Tag: Asset management


FSOC: Are Asset Managers’ Products and Activities Creating Systemic Risk?

The following post comes to us from Debevoise & Plimpton LLP and is based on a Debevoise & Plimpton Client Update.

In connection with its ongoing evaluation of the asset management industry, the U.S. Financial Stability Oversight Council (the “FSOC”) recently issued a notice seeking public comment (the “Notice”) on whether asset management products and activities may pose potential risks to U.S. financial stability. [1] Specifically, the FSOC seeks comment on the systemic risks posed by: (1) liquidity and redemption practices; (2) use of leverage; (3) operational functions; and (4) resolution, i.e., the extent to which the failure or closure of an asset manager, investment vehicle or an affiliate could have an adverse impact on financial markets or the economy. Comments on the Notice must be submitted by February 23, 2015; and we are working with several clients to prepare and submit such comments. This post summarizes some of the FSOC’s key concerns and questions outlined in the Notice.

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Compensating for Long-Term Value Creation in U.S. Public Corporations

Joseph Bachelder is special counsel in the Tax, Employee Benefits & Private Clients practice group at McCarter & English, LLP. The following post is based on an article by Mr. Bachelder, with assistance from Andy Tsang, which first appeared in the New York Law Journal.

Three categories of performers are rewarded for value creation in U.S. public corporations. They are: (1) the executives who manage the corporations; (2) the directors who oversee the performance of these corporations; and (3) the individual asset managers and others who provide investment services to investors who own, directly or indirectly, these corporations.

The following post takes a look at the correlation between the long-term incentive compensation of these three categories of performers and long-term value creation in U.S. public corporations that is attributable to them. In fact, such correlation appears to be limited. In addition, the article will consider a definition of “long-term” value creation, the roles of these three categories of performers in creating “long-term” value and the methods of compensating these different categories of performers in their respective roles in “long-term” value creation.

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Asset Manager SIFI Designation: Enter SEC

The following post comes to us from Dan Ryan, Leader of the Financial Services Advisory Practice at PricewaterhouseCoopers LLP, and is based on a PwC publication.

Asset managers who tuned in to last month’s Financial Stability Oversight Council’s (“Council”) conference regarding the industry’s potential systemic importance heard no surprises. The US Treasury Department and regulators did not defend the September 2013 report by the Office of Financial Research (“OFR Report”) which had suggested that the industry’s activities as a whole were systemically important. [1] Rather, officials continued to emphasize that they hold no predisposition toward designation. It was left to academics at the conference to argue that asset managers could pose systemic risk.

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An Informed Approach to Issues Facing the Mutual Fund Industry

Luis A. Aguilar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Aguilar’s remarks at the Mutual Fund Directors Forum’s 2014 Policy Conference; the full text, including footnotes, is available here. The views expressed in the post are those of Commissioner Aguilar and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

As a practicing securities lawyer for more than thirty years, I have in the past advised boards of directors, including mutual fund boards, and I am well acquainted with the important work that you do. I also understand the essential role that independent directors play in ensuring good corporate governance. As fiduciaries, you play a critical role in setting the appropriate tone at the top and overseeing the funds’ business. Thus, I commend the Mutual Fund Directors Forum’s efforts in providing a platform for independent mutual fund directors to share ideas and best practices. Improving fund governance is vital to investor protection and maintaining the integrity of our financial markets.

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Nonbank SIFIs: No Solace for US Asset Managers

The following post comes to us from Dan Ryan, Leader of the Financial Services Advisory Practice at PricewaterhouseCoopers LLP, and is based on a PwC publication.

Ever since the Treasury Department’s Office of Financial Research (“OFR”) released its report on Asset Management and Financial Stability in September 2013 (“OFR Report” or “Report”), the industry has vigorously opposed its central conclusion that the activities of the asset management industry as a whole make it systemically important and may pose a risk to US financial stability.

Several members of Congress have also voiced concern with the OFR Report’s findings, particularly during recent Congressional hearings, as have commissioners of the Securities and Exchange Commission (“SEC”). Further complicating matters, a senior official of the Office of the Comptroller of the Currency (“OCC”) recently expressed alarm about banks working with alternative asset managers or shadow banks on “weak” leveraged lending deals.

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Exploring Uncharted Territories of the Hedge Fund Industry

The following post comes to us from Daniel Edelman of Alternative Investment Solutions; William Fung, Visiting Research Professor at the London Business School and Chairman of Maple Financial Group; and David Hsieh, Professor of Finance at Duke University.

It is virtually impossible to obtain accurate historical data on the entire universe of hedge funds. In our paper, Exploring Uncharted Territories of the Hedge Fund Industry: Empirical Characteristics of Mega Hedge Fund Firms, forthcoming in the Journal of Financial Economics, we identify previously unexplored data sources whereby collecting data on fewer than four hundred large hedge fund management firms that do not participate in major commercial databases adds to the observable industry in assets under management (AUM) terms by as much as 34% in 2001 rising to 65% by the end of 2010. Towards the end of our sample period, these nonreporting firms collectively manage US $862 billion of AUM that is missing from the reported US $1,322 billion of AUM managed by firms in the three major commercial databases combined. We manually collect the names and AUMs of large hedge fund firms that do not participate in commercial databases from surveys published by Institutional Investor and Absolute Return+Alpha magazines, which are good sources of information with almost a decade of continuous history. These previously untapped sources of data provide valuable insight into the capital formation process of the industry over the past decade. While commercial databases have successfully depicted data on the growing trend of hedge fund industry’s AUM, from US $278 billion in 2001 to US $1,322 billion in 2010, there is a more important trend in the capital formation process of the industry that has not been considered in the research literature. We show that over this past decade, the AUM of nonreporting mega hedge fund firms has grown from US $118 billion (2001) to US $863 billion (2010). Results point to a rapid growth of mega hedge fund companies opting for privacy dropping out of the voluntary system of reporting to commercial databases. The empirical evidence confirms that a small group of mega hedge fund firms manages the bulk of the assets in the industry. Taken together, this implies that the assets of the hedge fund industry are concentrated in the hands of a small number of mega management firms with rising opacity as their AUM increases.

