Founder, Iron Road Partners
Managing partner, A&C Advisors
National practice leader for alternative investments, KPMG
Managing principal, financial sponsors and financial services industry, CohnReznick
What are the implications of the US Securities and Exchange Commission’s proposals on fund disclosure?
Igor Rozenblit: We expect the rules will be adopted, albeit with changes, and for some of the provisions to be litigated. The final rules likely will significantly impact funds and disclosures. Managers will need to disclose more details on fees, expenses, valuations and performance, and within 45 days of the close of each quarter. Investors will have more information to digest but also more questions. All this data will also be available during SEC examinations.
The new rules’ prohibitions also will impact fund disclosure. If these prohibitions take effect, any disclosure that the fund manager relied on concerning certain kinds of fee allocations, indemnity in the cases of negligence and returning clawback net of taxes will no longer have any effect and managers will need to adjust to this new reality.
Daniel Strachman: The SEC is looking, in its view, to bring transparency to private funds and to enhance investor protection – always a good thing. Discussions about what regulations, if any, will be adopted have been ongoing for some time, and will continue.
While this is welcomed by the industry, investors actually need to do more thorough and continuing due diligence on the managers who allocate assets in their portfolios. It is essential for investors to ensure they have all the information about how their money is being managed and associated costs. The SEC’s role is to help protect investors, but investors must make the effort to know how managers are investing their money.
Jeremy Swan: For LPs, the proposed rules will help standardise reporting across fund investments and improve transparency. That said, many LPs have developed strong reporting relationships with the funds they are invested in and have structured reporting to meet their needs. The typical reporting of fund and investment performance and other metrics in many ways necessitates a bespoke approach dependent upon fund resources, investment strategy and investor requirements.
The challenge with the SEC’s one-size-fits-all approach is that many LPs are satisfied with the current level of reporting; mid-size and smaller managers will most feel the major cost and resource impact.
How has the uncertainty surrounding recent geopolitical events and the US Federal Reserve’s change in rate stance affected fund administration?
Jeremy S: The increased borrowing costs coupled with geopolitical uncertainty has the potential to weigh on fund returns. If credit continues to increase in cost and the war in Ukraine continues to exacerbate the existing supply chain dilemma, we could expect to see a drop in investor performance, and hence, returns.
IR: The uncertainty will affect the health of borrowers, raise interest rates and impact interim valuations. In our experience, many managers, especially those focused on asset-backed securities, overlook the impact of prevailing interest rates in their valuation analyses. This has worked well over the past decades when interest rates didn’t change significantly. Now, as rates rise, valuations for fixed-rate debt will decrease even if the underlying collateral is healthy.
If current events impact the broader economy, however, borrowers may become distressed and collateral may become impaired. Measuring impairment correctly and incorporating prevailing rates will be key in avoiding issues.
Jim Suglia: While rates are top of mind and will clearly impact economics (the P&L), a lot of dialogue today is about geopolitical issues and how large administrators are revisiting their global operating models and physical footprints, in a way not too dissimilar to auto makers and other manufacturers assessing their operating plant locations and supply chains.
Digitisation of information is becoming increasingly important. Where are we in the transition?
Jeremy S: We are still in the early stages of the digitisation of information in the fund management industry (particularly private equity and hedge funds). As investors continue to focus on investments that will enhance returns, the digitisation of information and the funds’ operations themselves typically drop in the list of priorities. Until the investor community begins to demand better and more immediate access to data, the trend will likely continue. The proposed SEC disclosure regulations, ESG regulations and cybersecurity regulations may move digitisation up the priority list given the data-centric nature of the required reporting, but it is still too early to tell.
IR: Fund documentation is now increasingly signed and distributed electronically. We see no issues with this, but managers should still be mindful of the SEC’s Custody Rule. Even electronic documents, if securities are certificated, will need to be custodied with a qualified custodian. Additionally, cybersecurity, which is always important, will become increasingly so as we transition to digital communications.
How has the transition from LIBOR to SOFR been proceeding?
Jim S: Things are progressing and for managers with large portfolios tied to LIBOR, digitisation efforts have been most effective (using natural language processing, artificial intelligence and machine learning to determine fallback provisions which in turn drive key activities). The one challenge I’m hearing pertains to a small number of instances whereby certain types of fallback provisions are not covered by the Fed and need to be monitored closely by managers to assess potential economic impact(s).
IR: The main issue with the LIBOR transition was that it was coming quickly and many documents did not have fallback language in their legacy documentation. Now with the transition being delayed and the passing of the LIBOR Act, this area is significantly de-risked.