Ep. 16 The Long-Short | Unpacking the new SEC proposals for private funds and capital markets

Published: 23 February 2022

The Long-Short is a podcast by the Alternative Investment Management Association, focusing on the very latest insights on the alternative investment industry.

Each episode will examine topical areas of interest from across the alternative investment universe with news, views and analysis delivered by AIMA’s global team, as well as a host of industry experts.

Confused by the recent flurry of proposed rules by the US Securities and Exchange Commission for private funds and capital markets? The Long-Short spoke to Daniel Austin, Director of US Policy and Regulation at AIMA, to unpack each major regulatory requirement, including why they are being proposed, and what they mean for the alternative investment industry in the US and globally.

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Tom Kehoe  0:05 

Hello and welcome to The Long-Short, a new podcast brought to you by AIMA, the Alternative Investment Management Association, focusing on the very latest insights on hedge funds and private credit. My name is Tom Kehoe. AIMA is the global representative of the Alternative Investment Industry with around 2,000 corporate members spread across 60 countries. Of these are fund manager members account for approximately $2.5 trillion in hedge fund and private credit assets. Each weekly episode of The Long-Short will examine topical areas of interest from across the alternative investment universe news views and analysis delivered by AIMA's global team as well as a host of industry experts. So whether you're a hedge fund or private credit industry veteran, a student of the industry, or just someone interested in learning more about hedge funds and private credit, this podcast will be your ideal companion to help navigate you through, the long and short of this fascinating industry.

Hello, and welcome to episode 16. And if you are tuning in to listen to the Robyn Grew interview this has been postponed until next month, right Drew?

Drew Nicol  1:10 

Yes, that's correct. We will be sharing more details of that in the coming weeks. But the impressive output from the SEC last week meant that we had a last-minute change of schedule.

Tom Kehoe  1:23 

Yes, indeed. Instead, today's podcast will focus on the significant industry news that came out of the US on the ninth of February, where the FCC voted three to one to publish four new rulemaking proposals, which if adopted could significantly affect the trading operations, risk management, compliance and reporting functions of AIMA manager members as well as private funds, and the registered investment companies that they advise.

Drew Nicol  1:52 

And here tell us more about all of these issues is our colleague out of AIMA's DC office, Daniel Austin, Director of US policy and regulation. Daniel, thank you so much for speaking to us on The Long-Short

Daniel Austin  2:05 

Of course. Drew and Tom, it's a pleasure to be here with you today.

Tom Kehoe  2:10 

Yeah, great to have you make your debut and a great moment to do so, I guess. I'm so Daniel, the SEC has come hard out of the gates this year. You know with a bundle of proposals aimed at the private fund industry and in our introduction, we describe how these proposals could be among the most hard hitting for the industry. And our CEO Jack Inglis has been quoted as describing these proposals as representing a serious overhaul of existing market practices. Could you elaborate on that, please?

Daniel Austin  2:42 

Yeah, happy to I think Jack nailed it in his latest AIMA dispatch dispatches message when he said some of the proposals ranged from ambitious through to transformative to potentially disruptive. And what we are seeing under SEC Chairman Gary Gensler, some of these proposals would fundamentally change both existing market practices and market structure. Many of these proposals have their roots in what I think is a populist driver call for equality of information, and additional transparency purely for transparency's sake. This is a phenomenon that's not new or unique to financial markets and financial data. And a parallel can be drawn to the efforts we saw several years ago in New York State within insider trading 2.0.

However, in recent events, like the Treasury market volatility in March of 2020, the meme stocks of last year and the Archagos collapsing only intensified this movement. Since last December, the SEC has issued 12 proposed rules. So right now we have 12 outstanding rules with open comment periods, leaving the market with a lot to read, analyse and respond to in a very short timeframe. And even based on the Commission's ambitious regulatory agenda, there's much more to come including rules targeting potential short sale disclosures and 13F changes, a potential overhaul of equity market structure in ESG, disclosure framework and much, much more.

Drew Nicol  4:08 

And let's run through some of those proposals, as you mentioned, it’s a mountain and we'll do our best to get through those in this episode. But to begin with, the SEC published proposed rules applicable to registered advisors, that would, among other things, require new quarterly reporting to investors and standardisation of fees and expenses across all investors in the fund. On the surface, transparency seems like an intrinsically good thing but you mentioned there transparency for transparency's sake. Are there any unintended consequences here? Are there any other ways that we should be looking at this?

