Introduction

Regulators are moving the onus on private fund advisers away from risk disclosure and towards risk prevention. To date in 2023 the regulatory burden faced by private fund advisers in the United States has grown significantly. This article examines why the burden has increased and how private fund advisers have to become more data savvy than ever before in order to comply with emerging regulatory change and move on from risk disclosure to risk prevention.  

A whole new world of risk and compliance automation for private fund advisers

There is no doubt that the pace of innovation in private markets and the potential for disruption has accelerated. Investors and regulators alike expect frictionless compliance processes characterised by streamlined and digitised approaches. Automated compliance management and transparent data management are essential. New platforms and AI technologies are changing how private fund advisers do business; in turn, this changes the way private fund advisers have to comply with financial services regulations. 

Regulatory changes afoot in the USA

The new world of compliance for private fund advisers is not solely due to new platforms and AI technologies, regulatory change is impactful too. Form PF was launched by the Securities and Exchange Commission (SEC) twelve years ago and in May 2023 Form PF regulatory change was confirmed by the SEC. In May 2023 the SEC finalised the Form PF rule changes. 

Amendments to Form PF aim to improve transparency and the ability of the Financial Stability Oversight Council (FSOC) to improve their ability to assess systemic risk. As a result, the regulatory burden for private fund advisers has increased significantly and the operational challenges the amendments bring cannot be underestimated. 

In accepting the amendments, the SEC implemented Title IV of the Dodd-Frank Act, which authorises the SEC to require private fund advisers to file reports if “necessary and appropriate in the public interest and for the protection of investors, or for the assessment of systematic risk by FSOC”. The result of all this new and emerging regulatory change is a requirement for near real-time data and new internal reporting mechanisms. Meeting deadlines for regulatory filings will be evermore challenging for firms with regulatory reporting now required in hours rather than months. 

The SEC has also proposed a rule that will require registered private fund advisers to share quarterly statements with investors, including detailed records of all fees and expenses and performance. This will further increase the regulatory burden faced by private fund advisers.

Furthermore, the Commodity Futures Trading Commission (CFTC) and SEC are jointly working on another private fund reporting rule. This other private fund reporting rule broadens disclosure on items such as large hedge funds’ investment exposure or private equity groups’ fund performance. It remains to be seen how the CFTC rule will coexist alongside the Form PF amendments. Notwithstanding, the rule will likely challenge private fund advisers even further. 

Private fund advisers and the increased need for data transparency

The use of private fund advisers is on the rise. The quest for performance and diversification has further increased the use of unlisted assets by asset owners and asset managers which in turn is fuelling the need for more transparent data management and risk monitoring tools. There is little data available on the private equity, infrastructure, real estate and corporate loan fund assets typically held in private funds compared to listed assets. 

Transparent management of the data that exists and simulation of the missing data is key to full data transparency across liquid and illiquid asset classes in order for private fund advisers to analyse their investment risk and returns and to move on from risk disclosure to risk prevention. Full data transparency is hindered by challenges private fund advisers face when classifying instruments.

When one looks at a private fund and assesses the array of instruments that exist it is clear that ancillary data required for amended SEC regulatory reporting such as Form PF is a challenge faced by private fund advisers. 

Simulation of the missing data related to asset-backed securities, bad debt loans, collateralised debt obligations, commercial mortgage-backed securities, credit-linked notes, deposit and loan claims, financial leases, loans, non-negotiable debt instruments, non-tradable loans, profit participating notes, reverse repos, securities borrowing, securitised loans and tradable loans is challenging but key to full data transparency across liquid and illiquid asset classes in order for fund managers to analyse their investment risk and returns lies.

Situations exist whereby a reclassification of data is required. These include the following: change of counterparty country of residency; change of counterparty sector; restructure of assets or liabilities (e.g., maturity extension). Transparent data validations support reclassifications and ensure that calculations are robust and not dependent on historic classifications. When a counterparty changes its country or sector, for example when re-domiciling or after the revocation of a banking licence, the new country/sector has to be recognised. The challenge is that the data for risk management and regulatory reporting may require a historic classification for data aggregation purposes. This is why date-stamped and audited data reclassification is a must-have. 

Further complexity occurs when a restructuring such as a maturity extension takes place, the appropriate action is to transact down the previous position and transact up the new position. End-to-end data automation rules are required to ensure that this happens each time a restructuring takes place. 

How can private fund advisers best prepare for the Form PF amendments and data management challenges that lie ahead?

At the heart of any solution to meet new and emerging regulatory requirements lies data governance planning and automation of data management. Neither of these two areas has previously been the focus of private fund advisers. Private fund advisers now have to turn their attention to data management and all of the ancillary challenges that brings, including but not limited to cyber security. The only way to ensure that these challenges can be met is to engage with experts in the field of data management and automated technology specifically built for private fund advisers. The embedded domain knowledge will ensure that emerging regulatory change is managed from within the technology built by design for private fund advisers. 

Conclusion

In conclusion, as the regulatory landscape for private fund advisers undergoes significant changes, there is a clear shift in regulatory focus from risk disclosure to risk prevention. The increased regulatory burden faced by private fund advisers has fueled the need for more transparent data management and risk monitoring tools. However, challenges that arise in achieving full data transparency must not be underestimated by private fund advisers. To navigate these regulatory changes and data management challenges, private fund advisers must prioritise data governance planning and automate data management processes. Seeking expertise from professionals specialised in data management and automated technology tailored for private fund advisers is key. Technology solutions that incorporate domain knowledge and ensure effective compliance with emerging regulatory changes will ultimately assist private fund advisers in up levelling their compliance practices and embracing risk prevention.

Disclaimer

At AQMetrics, we provide a managed services platform that helps our clients address their most complex regulatory challenges. As a global software company, we bring multi-jurisdictional knowledge and high-quality technology to our clients.

This publication has been written in general terms and we recommend that you obtain professional advice before acting or refraining from acting on any of the contents of this publication. AQMetrics accepts no liability for any loss occasioned by any person acting or refraining from action as a result of any material in this publication.

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