Helping Emerging Managers Regulatory Updates, Financial Reporting - - PowerPoint PPT Presentation

Helping Emerging Managers Regulatory Updates, Financial Reporting and Industry Trends

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Deloitte PowerPoint timesaver – August 2011

Regulatory Update

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 Registration

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
• versight 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

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SEC High Level Concerns

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

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SEC Inspections

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))

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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

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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

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2011 Technical Update for Investment Companies

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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

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

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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)

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Industry Trends (continued)

Other Trends

• Investor composition
• Side pocket acceptance
• Lowering capital limits,
• Illiquid investment opt in/out options

Industry Trends (continued)

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Deloitte PowerPoint timesaver – August 2011

How Deloitte Can Help

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.

How Can Deloitte Help Emerging Managers?

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Deloitte PowerPoint timesaver – August 2011