Daniel Austin  4:48 

Sure, the idea of transparency might seem good on the surface. However, the Commission is simply taking the wrong approach to achieving the so-called additional transparency some of the proposed and future rulemakings will have broad and perhaps damaging impacts on US securities markets and market participants' practices. Like you mentioned the private fund advisor role. It's a prescriptive one-size-fits-all regime that will essentially govern how two sophisticated parties negotiate in engagement.

It's a marked departure from how LPs and GPS have operated for decades, and the Commission has failed to justify where the breakdown has been in this relationship that warrants such a significant change. And, ultimately, the negative effects of this change will trickle down to the investors of these LPs. Some of the recent proposals also have a clear Genesis or nexus to the events over the past 24 months. Let's take the Archagos collapse, for example. In December, the SEC proposed a new rule that would establish a reporting regime for certain security-based swap positions. And in that, any person that exceeds a certain threshold must file these reports and they must be filed T+1. In other words, by the end of the day, for the end of the following day on which the threshold is exceeded. And that's not all. They're also immediately made public upon filing. In doing so the Commission cites the need to improve or transparency close to 20-times in justifying this new reporting regime.

The Commission explains it's concerned about the manufactured defaults and the credit-default swap market or replay of the Archagos collapse. To prevent these types of events. However, the commission could have chosen a number of alternatives. For example, requiring the same reports being filed, but holding them confidentially and using its existing surveillance and examination capabilities, or requiring enhanced risk management requirements for security-based swap dealers. Both are much more narrowly tailored responses, than the route that is chosen. Moreover, with the T+1 disclosure, it essentially leaves the firm's proprietary data and strategies being available to the general public, which can lead to a host of negative market impacts including imitative trading, discouraging risk management and more. And you can look at in the wake of the financial crisis, the Commission specifically cited concerns with imitative trading, when it decided to maintain the confidentiality of managers short positions on Form SH, acknowledging that imitative trading already occurs with long positions disclosed on Form 13F. So there's clearly a precedent here for the Commission to maintain the confidentiality of this valuable data. However, it's decided not to do so in this case.

Tom Kehoe  8:43 

So Daniel, moving on to the filings, then listeners may be aware of the 13F filings that are required if investment managers but the SEC is proposing substantial changes to 13 Ds and 13Gs. What are these and why does it matter?

Daniel Austin  9:00 

That's a good question, Tom. So schedules 13D and G are filed when an investor beneficially owns what's called more than 5% of a covered class of equity securities, and these reports are available to the public. The current filing deadline is 10 days after a market participant reaches this 5% threshold. The Commission is proposing to shift this 10-day deadline down to a five-day deadline.

Among the other changes that the proposal looks to do is include that holders of cash-settled derivative securities will be deemed beneficial owners of the reference equity security if the derivative is held with the purpose or effect of changing or influencing controlled issuer. However, these products ultimately don't provide the buyer with any voting rights. So what is the Commission trying to achieve here? In the proposal, the Commission is really reaching in trying to justify its conclusion of including these products among the beneficial ownership calculation for purposes of 13D and G, these reports are ultimately about the ownership and control of companies and voting rights. Again, what has changed here over the past, however many years to have the reporting time, and now include these derivative securities in calculating beneficial ownership? nothing. It kind of goes back to this drive for additional transparency. And this is likely setting the stage for changes to Form 13F, and perhaps establishing a framework for the reporting and potential disclosure of short positions.

Drew Nicol  10:33 

So, Daniel, we are asking a huge amount of you here and jumping all over the place. But I think that does give some sense of the scope and scale of the proposals that have come out in the last few weeks. But just to move away from private funds exclusively and go on to the other big proposal that came through recently related to the shortening of the settlement cycle. Now, those people who have been in the industry or in financial markets for a decade or more, should be familiar with the fact that the settlement cycle has seen days shaved off it all the way since T+5 but for many other people, they may have first heard about this last year, when the CEO of Robinhood pointed to the T+2 settlement cycle as the reason for them having to pause trading on GameStop.

Obviously, a fair amount of controversy around that, but now we have this proposal and the timing does seem interesting. Is there any connection here at all? Or is this just part of the broader theme of trying to shorten a certain cycle when we can?

Daniel Austin  10:38 

Right, so the talks about moving to T+1 have been going on for a couple of years now. But they're also embedded in this drive for transparency in the belief that there will be cost savings and efficiencies. And like you noted, this discussion was a large part of the discussion of the $GME congressional hearings from last year, which were quite a sight to be seen and take in; it was much much-watched television. At the end of the day, we might see these results. The moving to T+1 does misalign US markets with other major capital markets that are settled on maintaining a T+2 settlement timeframe. This makes the US a global outlier. I mean, the US was a global outlier when we were stuck on T+3 and the rest of the market transitioned to T+2. But this situation is different because we are jumping ahead not playing catch up. In the proposal, it doesn't appear that the Commission either in the proposal or prior to issuing the proposal coordinated with foreign jurisdictions on reaching this decision. And of course, a change like this is so significant to the market structure in the US, the Fed and the Treasury will need to play a role in the transition. So this isn't just an SEC endeavour, it will take a lot of time and work to achieve.

