Helping Emerging Managers Regulatory Updates, Financial Reporting and Industry Trends
Regulatory Update 2 Deloitte PowerPoint timesaver – August 2011
SEC Registration Registration • New rules effective March 31, 2012 replacing SEC’s “private adviser exemption” • Individual states now responsible for regulating certain advisers • New exemptions from SEC registration • Reporting requirements for certain investment advisers that are exempt from registration • Generally, advisers to hedge funds and private equity funds must register with the SEC unless: • Private fund advisers – US AUM less than $150 million • Advisers with non-fund clients – US AUM less than $100 million • Voluntary registration allowed – US AUM greater than $100 million • If not SEC registered = must register with applicable state(s) where principal office is located • Exception – state doesn’t have registration requirement or regulatory examination regime, adviser would register with SEC if US AUM greater than $25 million • Note - assets is defined as “gross assets” not “net assets” • Approximately 1,500 additional private fund advisors have now registered with SEC (4,000 total)
SEC High Level Concerns Independence • Lack of independent checks on a hedge fund adviser’s valuation of portfolio securities Reliability • Fund performance data provided by HF advisers cannot be verified because of lack of independent oversight over the fund’s portfolio securities Discretion • HF advisors have complete discretion with respect to valuations used to price the fund’s securities. Valuation Framework is a critical component for all managers • Regulatory focus – defined valuation process, consistently applied and documented, use of independent qualified external sources • Investor focus • Knowledgeable investors and institutional investors require robust valuation framework • Financial reporting focus • US GAAP (2012) and IFRS (2013) new financial reporting requirements require management to disclose valuation process, techniques and inputs for level 3 securities • Main risk area for auditors ¡
SEC Inspections SEC’s near term focus: • The registrant’s control environment and risk management processes • Insider trading and the protection of material non-public information • Custody and safeguarding of assets • Derivatives • Potential conflicts of interest, including favoring one account over another • Marketing and sales practices • Securities valuations, including overvaluations and favoring early redeemers • “Pay to play” arrangements • Short selling practices • Securities lending arrangements ¡
Commodity Futures Trading Commission (“CFTC”) & National Futures Association (“NFA”) Rule 4.13(a)(4) Rescinded • Previously exempted many private fund advisors from registering as a commodity pool operator (“CPO”) • Rule did not restrict limits on amounts of commodity interests trading and therefore provided an appropriate exemption for several funds and fund of funds alike • Rule 4.13(a)(4) rescinded on April 24 2012 • Implications for funds that are no longer exempt: ‒ Register as CPOs with the CFTC; or ‒ Meet requirements under the de minimis rule (Rule 4.13(a)(3)) 6 2011 Technical Update for Investment Companies
CFTC & NFA (continued) De Minimus Rule – CFTC Rule 4.13(a)(3) • Exempt from registration if: ‒ All investors are accredited; and ‒ Fund trades only a de minimus amount of commodity interests trading • De minimus amount: ‒ No more than 5% of the liquidation value of the fund’s portfolio be made up of initial margin and premiums on commodity interests positions; or ‒ The aggregate net notional value of such positions should not exceed 100% of the liquidation value of the fund’s portfolio 7 2011 Technical Update for Investment Companies
CFTC & NFA (continued) Registration & Reporting Requirements • Funds that are required to register must do so by December 31, 2012 • No grandfathering for funds that previously met exemption • Filing of annual financial statements audited by certified public accountants within 90 & 180 days, for funds and fund of funds respectively (filed with the NFA) • Reporting requirements in a tiered approach for form CPO-PQR: ‒ Registered CPOs with <$150M in pool assets under management • Annual filing complete with Schedule A, 90 days after year-end ‒ Registered CPOs with >$150M in pool assets under management • Annual filing complete with Schedule A & B, 90 days after year-end ‒ Registered CPOs with >$1.5B in pool assets under management • Quarterly filing complete with Schedule A, B & C, 60 days after year-end 8 2011 Technical Update for Investment Companies
Industry Trends 9 Deloitte PowerPoint timesaver – August 2011
Industry Trends Liquidity Trends • Greater focus on liquidity and demand for liquidity • Risk of liquidity mismatch between investments and redemption rights • Typical redemption periods - monthly or quarterly • Reduced time to redemption - Less initial lock-ups and greater investor level gates • Move towards custom funds rather than commingling – investors can better control liquidity
Industry Trends (continued) Transparency Trends • Increased demands for transparency from investors • Fund operations • Performance • Investment exposure • How can this be achieved? • Due diligence procedures • SOC 1 reports on service providers such as the administrator • More frequent and detailed investor reporting ¡
Industry Trends (continued) Management and Performance Fees • Increased use of side letters – “most favored nations” clause very common • Fee compression continues as industry struggles with performance • Fees typically marketed as 2% / 20% but larger investors negotiating fees 1.5% / 15% • Hurdles becoming more prevalent • Tradeoff between time to redemption (lock-ups) and management fees • Multi-year clawback provisions (not commonplace but on the rise) ¡
Industry Trends (continued) Other Trends • Investor composition • Side pocket acceptance • Lowering capital limits, • Illiquid investment opt in/out options
How Deloitte Can Help 14 Deloitte PowerPoint timesaver – August 2011
How Can Deloitte Help Emerging Managers? Deloitte’s Global Reach World’s largest professional services firm – 185,000 professionals. Significant financial services experience. Our global financial services industry practice consists of more than 3,000 partners and directors, and 23,300 professionals in more than 40 countries. We maintain a leadership position in the industry, serving 85 percent of the financial services companies listed on the 2012 Fortune Global 500, including a client roster of institutional money managers, including BlackRock, Blackstone, Morgan Stanley, and Paulson & Co. Additionally, we provide professional services to: • 6 of the top 10 U.S. fund of hedge funds, as ranked by Institutional Investor • Serve the largest fund of hedge funds advisor — Blackstone Alternative Asset Management • 40% of the top 100 U.S. hedge funds, as ranked by Absolute Return • More than half of U.S. hedge funds with AUM > $10B • 8 of the top 10 U.S. hedge funds, as ranked by Absolute Return.
How Can Deloitte Help Emerging Managers? Hedge Fund Emerging Manager Platform • Platform focused on the unique needs of emerging managers and those that provide seed capital. • Trusted service provider to support and guide emerging managers through the early years. • Deep global bench of industry experience and knowledge • Offer a unique mix of traditional and non-traditional professional services across audit, tax, regulatory consulting, human capital consulting, risk, financial, technology strategy and operations • Sliding Fee Scale • Strive to be the standard of excellence with consistently delivering high-quality, world-class client service regardless of fund asset base. • What the industry is saying about Deloitte: • Our hedge fund practice has been ranked #1 by Institutional Investor‘s Alpha magazine • Deloitte is consistently voted above the rest of the Big Four by managers of more than 650 hedge funds with more than $1 trillion in AUM.
17 Deloitte PowerPoint timesaver – August 2011
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