The sheer size and influence of the hedge fund industry today has meant that concern has grown over the unregulated nature of offshore, non-domiciled funds, with calls for greater disclosure and transparency of their activities. While the jury is still out on how this can be done without damaging returns of these highly secretive and competitive vehicles, that cannot advertise, and have caveat emptor written all over them, guidelines are being drawn up that will in effect make investors more aware of where the gaps are, in the hope that hedge funds will respond with greater transparency to give credibility to their dealings.
While offshore hedge funds remain unregulated, hedge fund managers in the UK and US are subject to the same regulation as other market participants. According to Callum McCarthy, Chairman of the UK’s Financial Services Authority, hedge fund managers should set out the basis on which their funds are valued. This should start by establishing whether there is an independent valuation of the fund, but there is a need to go substantially beyond this, to cover policies and procedures such as the separation of duties between portfolio managers and back offices; the reconciliation of values between hedge fund manager, prime broker and administrator; price sources; and procedures for dispute settlement.
Also, the Hedge Fund Working Group (HFWG), led by Sir Andrew Large, the former Deputy Governor of the Bank of England, has joined with 14 leading hedge fund managers to produce best practice standards for the hedge fund industry, swiftly followed by the reports on best practices for hedge fund managers and investors published in the US by the President’s Working Group on Financial Markets.
Both initiatives come hot on the heels of the publication of the Alternative Investment Management Association’s ‘Guide to Sound Practices for Hedge Fund Valuation’ in 2007, and add to the growing pressure to improve the hedge fund management industry before mandatory regulation is forced upon it.
Based upon the FSA’s 11 principles, the HFWG standards include recommendations for managers to adopt an independent process for valuing portfolios and to improve the governance of funds. The report also recommends enhanced disclosure to investors and that managers should have a comprehensive framework to manage risk, an important area in the context of financial stability.
HFWG’s standards outline the importance of regular portfolio risk management disclosure, valuation, fee disclosure, shareholder conduct and fund governance for hedge funds. They require managers to disclose holdings in companies held through complex derivative instruments, to reveal their exposure to illiquid holdings, and to set up internal controls to avoid conflicts of interest. The code is voluntary and operates on a ‘comply or explain’ basis.
Putting it into practice
Most hedge funds will have an accounting engine in place, typically a system such as Geneva, Beauchamp or Paladyne. In many cases they may have outsourced some of this responsibility to their prime broker or to a hedge fund administrator.
Prime brokers assess hedge fund exposures on a daily basis using proprietary systems and methods in order to calculate initial margin and monitor the hedge fund daily to calculate variation margin. The small and medium-sized hedge funds tend to rely heavily upon their prime broker for back-office and reporting technology, as they often do not have this kind of expertise in-house.
For those hedge funds that have signed up to the newly emerged standards, on both sides of the Atlantic, the next step is putting these recommendations into practice. Transparency to investors should also include the material preferential terms to some (typically large) investors, where this has been granted, as well as disclosure of operational risk, especially where external reviews have been carried out, and disclosure of fund risk policies.
Flexible rules-based engine
Aquin’s MIG21 investment compliance system uses a high degree of automation to reduce the burden of work upon fund managers and their compliance officers. Its adaptable rules engine is designed to function in a changing regulatory environment, across all asset classes. It enables the automation of post-trade checking of legal, contractual and internal investment guidelines in a single system to reduce the time and cost associated with investment process controls. Furthermore, the hedge fund’s order management systems can be easily integrated to extend compliance into pre-trade.
Once in place, MIG21 loads the fund’s data from the manager’s accounting engine and does a daily check of LawCard(s) in the jurisdictions specified. The rules engine then holds all the fund data, the holdings of the fund and pricing to monitor any changes to the portfolio to ensure there are no rule breaches. Faulty data might be corrected or enhanced by the user and as most fund managers have their own internal investment rules and criteria, these too can be added to MIG21’s daily checks and held in a single system. The output is a variety of reports giving a snapshot of the day’s changes, a list of breaches and warnings of possible impending breaches.