Tom Kehoe  13:06 

As you say these proposals represent a huge task generally for compliance and regulatory teams across the industry as they all have concurrent deadlines for reviewing right, so how big a challenge Daniel, do you see this as being for compliance teams? First question. And then secondly, you know, what are the deadlines then, around the proposals and what the industry needs to be doing?

Daniel Austin  13:32 

I'm going to take the deadline question first and explain that the latest set of the proposed rules that were issued, the 9th and 10th of February, have a deadline of 30 days after publication in the Federal Register, or April 11, which is 60 days after the rule was issued. And it's whichever of those dates is later. And as we discussed, these are not immaterial proposals. They're significant, significant changes to market practices and market structure in our hundreds and hundreds and pages of complex texts for compliance and legal teams to analyse and formulate responses to many compliance legal teams are already fully occupied maintaining the health and wealth welfare their funds, and in turn protecting the fund’s investors. So their time and resources will now be stretched even further trying to get through the weeds of these proposals in crafting their responses. And these rulemakings aren't simply a legal or compliance task. Formulating responses to these will require consultations in coordination with senior management because of their significance and complexity, taking time and resources away from those individuals as well. In the shorter comment periods that we are seeing are an unwelcome trend and one that I fear will likely continue as the SEC continues to issue dozens of proposals over the coming months.

Drew Nicol  14:58 

And you mentioned that with the settlement cycle in the US cannot be seen in isolation and must also be viewed in the global scale in the sense that the shortening might put the US out of step. So in the same sense with these other proposals related to transparency and investor protection, we have to view them in that global perspective as well. If these proposals go through as is, and that's a big if, but would this make the US substantially less attractive as a jurisdiction for fund managers? And how differently would this position the US to other major markets?

Daniel Austin  15:38 

The short answer is yes, it will make it less attractive and more like other financial markets over which the US may have previously held a competitive advantage. You look at the SEC’s website, it claims, and usually when the chairman or a commissioner is testifying before a congressional hearing, so often, quote, the SEC’s mission, which is to protect investors, maintain fair, orderly and efficient markets and facilitate capital formation. I'm worried, however, that many of the changes to existing market practices and structure that have been proposed like the ones we saw on the 9th and the 10th February, and they're likely to cover over the next several months, will only make it more difficult for the SEC to achieve it's often stated mission and could knock be US capital markets off its perch, and I’m quoting the SEC here again, the deepest, most dynamic and most liquid in the world. I think these are very, very noteworthy significant proposals. There are so many adjectives to describe them, I would need a thesaurus to try to adequately to get through them.

Tom Kehoe  16:47 

And bringing this full-circle, then Daniel, as we say, you're on the ground out in DC, you know, part of the Government and Regulatory Affairs team at AIMA. How is AIMA working with the industry in response to all of this?

Daniel Austin 17:01 

So the AIMA GRA team once the proposals were issued, read through them, analysed them and publish some wonderful summaries that are available on our website for members. And in terms of next steps will be holding working group calls and collecting feedback from members on the proposals and going through the comment writing process and circulating those among the working groups for feedback, tailoring those and ultimately submitting them to the Commission. We're also working on scheduling meetings with commissioners and the relevant SEC staff that are working on these proposals to discuss the context of those proposals, the content and also our concerns with them.

Drew Nicol  17:46 

Well, it sounds like you've got a busy few weeks ahead of you. And I'm sure we'll be hearing more about this in the coming weeks and months. And I'm sure we'll get you and the rest of the team back on to go through this once you've had a chance to have a rest after this is all blown over and we're on to the next stage. Thank you so much for coming on, Daniel, we really do appreciate your time.

Daniel Austin  18:06 

Drew and Tom, it’s a pleasure to be with you. And we will work to keep our members apprised of how these rules play out and we'll see where we go from here.

Tom Kehoe  18:18 

And Daniel is one of three senior individuals in AIMA’s US policy and regulatory team. This team of course supported by a global effort comprising subject matter experts in London, Brussels and Singapore.

Drew Nicol  18:31 

And AIMA's preliminary thoughts on all these proposals are already available to aim and members via the AIMA website, AIMA.org, and the full responses to proposals will also be available in the same place.

Tom Kehoe  18.46

And we'll update you on the development of these proposals in future episodes.


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