Many experts anticipated headwinds in 2023 for alternative fund managers. The rising cost of debt, excess dry powder, and strong competition for investors and investment opportunities are just some of the challenges fund managers currently face. But regulatory changes may far outweigh the impact of any other issue for private capital.
With greater success comes greater regulatory scrutiny. Between 2016 and 2021, the number of private equity funds in the U.S. increased by 58%, and the aggregate assets of these funds grew by 116%. Globally, assets under management (AUM) in private capital grew from $4.08 trillion at the end of 2015 to $8.90 trillion at the end of 2021.
The same year, we saw a record number of U.S. Securities and Exchange Commission (SEC) Proposed Rules focused on private capital firms and a slew of widely discussed SEC risk alerts and exam findings along with similar activity in jurisdictions around the world. In Europe, fund managers must contend with the General Data Protection Regulation (GDPR) and continued evolution of the Alternative Investment Fund Managers Directive (AIFMD) II. Managers with complex global operations must also stay abreast of ongoing tax recommendations by the Organization for Economic Co-operation and Development as well as the anticipated ramp-up of regulatory activity by the Foreign Account Tax Compliance Act (FATCA) and the Common Reporting Standards (CRS).
The takeaway is clear. Private capital is on the radar for regulators and they’re doubling down on their efforts to protect investors, capital markets, and broader financial systems. With alternative assets predicted by Preqin to reach AUM of $17.77 trillion by 2026, regulatory efforts will increase.
Waterfalls: Dive into the data
Distribution waterfalls get to the heart of the matter for investors. After all, investing is about returns, and in private capital the waterfall provisions of the limited partnership agreement (LPA) directly control how those returns are distributed to investors.
A 2021 survey by Probitas of institutional investors and consultants found that the distribution of carried interest is a top issue of focus, and one that far outranks ESG as an investor priority.
The work of industry bodies such as the Institutional Limited Partners Association (ILPA) and standards such as the Global Investment Performance Standards (GIPS®) supports this shift toward more active oversight. By encouraging greater transparency around investment data, these organizations are helping shed light on this complex area and giving limited partners the information they need to understand and monitor the waterfall.
AML and KYC: Enhance the expertise
While the Anti-Money Laundering (AML) Act of 2020 enacted sweeping legislation to impose new data collection and reporting requirements on banks and other financial institutions, private capital firms have escaped these legal requirements.
However, given the continued growth and high visibility of alternatives and the trend toward far greater oversight of private funds, it’s in every fund manager’s best interest to prepare for a reality in which they must adhere to the same requirements be it from regulators, banks, or clients.
In the U.S. and across the globe, jurisdictions are making nuanced changes that have implications for the way fund managers collect and report on investor data. These changing guidelines, combined with complex structures and new investment strategies, place added pressure on fund managers and create a growing need for deeper expertise. Without specialized knowledge, compliance functions become displaced, as back-office resources struggle to keep pace with demand.
Fees and expenses: Focus on transparency
Fund managers are no strangers to the rigors of compliance. Legislative developments such as the Dodd-Frank Act and the Markets in Financial Instruments Directive (MiFID) marked the beginning of a new era of oversight. However, fees and expenses have historically fallen outside regulatory control. With the new set of rules and amendments proposed by the SEC on February 9, 2022, this is set to change.
Already a contentious area, fees and expenses will attract even greater focus among investors and regulators. Fund managers need to understand the requirements and best practices surrounding fees and expenses to meet stringent regulations and retain investor trust.
Rising to the challenges
Fund managers face many challenges in 2023. As regulatory oversight and competition for capital intensify, they need to turn their attention to the issues that are top of mind for regulators and investors. Building out operational capabilities that enable you to calculate distribution waterfalls and fees and expenses more consistently and transparently will commend your firm to both sets of stakeholders. Getting ahead of AML and KYC compliance will ensure you’re ready to support emerging requirements.
Ultimately, bringing greater transparency and consistency to these areas will enable fund managers to de-risk operations and protect the firm’s reputation so that they can take advantage of opportunities to grow and generate alpha in 2023 and beyond.
Read the full insight report to learn more about the challenges and the solutions: Top Three Challenges of 2023 for Private Fund Managers
How CSC helps
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 ACA, 2023 Regulatory Outlook webinar slide deck
 Preqin, Alternatives in 2022
 Probitas Partners 2022 Institutional Investors Private Equity Survey