Guide to Institutional Investors’ Views and Preferences Regarding Hedge Fund Operational Infrastructures

The Alternative Investment Management Association (AIMA) has written a guide for investors and managers aimed at highlighting preferences and priorities for institutional investors.

The guide is called  “A Guide To Institutional Investors’ Views And Preferences Regarding Hedge Fund Operational Infrastructures” outline the views and preferences on a number of operational and organizational issues which are increasingly become the subject of due diligence reviews.  The paper is divided into 5 sections.  I will list the contents of the sections below and starting tomorrow I will abstract each section.  Investors are organizing and will have a large impact on how the hedge funds will be organized in the future.   

As an example the guide, recommends that hedge funds issue voting units so investors have a say on material changes or events in the hedge funds.  More to come tomorrow.  Keep reading    

GOVERNANCE

Relevance

Board of Directors

RISK

Reporting

Portfolio Risk

Operational Risk

Counterparty Risk

Liquidity risk

INVESTMENTS

Performance

Terms

Economics

Control of Assets

Transparency

CAPITAL

Firm Ownership

Fund Investors

Investor Relations

Sales and Marketing

OPERATIONS

Organization and Control Environment

Corporate Structure

Oversight and Reporting Lines

Separation of Duties

Whistle blowing rules finalized by SEC

Not only can you look yourself in the mirror for doing the right thing by turning potential “violator” of the rules into the SEC, but you will also be handsomely rewarded for your efforts. Caution read the fine print of the 305 page final rule document before you blow that whistle.  See the attached link  http://www.sec.gov/rules/final/2011/34-64545.pdf  for the final rule.

On May 25, 2011 the SEC finalized the whistleblower rules. The Act establishes a whistleblower program that enables the SEC to pay an award, under regulations prescribed by the SEC and subject to certain limitations, to eligible whistleblowers who:

     

       voluntarily provide the SEC original information about a violation of the federal securities laws in writing that leads to the successful enforcement of a covered judicial or administrative action, or a related action resulting in monetary sanctions exceeding $1 million.

Awards will be paid out of the statutorily-created Investor Protection Fund. The SEC will independently determine the appropriate award percentage for each whistleblower, but total award payments, in the aggregate, will equal between 10 and 30 percent of the monetary sanctions collected in the Commission’s action and the related action.

Under the final rule, when determining the percentage of a whistleblower award, the following required criteria may increase a whistleblower’s award percentage:

(1) Significance of the information provided by the whistleblower

(2) Assistance provided by the whistleblower

(3) Law enforcement interest in making a whistleblower award (BTW this one is a little vague)

(4) Participation by the whistleblower in internal compliance systems

Oh and by the way your award might be decreased by the following:

(1) Culpability of the whistleblower

(2) Unreasonable reporting delay by the whistleblower

(3) Interference with internal compliance and reporting systems by the whistleblower.

SEC is requesting Public Comment on Proposed NSRO rating rules

 

On May 10, 2011 the SEC requested for public comment ideas that will ultimately reduce the potential conflict of interest of a NRSRO assigning a credit rating for a structured product instrument.  The comment period will end on or about September 10, 2011.   

The study will be asking the public to comment on four areas: 

• The credit rating process for structured finance products and the potential conflicts of interest associated with the issuer-pay and the subscriber-pay models.

•  The feasibility of establishing a system in which a public or private utility or an SRO assigns an NRSRO(s) to determine the credit ratings for structured finance

• The range of metrics one could use to determine the accuracy of credit ratings for structured finance products.

•  Alternative means for compensating NRSRO(s) that would create incentives for accurate credit ratings for structured finance products.

In addition, Section 939F provides that, after submission of the report to Congress resulting from the study, the Commission shall, by rule, as the Commission determines is necessary or appropriate in the public interest or for the protection of investors, establish a system for the assignment of NRSRO’s to determine the initial credit ratings of structured finance products, in a manner that prevents the issuer, sponsor, or underwriter of the structured finance product from selecting the NRSRO’s that will determine the initial credit ratings and monitor such credit ratings.

Macroprudential theories or "it's a small world after all"

On May 5^th Ben Bernanke addressed the Federal Reserve Bank of Chicago about implementing a “Macroprudential” approach to Supervision and Regulation.  Though the term macroprudential and associated policies have been around for decades, I feel that the term will now be infused in our lexicon.  Mr. Bernanke indicated that a central element of the Dodd Frank Reform bill is the requirement that the Federal Reserve as well as other financial regulatory agencies adopt a so-called macroprudential approach--that is, an approach that supplements traditional supervision and regulation of individual firms or markets with explicit consideration of threats to the stability of the financial system as a whole.  In other words, the “macro-prudential” approach to supervision of the financial industry will require that all US and Global regulatory agencies work in concert with each other to provide oversight and exchange information. 

Relative to traditional regulation and supervision, executing a macroprudential approach to oversight can involve heavier informational requirements and more-complex analytic framework.  So start getting prepared.

Moreover, broadly speaking, macroprudential regulators will be concerned with at least two types of risks. The first type encompasses aspects of the structure of the financial system--such as gaps in regulatory coverage or the evolution of shadow banking--that pose ongoing risks to financial stability. The second class of risks are those that vary over time with financial or economic circumstances, such as widespread buildups of leverage in good times that could ultimately unwind in destabilizing ways.

My view

We have heard the coordinate oversight approach from the SEC and now from the Fed.  With the world getting smaller and the financial industry becoming more complex, we will eventually need one set of rules that will govern the world financial markets.  It is time that financial industry firms realize this and look for ways stay ahead of the regulations rather than begrudgingly reacting to them.