Could Large Hedge Funds Be Regulated By The Fed?
June 22, 2009
At first glance, the Obama administration's financial regulatory reform proposals appear to hold few surprises for hedge funds. To no one's astonishment, the plan calls for hedge fund advisers with assets under management above "some modest threshold" (likely $30 million) to register with the Securities and Exchange Commission. The modest requirement is essentially the same as an SEC rule that briefly went into effect in 2006 before being struck down by the District of Columbia Circuit Court of Appeals.
The hedge fund adviser registration proposal, which has bipartisan support and is similar to a bill introduced on June 16 by Senate Banking Committee member Jack Reed, D.-R.I., is widely expected to emerge fairly intact from Congress. The main hedge fund trade association, the Managed Funds Association (MFA)--which formerly opposed the measure--is now on record as supporting it.
But there may be a devil lurking in the details. A major thrust of the Obama plan is broad regulation of "institutions that are too big to fail," that are termed "Tier 1 Financial Holding Companies" in the plan. Oversight of these large firms would be the responsibility of the Federal Reserve Board, where they would be subject to "robust consolidated supervision and regulation," the plan says.
Deep into the text of the 85-page proposal, there is this paragraph on oversight of hedge funds: "We further propose that all investment funds advised by an SEC-registered investment adviser be subject to record-keeping requirements...with respect to disclosures to investors, creditors and counterparties; and regulatory reporting requirements. These should require reporting on a confidential basis of assets under management, borrowings, off-balance-sheet exposures and other information necessary to assess whether the fund or funds is so large, highly leveraged or interconnected that it poses a threat to financial stability."
The plan further says that the SEC should share this information with the Federal Reserve. Then, it adds, "The Federal Reserve should determine whether any of the funds or fund families meets the Tier 1 FHC criteria. If so, those funds should be supervised and regulated as Tier 1 FHCs."
"If I am a hedge fund, I'm focused exactly on this paragraph," said Jill R. Whitelaw, an attorney at Philadelphia law firm Montgomery McCracken who specializes in investment pools. "This will get more attention. This was not in the Treasury Blueprint, and it was not in the old SEC plan."
As Whitelaw notes, an ongoing element of discussion is the role or potential role played by hedge funds large enough to pose systemic risk. "It's not clear how big you need to be to pose systemic risk," she notes. "The devil would be in their test of what is systemically important. I do not think it comes completely out of left field. Certain funds and managers will be subject to a lot more oversight if they qualify as Tier 1 FHCs. It sounds a lot more like bank regulation than the disclosure regime you have with securities laws. I see that as a significant change"
Stuart J. Kaswell, executive vice president, managing director and general counsel at the MFA, said that while the MFA is on record supporting the registration of hedge funds, "We want to know more on the systemic risk reporting mechanism before we can endorse it."
