The SEC’s latest amendments to reporting Form PF assess “trigger events” in private equity and hedge funds that could threaten investor protections. We look at how fund advisers can comply with the new rules while keeping operational burdens and costs to a minimum.
The year 2023 will go down in history as a time when the governance and performance of large private equity and hedge funds were put to the test.
Along with macroeconomic challenges such as inflation and rising interest rates, private equity, and hedge fund advisers now must make more detailed disclosures to the U.S. Securities and Exchange Commission (SEC).
The SEC’s commissioners have voted for the Financial Stability Oversight Council to have greater powers to assess financial systemic risk that could be sparked by certain stress events in private equity and hedge funds.
We explain what the new regulations could entail, the deadlines to report them, and the additional reporting requests the SEC is making to bolster investor protection.
What are the new SEC reporting rules and who is affected?
All registered private equity fund advisers—those with $150 million or more in assets under management—will need to file additional quarterly disclosures to the SEC. Private equity managers with at least $2 billion in assets under management (AUM) and hedge fund managers with $1.5 billion in AUM are required to file a report to the SEC about any significant stress or event that could bring harm to the adviser’s funds or its investors and trigger systemic market risk.
The changes will require funds and larger advisers to file current reports (within 72 hours) on certain trigger events. The SEC’s amendments also require hedge fund advisers to provide current reporting to the Commission when their funds are “facing certain events that may signal stress or potential future stress in financial markets or implicate investor protection concerns”.
Amendments to current reporting will become effective six months after publication of the adopting release in the Federal Register. The remaining amendments will become effective one year after publication in the Federal Register.
According to David Sarfas, managing director, Luxembourg, this development is part of a trend: “Because of the growing size of the alternative asset industry—approximately $14 trillion in AUM today—there are more players accessing the private equity market as a whole. It is a natural evolution to have the SEC ensure that minimum safeguards are in place to help protect smaller investors. The legislation is a positive step in that direction.”
What private equity events need to be reported and how often?
The final amendments will require Section 6 of Form PF to be filed on a quarterly basis within 60 days of the fund’s fiscal quarter end. Events private equity fund advisers must include are the following:
- An adviser-led secondary transaction (i.e., a conflict of interest)
- An investor election to remove a fund’s general partner and an updated calculation of management fees for the remainder of the fund’s life
- An investor election to terminate a fund’s investment period or a fund. This would include any significant liquidation of the fund where the investment strategy and planning could be “disrupted earlier than anticipated”, posing risks to investors and markets where the fund assets are invested
Other areas of reporting for private equity funds
In addition, the amendments request data quality improvements and more information about fund investment strategies. Advisers can choose from a list of strategies by percentage of deployed capital, even if the categories “do not precisely match the characterization of the reporting fund’s strategies”.
Large private equity fund advisers must now report information on general partner and limited partner clawbacks on an annual basis. They are also required to provide information on their strategies and borrowings as a part of their annual filing.
Hedge funds
The SEC is modifying the proposal for reporting changes in unencumbered cash. This moves from one business day to as soon as practicably possible but no later than 72 hours after any event that could indicate significant stress or “signals of potential systemic risk”.
Commissioners have voted to make changes to the metrics for the 20% extraordinary loss and margin thresholds. These, they feel, “should alleviate concerns about the burdens and uncertainties concerning the timely valuation of illiquid or hard-to-value assets”.
Current reporting events include extraordinary investment losses created by:
- Margin events (for example, if counterparties to a fund in distress reacted by increasing margin requirements, limiting borrowing, or forcing asset sales, amplifying the event to have “potential contagion effects” on the broader financial system)
- Counterparty defaults
- Material changes in prime broker relationships
- Operations events
- Certain events associated with redemptions
How will reporting impact fund operations?
The final amendments to Form PF will mean additional costs and specialized talent for private fund advisers. The SEC suggests that these costs are most likely to be borne by private funds and advisers—and therefore by private funds’ investors.
Costs will be reflected on the size and type of funds managed, whether funds experience a reporting event, and the frequency of those events. The SEC has admitted that “at the margin, the heightened compliance costs for smaller advisers from the final amendments may negatively affect competition”.
Direct cost considerations for advisers include attorneys and other non-legal staff such as computer programmers. External costs would include any outsourcing related to Form PF reporting responsibilities to a filing agent, software consultant, or third-party service provider.
Private fund advisers can expect the direct costs covering the final amendments will be most significant for the first updated Form PF. This is because the adviser will need to become familiarized with the new reporting form and likely configure systems to gather the required information.
Why CSC?
The SEC suggests that large private fund advisers will find it “efficient to automate” some portion of the reporting process. This may increase the burden of the initial filing, but automation can lower costs of subsequent filings once efficiencies from system reconfiguration are realized.
CSC’s internal Form PF software can streamline reporting outputs for hedge and private equity funds to ensure timely and accurate annual and quarterly reporting.
We can also offer a cost analysis of in-house talent resources required, versus outsourcing to accommodate the new reporting burdens and timelines.
For further background and commentary on the SEC Private Fund Advisers Rule Proposal, read The SEC Private Funds Advisers Rule Proposal: No Free Ride.
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