Even with pan European transparency guidelines for hedge funds, there will still be room for interpretation by the national regulator. It will be very difficult for a hedge fund manager, with funds in multiple jurisdictions and languages, to keep up to date with the local variations and nuances of the different regulatory requirements. By applying MIG21 LawCards the various rules and limits for each jurisdiction, in which the fund is distributed, are automatically installed into the system.
The flexibility of the MIG21 rules engine also means that even complex structured products and derivatives can be included for both compliance with the necessary jurisdictions, and for risk management. MIG21 can decompose the component products and look at the underlying structures to break down and analyse the risk. This can then be added to any existing risk in the portfolio to give an overview of the risks, regardless of the product wrapper. As users have 100 per cent control over customising which rules it wants MIG21 to apply to their funds, its data mapper consolidates data input from any source and can be enriched, ‘on the fly’, to cover any asset class.
MIG21 includes workflow management tools, which enable compliance to be better automated and breaches to be flagged and responded to. The toolset within MIG21 allows the tracking of breaches throughout their lifecycle until they are resolved. Aquin’s compliance experts are on hand to continually update MIG21’s LawCards to comply with regulatory updates, to support the new instrument processes, with advice on modelling the corresponding rules in MIG21, and provide structured product decomposition or look-through.
Next generation web reports
Calls for greater transparency mean that any technology in place must be web-enabled and be able to produce high quality reports at the touch of a button. The major issue here is obviously security, the holdings of the hedge fund being a matter of absolute secrecy. In this new era of increased transparency, usability will also be of key importance, as the investor will want to be able to drill-down through the fund and slice and dice the information to analyse it properly.
For hedge funds and fund administrators, the web is of vital importance as a more efficient way of communicating with investors by enabling them to log-in and find the information they want, to see exactly what the fund is doing, and conduct their own analysis. The transparency this gives to institutional investors is much greater as they can drill down and find the information they want, rather than having a static report.
MIG21 Web provides hedge funds with powerful web reporting tools and management dashboards to produce customisable management and client reports. Furthermore, in readiness for an increasing focus on web-based reporting, the next generation web interface for Aquin’s investment compliance software is an interactive, web-services based reporting framework that can be seamlessly integrated into any corporate web portal.
Improvements include a fully redesigned user interface, enhanced reporting and auditing functions via the modified calendar feature and a display of historical data that offers an option for in-depth analysis. This grants easy access to detailed asset information as well as enabling users with a comprehensive overview of past compliance breaches, including the breach’s entire lifecycle. Additional configuration options enable client-specific layout adaptations to help improve communications with investors through further customisation of the portal.
The redeveloped integrated report engine, based on Microsoft.NET, allows reports to be generated and e-mailed automatically, distributed via the web application and downloaded as a pdf-file.
Third party services
Another alternative to further investment in-house is the use of a hedge fund infrastructure provider, which offers non-core services to hedge funds to enable them to get on with focusing on managing returns. In response to the more onerous transparency requirements of hedge funds, PCE Investors, an independent services agency, has recently installed Aquin’s MIG21 investment compliance system to offer middle and back office operational and risk management services to hedge funds. Additionally, PCE’s investment framework provides security and facilitates fund raising and investor relations.
Currently, 15 fund management strategies are supported by PCE’s infrastructure. These funds can now realise the advantages of MIG21 as an integrated component of their infrastructure provision. The enhanced transparency, through thorough investment compliance monitoring, gives PCE’s clients a competitive edge and reduces related costs, at a time when the fund industry is seeing challenging circumstances.
Just as the financial services industry can no longer afford to treat hedge funds as alternative investments, away from the mainstream, neither can hedge funds ignore the increasing push for greater transparency and investment compliance if they are to remain credible to their target market. The changes that the hedge fund industry will undergo in adopting the current recommendations and guidelines will hopefully see the industry emerge as a more stable and robust investment class, without damaging investment returns through more onerous regulation.
