administrators are undoubtedly well placed to assist managers gather, compile and scrub the fund data required for Form PF but, in order to be in a position to assist multiple clients with the same filing dates, administrators need to ensure they invest in systematic processes for both data aggregation and data storage (e.g. a data warehouse) and develop tools to handle the XML filing format requirements. Registered CPOs will need to complete Form CPO-PQR, which is effectively the CFTC’s version of the Form PF. Form CPO-PQR is filed electronically with the NFA through its website and consists of three Schedules A, B and C. SEC-registered investment advisers reporting on Form PF need only complete Schedule A, which schedule must be completed by all registered CPOs. Schedule B must be completed only by CPOs with assets under management attributable to commodity pools (AUM) equal to or exceeding $150 million but less than $1.5 billion (Mid-Size CPOs) and Schedule C must be completed only by CPOs with AUM equal to or exceeding $1.5 billion (Large CPOs). Given the overlap with Form PF reporting, only administrators with automated processes for gathering, accumulating and storing relevant source data (from multiple sources), together with experienced, specialist regulatory reporting teams can reasonably be expected to assist clients meet these reporting obligations.
Notwithstanding the recent announcement from the US Treasury and IRS extending the implementation of the withholding and reporting obligations of FATCA to various dates in 2014 and 2015, FATCA remains a significant extraterritorial piece of legislation which will impose extra due diligence and reporting obligations on hedge funds. Very generally, FATCA will require offshore hedge funds to enter into Foreign Financial Institution agreements (“FFI Agreements”) with the IRS to identify their US investors or otherwise be subject to 30% withholding on certain U.S.source income. The FFI Agreement will require offshore hedge funds to perform additional investor due diligence to identify investors that are US “accounts”, report account information on US accounts to the IRS and withhold on investors that are noncompliant with document requests. Again, administrators are best placed to provide a service offering to help managers categorize investors in client funds as required by FATCA and to document the due diligence procedures performed. Administrators undertaking this service will need to enhance their transfer agency systems and update investor KYC procedures to be able to capture and record the data in accordance with the FATCA obligations. Administrators looking to provide a comprehensive FATCA service offering will also need to ensure their accounting systems can calculate the 30% withholding on redemption “pass-through” payments attributable to a fund’s U.S. source income. Furthermore, administrators will need to develop reporting capabilities to provide reports which include the relevant data required for IRS reporting on any identified U.S. accounts. FATCA services will be best provided by administrators with dedicated US tax expertise who can work with managers to oversee all aspects of complying with FATCA from the initial investor due diligence analysis to any calculation and reporting obligations.
Whether managers choose to share the increased information provided to regulators in Form PF and other new regulatory filings with investors remains to be seen. It is certainly conceivable that investors will amend their due diligence protocols to ask managers questions that concentrate on information in the filing such as borrowing and financing, counterparty exposures, derivative positions or risk analytics.
In any event, there is little doubt that the increased allocations by institutional investors to alternative investments has resulted in the investor community demanding greater cooperation from managers in supplying information. Investors are insisting on transparency in geography, issuer, sector, credit and liquidity to avoid the mistakes of the credit crisis, when their view of concentration was limited or they maintained a disproportionate allocation to illiquid assets as other investors redeemed. Investors also want to such receive transparency reports based on consistent methodologies so they can plug the data into their risk systems.
Ultimately, fund administrators who want to be valuable partners to both fund managers and investors need to continue to evaluate and develop their service offerings to ensure they have the right technology and expertise which will enable them to help managers meet the increasing regulatory and investor reporting requirements.