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Financing Through Asset Sales

The following post comes to us from Alex Edmans and William Mann, both of the Department of Finance at the University of Pennsylvania.

In our paper, Financing Through Asset Sales, which was recently made publicly available on SSRN, we analyze a source of financing that is first-order in reality but relatively unexplored in the literature — selling non-core assets such as a division or a plant. Asset sales are substantial in practice: in 2010, there were $133bn of asset sales in the U.S., versus $130bn in seasoned equity issuance. In contrast, most existing research on a firm’s financing decisions studies the choice between debt and equity and ignores asset sales. We build a model that allows asset sales to be undertaken not only to raise capital, but also for operational reasons (dissynergies). We study the conditions under which asset sales are preferable to equity issuance and vice-versa, how financing and operational motives interact, and how firm boundaries are affected by financial constraints.

The firm comprises a core asset and a non-core asset. The firm must raise financing to meet a liquidity need, and can sell either equity or part of the non-core asset. Following Myers and Majluf (1984) (MM), we model information asymmetry as the principal driver of this choice. The firm’s type is privately known to its manager and comprises two dimensions. The first is quality, which determines the assets’ standalone (common) values. The value of the core asset is higher for high-quality firms. The value of the non-core asset depends on how we specify the correlation between the core and non-core assets. With a positive (negative) correlation, the value of the non-core asset is higher (lower) for high-quality firms. The second dimension is synergy — the additional value that the non-core asset is worth to its current owner.

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Swap Trading in the New Regulatory World

Annette Nazareth is a partner in the Financial Institutions Group at Davis Polk & Wardwell LLP, and a former commissioner at the U.S. Securities and Exchange Commission. This post discusses a Davis Polk memorandum, available here; an accompanying timeline is available here.

As a result of the Dodd-Frank Act, the over-the-counter derivatives markets have become subject to significant new regulatory oversight. As the markets respond to these new regulations, the menu of derivatives instruments available to asset managers, and the costs associated with those instruments, will change significantly. As the first new swap rules have come into effect in the past several months, market participants have started to identify risks and costs, as well as new opportunities, arising from this new regulatory landscape.

This memorandum and the accompanying timeline is designed to provide asset managers, and those interested in the activities of asset managers, with background information on key aspects of the swap regulatory regime that may impact their derivatives trading activities. The memorandum highlights practical considerations and potential opportunities for asset managers, as they assess the impact these regulations will have on their trading activities.

In the short term, asset managers should be sure to:

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Enforcement Priorities in the Alternative Space

Editor’s Note: The following post comes to us from Bruce Karpati, chief of the Division of Enforcement, Asset Management Unit, at the U.S. Securities and Exchange Commission. This post is based on Mr. Karpati’s recent remarks before the Regulatory Compliance Association, which are available here. The views expressed in this post are those of Mr. Karpati and do not necessarily reflect those of the Securities and Exchange Commission, the Commissioners, or the Staff.

I plan to speak about the Enforcement Division’s and in particular the Asset Management Unit’s priorities in the hedge fund space. I’ll discuss the importance of specialization and expertise to this effort; the risks for investors; how these risks are informed by the hedge fund operating model; and how a hedge fund manager’s business may be at odds with the manager’s fiduciary duty to the fund. I’ll also discuss the types of misconduct we’ve seen crossing our desks in the Asset Management Unit, and I’ll conclude with certain best practices to avoid the specter of an enforcement referral or inquiry.

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European Regulation of Fund Managers

Barnabas Reynolds is head of the global Financial Institutions Advisory & Financial Regulatory Group at Shearman & Sterling LLP. This post is based on a Shearman & Sterling client publication by William Murdie and John Adams.

The EU Alternative Investment Fund Managers Directive (the “Directive”) came into force on 21 July 2011. The Directive promises to reshape the regulation of managers of alternative investment funds in the EU and beyond, and is required to be implemented across the EU by 22 July 2013. Yet the Directive requires significant rulemaking in the form of so-called Level 2 implementing measures in order to put flesh on its bones. The body tasked with bringing forth those implementing measures, the European Commission (the “Commission”), has now received final advice from the European Securities and Markets Authority (“ESMA”). That advice, upon which the Commission is expected to rely heavily in its own rulemaking, has been the subject of fierce debate during consultation. This note analyses ESMA’s Final Advice and the possible consequences for the fund management industry going forward.

Introduction

After two years of development, argument and fine-tuning, the Directive was finally published in the Official Journal of the European Union on 1 July 2011 and entered into force for European law purposes on 21 July 2011. EU Member States are required to implement the Directive by 22 July 2013.

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