Hedge Funds Face Double Exposure
Larry Fink chairman and CEO of BlackRock Inc.
Larry Fink, chairman and CEO of BlackRock Inc., called the SEC’s chairman Oct. 18 to talk about the Dodd-Frank rule and supplied the agency a list of inconsistencies between its approach and the CFTC’s. Photo: Jerome Favre/Bloomberg
Larry Fink, chairman and CEO of BlackRock Inc., called the SEC’s chairman Oct. 18 to talk about the Dodd-Frank rule and supplied the agency a list of inconsistencies between its approach and the CFTC’s. Photo: Jerome Favre/Bloomberg
When hedge funds and private-equity funds begin to reveal their inner workings to U.S. regulators, they may have to do it under different systems for two agencies.
The new disclosures are required by the Dodd-Frank financial regulatory law and a centerpiece of federal efforts to prevent another credit crisis. They are intended to help regulators gauge the risk the lightly regulated funds could pose to the financial system. The Securities and Exchange Commission voted unanimously today to approve final guidelines for the funds.
Fund companies and Republican lawmakers have complained about the rule’s costs and expressed concern about whether regulators will protect the confidential trading information they receive.
Money managers say they are also angry that the SEC pushed ahead without apparently ironing out some differences with a similar rule being considered by the Commodity Futures Trading Commission -- setting up a situation where the funds could be required to report the data differently.
“This is a perfect example of government at its finest, where you’ve got two agencies asking the same company the same questions in two different ways,” joked Cliff Rossi, executive- in-residence at the Robert H. Smith School of Business at the University of Maryland.
‘Not a Bad Thing’
Still Rossi, who was chief risk officer at Citigroup Inc. (C)’s consumer lending group and advocated for a federal office to collect and monitor financial data, said it is important that the government have access to more information on hedge funds.
“Some reporting is not necessarily a bad thing for this group,” said Rossi. “If we’re talking about managing systemic risk in our financial sector altogether, I don’t know how you can manage it without having at least some idea of what these entities are doing.”
Advocates for investors generally supported the SEC’s proposal, though some said the agency may not be going far enough.
Richard Trumka, president of the AFL-CIO, asked the SEC in a letter to increase both the volume of information and the frequency of collection.
“The fact that opaque, highly leveraged pools of capital - - or ‘shadow banks’ -- can pose systemic threats is well acknowledged,” Trumka wrote.
Market Shocks
The new disclosure will give regulators an unprecedented look into hedge and private-equity funds’ assets, leverage, investments, valuation and trading practices. The information will be shared with the new Financial Stability Oversight Council and the Treasury Department’s financial research office as they seek to monitor potential shocks to the markets.
Today’s SEC rule demands the most information from the largest funds -- including hedge funds with more than $1.5 billion in assets, private-equity funds with $2 billion in assets and liquidity funds with $1 billion. Those with more than $5 billion will have to report first, some as early as June. The big hedge funds will have to file their reports quarterly, revealing exposure to various asset categories, leverage, investor information and performance.
The CFTC is expected to follow with its own vote within the next week, according to SEC rule documents. Its five commissioners are planning to vote on the rule in an on-paper process known as seriatum, according to a person familiar with the rulemaking process.
Financial Crisis
While hedge funds didn’t play a central role in the 2008 financial collapse, there have been failures that rattled markets, including the 1998 collapse of Long Term Capital Management LP and the record $6.6 billion loss that dragged down Amaranth Advisors LLC in 2006.
The biggest asset management firms, like BlackRock Inc. (BLK), have pushed the SEC and CFTC to allow them to report the new information in the same format, arguing that different forms would make it harder for the government to process the data.
BlackRock Chief Executive Officer Larry Fink called SEC Chairman Mary Schapiro last week to make the case, according to disclosures posted on the agency’s website. The company, which manages $3.6 trillion, has hundreds of funds that would each need to file information to one or both of the agencies.
Fink supplied the SEC a list of inconsistencies between its approach and the CFTC’s, detailing differences ranging from how the agencies require funds to value derivatives to how and when assets are counted. A few of those -- such as the requirement to certify the information in the form -- were ironed out by the changes adopted in today’s rule.
‘Duplicative, Unnecessary’
In an earlier letter to the SEC, Joanne Medero, a managing director at BlackRock, urged the agencies to use the same reporting standards, saying that a two-track effort would be “duplicative, unnecessary and highly burdensome.”
Schapiro, in a speech last week to hedge-fund managers in New York, said the two agencies have tried to coordinate “but there are unique areas where each of us has interests.”
Fund managers have largely operated in secrecy for years. Even firms that have voluntarily registered with the SEC don’t give the agency information on their portfolios unless they face an examination by the agency’s compliance staff.
Asset-management company TCW, a Los Angeles-based unit of Societe Generale SA, had said the SEC’s initial proposal “places an enormous burden on advisers, particularly those with a variety of strategies and funds,” according to a letter to the agency from Michael E. Cahill, general counsel, and Linda Barker, deputy general counsel.
Not Systemically Risky
In addition, many in the industry say that the data isn’t likely to provide much of a window into potentially dangerous areas. While hedge funds trade frequently, they argue that they’re not large enough to put the markets at risk or require a bailout if they fail.
“I think there’s a general sense that it’s hard to see how a billion-dollar fund could be systemically important,” said Henry Kahn, a Washington securities lawyer at Hogan Lovells LLP, arguing that regulators will demand “an awful lot of detailed information that the government’s not going to have the resources to use.”
Under the SEC’s new definitions, about 230 U.S.-based hedge funds and 155 private-equity fund advisers would be subject to the large-fund disclosure system. Many of the largest fund firms would also operate under the CFTC’s authority.
The SEC had estimated that its proposed rule would cost $30.2 million industrywide in the first year and then fall to $15.8 million annually after that. Fund companies say that the figure doesn’t come close to tallying all the legal, software, personnel and other expenses they’ll incur.
‘Understated’ Expense
The SEC “grossly understated” the expense of the rule, the Securities Industry and Financial Markets Association’s asset management group wrote to the agency. The association also noted that funds will be forced to pass the costs on to investors, reducing their returns.
Hedge and private equity funds have also told the SEC that they’re concerned about keeping the vast amounts of data on their trades private. They’re especially concerned that Congress will demand the data and then release it.
“There have been instances for government agencies in which information has made its way outside approved purposes by one way or another,” said Heather Traeger, a Washington lawyer at O’Melveny & Myers LLP. “If it does happen, the information could be misused or misinterpreted.”
To contact the reporters on this story: Jesse Hamilton in Washington at jhamilton33@bloomberg.net; Robert Schmidt in Washington at rschmidt5@bloomberg.net.
To contact the editor responsible for this story: Lawrence Roberts at lroberts13@bloomberg.net.
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