On May 3, the Securities and Exchange Commission approved a new rule that will require hedge fund advisers and private equity advisers to disclose more information to regulators on Form PF about their stability risks and investment strategies, including litigation finance, and to report that information on a more frequent basis. The SEC and the Financial Stability Oversight Council use the data provided by hedge fund advisers and private equity advisers on Form PF to assess the US’s systemic risk to the private fund industry. The new information required to be reported on Form PF will enhance the SEC’s ability to monitor systemic risk. The new disclosures will also strengthen regulatory surveillance of private fund advisers and enhance investor protection, including by identifying examination and enforcement concerns and priorities. Recent market events, including COVID-19 effects and broader market volatility, have showcased the importance of the SEC possessing current and robust information from market participants.
The new rule and the increased disclosures arising thereunder will give the government better visibility into a portion of the financial market that has grown substantially since the SEC initially passed private fund disclosure rules in 2011.
“Private funds today are ever more interconnected with broader capital markets. They also nearly have tripled in size in the last decade,” SEC Chair Gary Gensler said in a statement, pointing out that SEC data shows registered investment advisers currently oversee $21 trillion in private fund assets; that amount is nearly as large as the US commercial banking sector.
The changes to the confidential disclosure Form PF will include a requirement for the largest hedge fund advisers to quickly report certain “triggering events” that the SEC argues could be signs of systemic risks or cause potential harm to investors. The SEC defines large hedge fund advisers as those with $1.5 billion or more in hedge fund assets under management. Currently, large hedge fund advisers are required to report to the SEC on a quarterly basis, but when the new rule takes effect, they will be required to report the aforementioned triggering events within 72 hours. Triggering events include:
- Extraordinary investment losses
- Certain margin and counterparty events
- Terminations of, or material restrictions on, prime broker relationships
- Significant disruption or degradations of a hedge fund’s “critical operations”
- Events regarding withdrawal or redemption requests
An extraordinary investment loss will qualify as a “triggering event” requiring disclosure to the SEC when a hedge fund’s investment losses are equal to or greater than 20 percent of a fund’s reporting fund aggregate calculated value (RFACV). RFACV is defined by the SEC as “every position in the reporting fund’s portfolio, including cash and cash equivalents, short positions, and any fund-level borrowing, with the most recent price or value applied to the position for purposes of managing the investment portfolio.”
Disclosure requirements on Form PF will additionally be triggered when increases in the dollar value of the margin, collateral, or functional equivalents posted by a reporting fund at the beginning of a rolling 10-business-day period are greater than or equal to 20 percent of the fund’s average daily RFACV during that period. Funds will further be required to disclose each instance in which a reporting fund is either in default or unable to meet a margin call, and the fund will be required to disclose and provide additional information regarding the default or failure to meet a margin call. Further, a disclosure will be mandated when a counterparty to the reporting fund does not meet a margin call or has failed to make any other contractually required payment and the amount involved is greater than 5 percent of the fund’s RFACV. Additionally, reporting will be mandated when a prime broker terminates an agreement or materially restricts its relationship with a reporting fund, in whole or in part, in markets where the broker continues to be active.
“Significant disruption or degradations” of a reporting fund’s “critical operations,” referring to operations critical to the fund’s investment, trading, valuation, reporting, and risk management of the reporting fund, or the fund’s operation in accordance with federal securities laws and regulations, must now be disclosed. No guidelines were published in the final rule regarding what qualifies as “significant.” Such a determination will be left to the fund adviser’s judgment.
Under the new rule, private equity fund advisers also have a list of their own triggering events that they will be required to report, though the SEC’s new rule only requires them to file their reports within 60 days after the end of a fiscal quarter. These triggering events include adviser-led secondary transactions, the removal of a general partner, an election to terminate an investment period, and partner clawbacks. The agency has also changed the definition of large private equity fund advisers from those managing $1.5 billion or more in assets to those managing $2 billion or more.