No one wants to see direct regulatory supervision of the hedge fund industry to a level that could stifle innovation and returns but the fund management industry agrees that investors need improved transparency and the pressure is building to find cost-effective, manageable solutions for compliance and disclosure. Aquin has some of the shortest times to market of all compliance vendors. Installations at hedge funds can, and have, taken a little as eight weeks, and no more than three months.
The most recent issue that has worried regulators, post credit-crunch, is the growing realisation that hedge funds lack the ability to evaluate assets that they hold. Furthermore, the increasing use of more and more complex instruments is making disclosure to investors less clear.
This is not a problem that is going to diminish over time. As the hedge fund industry grows – it was last valued at $2.5 trillion of assets under management at the end of 2007 -- it is getting harder to ignore and the regulators’ biggest fear is the systemic risk that these funds could carry, as well as the unprecedented influence activist funds were having within organisations. This has prompted a call for a database in which hedge funds would have to register their interests for full public disclosure.
Aquin’s award-winning investment compliance technology has been built to provide solutions for both the hedge fund managers and their clients by taking the burden off the hedge fund manager and letting them get on with focusing on what they do best, while still enabling compliance with the world’s main jurisdictions and allowing hedge funds to customise the rules contained in MIG21 quickly, onsite, to adhere to current transparency recommendations to keep investors, regulators and corporate chief executives, happy. Thus, complex risk and hedge controls can be established and thus every client demand satisfied.
While offshore hedge funds remain unregulated, hedge fund managers in the UK and US are subject to the same regulation as other market participants. According to Callum McCarthy, Chairman of the UK’s Financial Services Authority, hedge fund managers should set out the basis on which their funds are valued. This should start by establishing whether there is an independent valuation of the fund, but there is a need to go substantially beyond this, to cover policies and procedures such as the separation of duties between portfolio managers and back offices; the reconciliation of values between hedge fund manager, prime broker and administrator; price sources; and procedures for dispute settlement.
Also, the Hedge Fund Working Group (HFWG), led by Sir Andrew Large, the former Deputy Governor of the Bank of England, has joined with 14 leading hedge fund managers to produce best practice standards for the hedge fund industry, swiftly followed by the reports on best practices for hedge fund managers and investors published in the US by the President’s Working Group on Financial Markets.
Both initiatives come hot on the heels of the publication of the Alternative Investment Management Association’s ‘Guide to Sound Practices for Hedge Fund Valuation’ in 2007, and add to the growing pressure to improve the hedge fund management industry before mandatory regulation is forced upon it.
Based upon the FSA’s 11 principles, the HFWG standards include recommendations for managers to adopt an independent process for valuing portfolios and to improve the governance of funds. The report also recommends enhanced disclosure to investors and that managers should have a comprehensive framework to manage risk, an important area in the context of financial stability.
HFWG’s standards outline the importance of regular portfolio risk management disclosure, valuation, fee disclosure, shareholder conduct and fund governance for hedge funds. They require managers to disclose holdings in companies held through complex derivative instruments, to reveal their exposure to illiquid holdings, and to set up internal controls to avoid conflicts of interest. The code is voluntary and operates on a ‘comply or explain’ basis.
Putting it into practice
Most hedge funds will have an accounting engine in place, typically a system such as Geneva, Beauchamp or Paladyne. In many cases they may have outsourced some of this responsibility to their prime broker or to a hedge fund administrator.
Prime brokers assess hedge fund exposures on a daily basis using proprietary systems and methods in order to calculate initial margin and monitor the hedge fund daily to calculate variation margin. The small and medium-sized hedge funds tend to rely heavily upon their prime broker for back-office and reporting technology, as they often do not have this kind of expertise in-house.
