May 1, 2012
In October 2011, the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) adopted the much-anticipated final rule 204(b)-1 for Form PF. The form requires reporting of risk measurement information by registered investment advisers regarding the private funds they manage. The purpose of the form is to provide the Financial Stability Oversight Council (FSOC) with information important to the FSOC’s understanding and monitoring of systemic risk in the private fund industry.
Since 1940 Act traditional advisors have been exempt from many of the disclosure rules. Many hedge fund advisors are likely to be stunned by the unprecedented depth of detail the 42-page form requires – four main sections covering different types of funds, and approximately 2,000 data elements. From an operational perspective, many hedge fund managers will face challenges in meeting the initial filing date, as well as subsequent reporting deadlines, because they currently do little or nothing in the way of formal risk measurement analysis and most likely do not produce all of this information in the format that the SEC now requires from them.
The volume of information required and the degree to which it must be auditable and consistent necessitate a long-term technology support solution. However, the type of risk infrastructure design and build required by Form PF is not merely a simple information technology project. The most involved and difficult part of this process is not related to technology, but rather to data identification and mapping. Key requirements include:
- Periodic reporting on performance, risk, investor, and portfolio information, which has previously been outside the scope of regulatory reporting and SEC supervision
- Identification and aggregation of funds deemed to have parallel strategies to determine whether a private fund is a qualifying hedge fund for regulatory purposes
- Ongoing assessment of funds subject to reporting based on variable fund characteristics, such as AUM and trading strategies
- Reporting on non-standardized metrics, including portfolio liquidity, investor liquidity, financing liquidity, and trading and clearing mechanisms.
Completing the form will require the aggregation and standardization of an enormous amount of data from disparate functional areas, some of which may not even reside within a firm’s own systems. As such, the preparation process is front loaded from an analysis standpoint and requires centralized coordination – virtually every facet of the funds’ daily operations will have some type of input into the new form.
Building the necessary and proper technology infrastructure and processes to calculate, verify and report the required risk data and information for Form PF is a lengthy process that can take many months, especially for those hedge fund managers that do not already possess the infrastructure, processes and personnel to produce these reports in an accurate and timely manner. These operational impediments will be especially problematic for funds that are depending solely upon their service providers, such as fund administrators, to provide them with all of the risk information and data needed to complete Form PF on an ongoing basis.
There is certainly an upside to the Form PF exercise – funds will have more information on their business organized in one place than ever before, resulting in smarter decisions that could potentially drive growth. Nonetheless, the operational challenges are many and complex. Preparation for new regulation requires a phased and disciplined approach. To address the challenges, fund managers should develop a detailed understanding of the impact of the requirement, and then develop and implement a strategic solution. Implementation of a Form PF solution may require development of an implementation plan to drive the required changes to people, processes, and technologies. This plan can provide a controlled and cost effective schedule of activities executing the Form PF solution design without interruption to existing operations.