By Nigel Someck, 16 October 2012, www.prohedge.co.uk
In our series on the evolution of hedge fund technology, PROHEDGE investigates how the wave of new regulations have forced hedge funds to ramp up their operations and technology infrastructure, and how technology companies have responded by generating tailored solutions to help hedge funds survive and thrive.
Regardless of the jurisdiction, new regulations have permanently stunted the daily mechanics of the hedge fund industry.Dodd-Frank, The Volcker Rule, Form PF, and the Foreign Account Tax Compliance Act (FACTA) are just some of the main protagonists in the US alone.
Similarly, Europe is gearing up for the Alternative Investment Fund Managers Directive (AIFMD) which will dramatically change the landscape, while growing popularity of UCITS funds serves only to exacerbate the proliferation of regulatory burden. Asia is also facing an ominous period of transition, with regulatory bodies in Singapore considering a ‘FATCA’-like directive, while Australian regulators have sought to draft rules to protect investors.
Hedge fund managers are inevitably buckling under the pressure of the new regulatory framework. Not only have rules and regulations manifested additional work and expense, but invariably regulators have failed to communicate with any real clarity the cause for such encumbrance.
“Hedge Funds must now operate at Federal rather than State level as was the case pre-Dodd-Frank” comments Andrew Schneider, CEO of consultancy services provider Global Hedge Fund Advisors. He adds: “Hedge funds now need to show their hand and report everything to the government. They lose their competitive edge and we must ask the question: ‘what will the government do with this mountain of data?’”
Such data is relayed back to the SEC (Securities and Exchange Commission) via Form PF filings. “Filing Form PF is the biggest challenge SEC registered hedge funds face” posits Michael Poisson, Managing Director at Investor Analytics – a market risk analytics firm. Very little is left to the imagination when it comes to Form PF. Fund managers must report quantitative and qualitative data on GAV, NAV, borrowing, investors, investment style, counterparties, clearing practices and more.
Art Murphy, Director at Abacus Group – a leading provider of hosted IT solutions for hedge funds – compounds Poisson’s appraisal: “For many funds, Form PF is still the biggest concern. Many filed for the first time on August 29th and now realise the amount of work involved.” Indeed, some of the larger funds will need to file again on December 31st, and any blunders in the reporting process must be rectified ahead of that date.
But it is not only SEC registered funds that are in the spotlight. Sean Sullivan, President of regulatory compliance software provider Advise Technologies, warns: “While much of the attention has been on Form PF lately, the focus is now moving to Forms CPO-PQR and CTA-PR for entities registered with the CFTC (Commodity Futures Trading Commission).” He further adds: “In Europe, AIFMD is the big story and will continue to gain momentum.”
So now it’s Europe’s turn to weather the storm. Dodd-Frank’s evil sibling – AIFMD – is European of origin and will avail itself in 2013. Subject to AIFMD, European hedge funds will need to document the strategies they are employing, as well as detailing asset classes and risk exposure to regulators. Accordingly, this will necessitate a wholesale reworking of infrastructure, as hedge funds adapt to the need to provide large bodies of data as per their American counterparts.
FATCA will also bombard Fund Managers with new responsibilities. Indeed, they will be obliged to identify any American taxpaying investors and report on them annually, impacting both US and non-US funds alike.
Service providers continue to explore innovative ways to improve their compliance offering for hedge funds, be it through outsourcing or adaptive infrastructures. When approaching compliance solutions, it is crucial therefore to leverage work that has already been undertaken on behalf of others.
With the December 31st Form PF deadline rapidly approaching, Fund Managers will need to ensure that appropriate systems and tools are firmly embedded. To this end, Sullivan comments: “Advise Technology’s Consensus RMS product suite provides easy to use tools for firms to meet Form PF filing requirements”. PROHEDGE have reported on a number of service providers that have used a template approach to collect and report data necessary for Form PF filings, there is little reason for a fund manager to build the tools themselves.
Poisson further extols: “(Investor Analytics) produce daily risk reports for UCITS funds. Our technology platform automatically communicates with the Fund’s administrators to collect holdings data and produce risk reports.” The UCITS wrapper for European funds is hugely popular with an estimated €5.92 trillion AUM. Service providers release solutions to ease the pain of setting up a UCITS fund and manage the investor and regulatory reporting aspect more efficiently.
According to Art Murphy, Abacus’s cloud model which hosts a number of compliance tool under one umbrella, will play a fundamental role in solution provision. He envisages that this robust technology ecosystem will provide the requisite tools to ensure compliance with regulations, past, present and future.
Fund Managers are increasingly opting for the outsourcing model, either through infrastructure-based solutions such as Abacus or via third party services like fund administrators. Fund administrators are in a strong position to start providing middle-office services in conjunction with their traditional back-office product; they are already custodians of holdings information for their clients and employ staff to produce reports on a regular basis.
“Administrators will need to ramp up their technology infrastructure” claims Andrew Schneider, who also runs his own administration business. While he is confident that administrators are well-positioned within the business, he anticipates that more can be done to provide a complete solution for Fund Managers: “There are new accounting rules in the US. Investors cannot hide behind an LLC (Limited Liability Company) anymore. It is the fund manager’s responsibility to identify exactly where their funds are coming from. Administrators need software for background checks and KYCs (Know Your Customer)”.
We have explored the headline regulations currently sweeping the market, as well as some of the more obscure offerings. Once the dust settles, where will regulators go next in their unflagging mission to protect investors and the economy from hedge funds?
Investor Analytics are trying to make sense of it all. Regulators are stock-piling data to determine how hedge fund activity is impacting the market. Poission muses: “Investor analytics is currently studying the use of agent-based modelling as a way to make sense of the interrelationships of this data and its impact on systematic risk.”
If such interactions cannot be identified, it begs the question as to whether regulators will do an about-turn on what could be perceived as a disproportionate vilification of the hedge fund industry. Schneider observes: “In Wall Street every action leads to an over-reaction. We will see a period of rules being contested and repealed. How governments will react is hard to predict but I would expect the introduction of regulations to level-off and slow down.”
In the next article, PROHEDGE will examine the strides technology providers have taken to help hedge funds cope with increased investor due diligence and investor servicing. We aim to tackle the key concerns of fund managers and some of the solutions available to help.
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Nigel Someck has eight years’ experience of working in the alternative investments technology space. During his career, he has managed solutions for hedge funds, private equity funds and investment banks in London, Singapore and Hong Kong.
PROHEDGE, founded by Nigel Someck, is a new online forum dedicated to hedge fund technology and operations. By providing news, insights and discussions, its aim is to promote operational excellence and the sharing of best practice while inspiring innovation across the industry.