Private equity and hedge funds pan SEC's push for more data disclosure

Too much and too fast.

That's how private equity firms and hedge funds assessed the SEC's proposed rule changes that would significantly expand the amount of confidential information large funds must share with regulators, increase the speed with which they must share it, and boost the number of funds that fall under the reporting requirements.

Under the new rules, large PE funds would have to report any secondary transaction initiated by a fund's adviser, certain general or limited partner clawbacks, the removal of a GP, termination of a fund's investment period, or the termination of a fund.

Large hedge funds would have to report a 20% drop in net asset value over 10 days, a 20% increase in margin requirements over 10 days, an inability to meet a margin or collateral call, and redemption calls that exceed 50% of a fund's value, among other significant events.

SEC Chairman Gary Gensler said the new rules were needed to enhance regulators' ability to detect systemic risk, regulate the private funds industry and protect investors.

Since taking charge at the agency last spring, Gensler has laid out an ambitious agenda reshaping policy on a wide range of private market activity including environmental, social and governance issues, regulation of blank-check deals, and beefing up cybersecurity.

But industry groups panned the transparency rules as onerous new requirements that would accomplish little more than bog down investment firms in more red tape.

Some critics of the effort questioned whether the data gathered under the new rules would actually help regulators to prevent a market crisis and said the agency was rushing to adopt the changes.

"We have concerns that this new proposal will burden firms with unnecessary paperwork even though private equity poses no systemic risk," a spokesperson for the American Investment Council, the lobbying arm of the PE industry, wrote in an email to PitchBook.

The SEC is trying to catch up with an asset class that has seen sharp growth since the global financial crisis. PE funds worldwide had assets of over $4.5 trillion last year, up from $1.7 trillion in 2011, PitchBook data shows.
 
 

What do the new PE, hedge fund rules require?

• Large private equity funds would be required to report confidentially within one business day events such as an adviser-led secondary transaction, clawbacks by general or limited partners when the GP has to return performance-based compensation that exceeds the amount it was ultimately entitled to receive under the fund's governing documents, the removal of a fund's general partner, and termination of a fund or of a fund's investment period.


• Large hedge funds would have to report within one business day events including investment losses of 20% or more over 10 days, defaults or margin increases of 20% or more over 10 days, material changes in prime broker relationships, changes in free cash levels, and withdrawals or redemptions that exceed 50%.


• Previously, large private equity and hedge funds were required to report such events quarterly or annually, months after the reporting period had ended.


• Large PE fund advisers would also be required to provide regulators with more information on fund strategies, use of leverage and portfolio company financings, controlled portfolio company borrowings, fund investments in different levels of portfolio company capital structures, and portfolio company restructurings or recapitalizations.


• The proposed rules would also lower the threshold for next-day reporting by private equity funds to $1.5 billion from $2 billion in assets under management. PitchBook data shows that last year there were 337 different PE funds at the $2 billion level, and that group increases by about 100 funds when including assets of $1.5 billion or more.

Read the full text of the proposed SEC rule.

How are PE firms, hedge funds reacting?

Trade groups representing the private equity and hedge fund industries said the new rules could lead to regulatory overreach.

"We want to study the details to ensure that this proposal is calibrated to collect information at the right interval and granularity without inadvertently capturing routine activity, but we support the SEC's broad goal of obtaining timely and relevant information from market participants in a crisis," Noah Theran, spokesperson for the Washington-based Managed Funds Association, which represents hedge funds, wrote in an email to PitchBook.

Brian Daly, a partner at the law firm of Akin Gump Strauss Hauer & Feld, which advises private fund managers on regulatory matters, said hedge funds were likely to object to the one-business-day reporting requirement and would seek to change it during the 30-day comment period. PE funds, he said, would have a different set of concerns.

"For the PE funds, the burden is that the reporting goes to the relationship among the general partner, the fund and the investors," Daly said.

Republican SEC Commissioner Hester Peirce, who cast the lone vote against the new rules, questioned the need for more stringent disclosure requirements.

"A hedge fund suffering losses equal to or greater than 20% of its net asset value over the course of 10 days is unquestionably a significant turn of events for that hedge fund and its investors, but why is it appropriate or even wise for the commission to insist on being notified of this within one business day?" she said in a statement.

What is the systemic risk that regulators seek to monitor?

For decades, regulators have had growing concerns about the potential for problems in one corner of the market—say a fund not being able to meet margin calls—to create a chain reaction of redemption calls and a scramble by counterparties to raise cash through asset sales. Big blowups of hedge funds like Long Term Capital Management in 1998 and Archegos Capital Management last year, along with failures by public companies in the 2008 financial crisis, have highlighted the potential for one fund's or company's problems to have ripple effects through the global financial system.

According to the SEC, the new disclosure rules cover events that could signal stress in the market, and timely reporting would give regulators an opportunity to contain potential fallout.

In the proposed rules, the SEC says a problem at one fund could indicate that other funds in the same investment space are facing similar issues, and could be a sign of secondary effects such as increasing margin or redemption calls in other parts of the financial markets.

Similarly for PE funds, the SEC said that being aware of GP clawbacks could give authorities time to intervene and head off systemwide failures.

Will the rules address systemic risk for large private funds?

In the aftermath of the Archegos collapse, which erased billions of dollars in trading profits at some investment banks, Gensler has said systemic risk is a concern and has targeted securities swaps for reform.

Mike Sherman, a financial services specialist at the law firm of Dechert, cast doubt on whether the new rules could help the SEC prevent an Archegos-type failure from spreading into a broader market meltdown.

"Even if we take on faith that it would prevent some percentage of significant kerfuffles or whatever in the market, you have to then balance that against the costs that are imposed and ask how much it is worth to be able to stop one out of ten," he said.

Blackstone, which as a publicly traded company already discloses more information to regulators than private funds, said it would adjust.

"Whatever comes out from a regulatory environment, we will adapt, and we will of course, comply and that's just the way we run our business," said Jonathan Gray, Blackstone's chief operating officer, during the company's earnings call on Thursday. "So we understand that we're in an environment of heightened scrutiny and we will obviously respond to it in the right way."