Stealth regulator - the SEC's global reach

Originally published in FTfm Talking Head, 22nd August 2011

By Jonathan Wilson, Director of Project Consulting, The IMS Group

The financial crisis was characterised by calls for global regulatory standards over bank capital and systemic risks, which mutated into politically driven calls for tighter regulation of the alternatives sector – even though the sector’s role in the crisis has been defined speculatively not evidentially.

Politicians in the US and Europe rushed to implement their own alternative manager regulatory framework and in June The Securities and Exchange Commission (“SEC”) approved rules that implement the Dodd-Frank Act Title IV requirements, bringing many non-US hedge fund and private equity managers under its oversight from 30 March 2012 - even where they have no, or very limited, activities in the US.  By implementing this aspect of the Dodd Frank Wall Street Reform and Consumer Protection Act 2010, the US is first to deliver. In contrast, Europe’s own Alternative Investment Management Directive (“AIFMD”) is currently wallowing in Level Two negotiation and is not expected to be implemented until 2013.

This was unfinished business for the SEC. In 2004 the Supreme Court had forced the SEC to repeal its “arbitrary” registration of private funds. Dodd-Frank reverses that judgement and private fund managers now need to determine whether to register or report to the SEC. The SEC believes it is filling a key gap in the regulatory landscape giving it, and the public, greater insight into hedge fund and other private funds that previously operated outside of the regulator’s radar. This new radar, however, is super-strength, and will have more impact globally than its European counterpart.

So how will rules passed in Washington affect fund managers in the UK – or indeed any manager responsible for the assets of US investors? If there are 15 or more US investors in private funds advised or managed by the firm, or the firm advises or manages more than $25m assets attributable to US investors, the SEC is likely to want to hear from it. If less than $150m of private fund assets are managed from a location in the US, and this will apply to many non-US managers, the firm may be eligible for Exempt Reporting Adviser (‘ERA’) status.

There is an annual reporting minimum for funds subject to ERA, though the SEC will also require books and record-keeping requirements, Pay to Play rules for political contributions and lobbying and the right to inspect non-US managers. Full registration means complying with the SEC’s rules and regulations - code of ethics, personal account trading, marketing disclosures - that may be stricter, or more prescriptive than existing compliance obligations.

Even where firms are not required to register, US investors are often demanding they do. Post Madoff concerns for stronger investor due diligence mean that the box marked “SEC” must be ticked. US pension funds and endowments will often insist on the registration of their managers, in most cases because their organisational charters or governing State laws require it.

Global regulators’ interests are, however, largely aligned. The FSA and SEC’s rules cover similar ground – governance and compliance programmes, conflicts of interests, investment execution and commission sharing, business continuity and data security. If caught by the SEC’s scope, firms should consider how they integrate SEC requirements into existing compliance arrangements rather than introducing boilerplate compliance documentation.

This creates an opportunity for many firms. Faced with continuing regulatory uncertainty in the UK and across Europe and the extension of the SEC’s ambit, firms are looking to the highest common denominator of the different regimes to stay ahead of the regulators and politicians. For many firms, it will not be cost-effective, practical or logical to run dual compliance regimes, reflective of which authority cares to call. It will become incumbent upon them to define arrangements that meet their interpretation of global regulation.

Despite all their G20 pronouncements, the world has moved on and politicians have lost interest in a global framework of regulation. The new regulatory institutions that politicians have created, in the UK and across Europe, will need time to come to terms with their new authority and how they will co-exist.

Meanwhile the SEC has first mover advantage - it has established a regulatory framework for private fund managers. Faced with the difficulty and cost of implementing multiple regulatory regimes, fund managers will look at how they structure compliance in their firms and its cost. A common regulatory framework could be developing for alternative fund managers – not one shaped by politicians or by European regulatory integration – but by the US’ insistence that it must have oversight of funds containing US investors.