INVESTMENT COMPANIES—Gensler outlines SEC’s efforts to update rules for private funds - 04 May 2023

In remarks to the MFA, he discussed some of the reasoning behind the Commission’s pending proposals that affect how private funds operate.

Private funds currently are the focus of a number of SEC initiatives, including February 2022 proposals to enhance the regulation of private fund advisers, many of which are intended to keep up with fast-changing technology and business models, according to SEC Chair Gary Gensler. In remarks to the Managed Funds Association (MFA), he provided some context and rationale for the Commission’s work on those initiatives.

As a backdrop, Gensler noted that advisers currently report more than $25 trillion in private fund gross asset value among tens of thousands of funds, eclipsing the size of the $23 trillion banking sector. In contrast, 25 years ago the private fund industry had a little under $1 trillion in assets representing about 25 percent of the value of the $4-plus trillion banking industry. Average fees now add up to 3 to 4 percent in private equity and 2 to 3 percent in hedge funds each year, resulting in hundreds of billions of dollars in fees and expenses annually, he said.

2022 proposed rules. Given the industry’s size, the SEC monitors the industry as part of its remit to maintain fair, orderly, and efficient markets, Gensler indicated. Accordingly, it proposed rules in 2022 that would increase transparency by requiring registered private fund advisers to provide investors with quarterly statements detailing certain information regarding fund fees, expenses, and performance.

The proposed rules also would prohibit private fund advisers from providing certain types of preferential treatment to investors in their funds and all other preferential treatment unless it is disclosed to current and prospective investors, and would create new requirements for private fund advisers related to fund audits, books and records, and adviser-led secondary transactions.

Gensler noted that the proposals use transparency and market integrity to promote competition and efficiency. The effort can be traced back to 1996 reforms, he stated, when Congress explicitly instructed the SEC to consider efficiency and competition in the capital markets in its rulemaking.

Congress also gave the SEC a role in promoting market integrity and disclosure, Gensler added, and he outlined five pending projects focused on those issues, all of which were authorized by the Dodd-Frank Act. The projects include proposals to reduce information asymmetries between borrowers and sellers in the securities-lending market and proposals to make aggregate data about large short positions available to the public. The three additional proposals relate to investment advisers’ custody of client assets, beneficial ownership, and large positions in security-based swaps, Gensler noted.

Custody rule proposal. After the Bernie Madoff scandal, Congress provided updated authorities to the Commission to ensure that that investment advisers safeguard client assets over which they have custody. The result was the safeguarding proposal, Gensler said, which would update the existing custody rule.

He pointed out that Congress gave the agency the authority to expand the advisers’ custody rule to apply to all assets, not just funds or securities. The proposal also would enhance the protections that qualified custodians provide, which helps protect assets should the adviser or custodian go bankrupt, he stated.

Gensler noted that the SEC received additional Congressional authority after the 2008 financial crisis to address security-based swaps, including credit default swaps, which played a leading role in the crisis. The Commission used that authority to propose rules requiring prompt disclosure of large security-based swap positions and strengthening investor protection in security-based swaps, he said.

Form PF changes. Gensler reminded his MFA audience that history is full of instances when trouble in one corner of the financial system or at one financial institution spilled into the broader economy. The 2008 crisis is one such example, he said, and that led to the Dodd-Frank Act and its Form PF requirements regarding registration and reporting of private fund advisers.

Since that form was adopted, Gensler said, market conditions have changed resulting in the need to update the form. The day after his remarks, the Commission voted to finalize those updates, including one related to current reporting, and one that expands the reporting requirements for large hedge fund advisers on their large funds.

Gensler also mentioned important projects to address the registration and regulation of Treasury dealers and platforms, as well as to facilitate greater clearing of treasuries in both cash and funding markets. In his view, the projects are important because hedge funds can create risks for financial stability through the use of leverage and through counterparty exposures. Moreover, risks from hedge fund exposures to repurchase agreements, reverse repurchase agreements, and Treasury securities have increased in recent years, he said.

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