In terms of private funds regulation, 2023 has been one of the more remarkable years that we have seen. The headline development is, of course, the changes announced on August 23rd which, on paper, could have far-reaching implications.
The trade media has been focusing mostly on the ‘preferential rule’ issue, which now states, “the final rules will prohibit all private fund advisers from providing investors with preferential treatment regarding redemptions and information if such treatment would have a material, negative effect on other investors.” The noise around this development is understandable because, all of a sudden, terms for all investors will be clear for all to see. The counter argument to the uncertainty is that, in the case of seeding arrangements, many investors will – should? – expect that the initial capital of the fund(s) would have better terms, and serious investors won’t mind. What will be interesting to see is the extent to which this impacts fundraising. While the SEC has enacted a legacy status provision for existing funds, it’ll be interesting to see whether open-ended funds in particular could see some short-term asset flows out of their products from investors that want to ‘shop around’ for better terms in potential new funds.
The private funds rules have other impacts, most of which are more administrative. The requirement for quarterly statements detailing ‘certain information regarding fund fees, expenses, and performance’, for example. So, there will be generally more time – and cost – going to the compliance effort in future (unless the lawsuit brought by numerous industry bodies is successful).
And there’s more, of course. Just since Labor Day, there have been updates to securities lending rules, short selling disclosures, and even tightened requirements around fund names (does this mean that all the investment firms that are named after trees now have to invest in forestry assets?)
But one that – at the time of publishing – hasn’t been finalised is the cybersecurity rule. We’re interested in that one because of the potential impact on the service provider community, which is our primary customer base. The proposed rule – announced 18 months ago, in February 2022 – says that:
“The proposed cybersecurity risk management rules would require advisers and funds, when conducting this risk assessment, to…Identify their service providers that receive, maintain or process adviser or fund information, or that are permitted to access their information systems, including the information residing therein, and identify the cybersecurity risks associated with the use of these service providers.”
Service provider due diligence is nothing new in the private fund adviser industry, but when this rule gets finalised, it will be interesting to see the impact here on the fund administration market in particular. Fund administrators are not regulated entities in the United States – but they now will be, by association. Private funds and their advisers will now have to dedicate ongoing time and effort into not only the selection of fund admins and shadow admins, but in terms of ongoing due diligence on these firms. But the flip side of this is that fund administrators that are ahead of the game in terms of having their own cybersecurity program and process will be in pole position to secure new clients. Those admins that go the extra mile – because the SEC’s rules will only set a floor, not a ceiling – may be able leverage this into something of a competitive advantage.
The SEC has enacted an aggressive program of reforms since Gary Gensler became Chair in April 2021. The spate of activity just in the past few months would seem to have covered many of the sub-topics that affect the private funds world, either directly or indirectly. But it wouldn’t surprise us if that continued into 2024 at least. How the private funds industry reacts and adapts to the changes will be fascinating to see.
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