Seeking U.S. backing, the Hedge Fund Standards Board in London amended its best practice guidelines to accommodate international standards. The changes strengthen disclosure and risk management practices for alternative investment funds.
The new proposed standards – originally issued in 2008 -- were explained in a consultation paper. Comments are due by October 28.
Here are five of the key proposals either reworded from older standards or brand new:
- Valuation policies: The HFSB said hedge fund managers should put valuation policies in place and the fund should explain in adisclosure statement when its governing body doesn’t agree with its recommendations on how to value securities
- Consistency in valuation disclosure: The HFSB wants the hedge fund manager to better explain to investors how it values “hard-to-price” assets. If the hedge fund manager values so-called Level Three assets inhouse or is involved in providing final prices to a valuation firm it should adopt valuation procedures for the assets which ensure a consistent approach to determining their fair value. Such assets have little, if any, market activity on which to base measurements.
- Disclosure of investment policy and risk: The HFSB wants some explanation of the fund’s investment policy/strategy, process, guidelines and associated risks to be included in its offering documents. The HFSB said that in most circumstances such disclosure would include an appropriate description of the investment strategies and techniques used and the risks involved; general details of the investments and financial instruments; details of any investment restrictions or guidelines the manager will follow; details of the investment process including internal reviews and controls and an explanation of the circumstances in which the fund may use leverage. The HFSB also wants the fund to explain how its manager defines leverage or net exposure levels.
- Disclosure of commercial terms: The HFSB wants the hedge fund manager to explain the methodology used to calculate performance fees, details of any other renumeration received by the fund manager; the basis for calculating any management fee and to the extent possible the amount and method of calculating fees payable to other service providers. The trade group is also recommending for the first time that hedge funds disclose the existence of side letters which contain “material terms” and the nature of those terms. Those material terms might provide some investors with more favorable treatment than others of the same class of shares.
- Strengthening risk management: The hedge fund manager should ensure that “material” aspects of its operational procedures are adequately documented and training is provided to staff. Those operational procedures should include compliance procedures, back-up disaster recovery procedures and client confidentiality. For the first time, the HFSB is also addressing how hedge fund managers should reduce the operational risk of outsourcing some of its middle and back office functions. The hedge fund manager, said the HFSB, should report to the fund’s board any concerns in relation to the quality of services provided by a third party and monitor those services against contractual and other agreed standards.
Founded by 2008 by 14 hedge fund managers, the HFSB currently has about 60 hedge fund managers. Of those only three are U.S. hedge fund managers—Gramercy Advisors, Concordia Advisors and the London arm of Och-Ziff. The remainder are in London, continental Europe and Asia-Pacific. The group specializes in setting operational standards for hedge fund managers.
“The standards are now widely accepted in the European market and most of the leading hedge fund managers in the UK and Continental Europe have become signatories,” said Dame Amelia Fawcett, the newly appointed chairman of HFSB who also serves as non-executive director at State Street in Boston “Investors are now telling us that they would like to see wider adoption of the standards by managers in the US and Asian markets.”
Among the investors represented on the HFSB’s board of directors are: the Government of Singapore Investment Corporation; BT Pension Scheme Management; Caisse de depot et placement du Quebec, Future Fund, Australia and New Holland Capital.
“The standards were originally developed in the context of the U.K. regulatory environment and the principles-based approach followed by the U.K. regulator, the Financial Services Authority,” said the HFSB in the executive summary to its proposals.