For those hedge funds that have signed up to the newly emerged standards, on both sides of the Atlantic, the next step is putting these recommendations into practice. Transparency to investors should also include the material preferential terms to some (typically large) investors, where this has been granted, as well as disclosure of operational risk, especially where external reviews have been carried out, and disclosure of fund risk policies.
Flexible rules-based engine
Aquin’s MIG21 investment compliance system uses a high degree of automation to reduce the burden of work upon fund managers and their compliance officers. Its adaptable rules engine is designed to function in a changing regulatory environment, across all asset classes. It enables the automation of post-trade checking of legal, contractual and internal investment guidelines in a single system to reduce the time and cost associated with investment process controls. Furthermore, the hedge fund’s order management systems can be easily integrated to extend compliance into pre-trade.
Once in place, MIG21 loads the fund’s data from the manager’s accounting engine and does a daily check of LawCard(s) in the jurisdictions specified. The rules engine then holds all the fund data, the holdings of the fund and pricing to monitor any changes to the portfolio to ensure there are no rule breaches. Faulty data might be corrected or enhanced by the user and as most fund managers have their own internal investment rules and criteria, these too can be added to MIG21’s daily checks and held in a single system. The output is a variety of reports giving a snapshot of the day’s changes, a list of breaches and warnings of possible impending breaches.
Even with pan European transparency guidelines for hedge funds, there will still be room for interpretation by the national regulator. It will be very difficult for a hedge fund manager, with funds in multiple jurisdictions and languages, to keep up to date with the local variations and nuances of the different regulatory requirements. By applying MIG21 LawCards the various rules and limits for each jurisdiction, in which the fund is distributed, are automatically installed into the system.
The flexibility of the MIG21 rules engine also means that even complex structured products and derivatives can be included for both compliance with the necessary jurisdictions, and for risk management. MIG21 can decompose the component products and look at the underlying structures to break down and analyse the risk. This can then be added to any existing risk in the portfolio to give an overview of the risks, regardless of the product wrapper. As users have 100 per cent control over customising which rules it wants MIG21 to apply to their funds, its data mapper consolidates data input from any source and can be enriched, ‘on the fly’, to cover any asset class.
MIG21 includes workflow management tools, which enable compliance to be better automated and breaches to be flagged and responded to. The toolset within MIG21 allows the tracking of breaches throughout their lifecycle until they are resolved. Aquin’s compliance experts are on hand to continually update MIG21’s LawCards to comply with regulatory updates, to support the new instrument processes, with advice on modelling the corresponding rules in MIG21, and provide structured product decomposition or look-through.
Next generation web reports
Calls for greater transparency mean that any technology in place must be web-enabled and be able to produce high quality reports at the touch of a button. The major issue here is obviously security, the holdings of the hedge fund being a matter of absolute secrecy. In this new era of increased transparency, usability will also be of key importance, as the investor will want to be able to drill-down through the fund and slice and dice the information to analyse it properly.
For hedge funds and fund administrators, the web is of vital importance as a more efficient way of communicating with investors by enabling them to log-in and find the information they want, to see exactly what the fund is doing, and conduct their own analysis. The transparency this gives to institutional investors is much greater as they can drill down and find the information they want, rather than having a static report.
MIG21 Web provides hedge funds with powerful web reporting tools and management dashboards to produce customisable management and client reports. Furthermore, in readiness for an increasing focus on web-based reporting, the next generation web interface for Aquin’s investment compliance software is an interactive, web-services based reporting framework that can be seamlessly integrated into any corporate web portal.
Improvements include a fully redesigned user interface, enhanced reporting and auditing functions via the modified calendar feature and a display of historical data that offers an option for in-depth analysis. This grants easy access to detailed asset information as well as enabling users with a comprehensive overview of past compliance breaches, including the breach’s entire lifecycle. Additional configuration options enable client-specific layout adaptations to help improve communications with investors through further customisation of the portal.
The redeveloped integrated report engine, based on Microsoft.NET, allows reports to be generated and e-mailed automatically, distributed via the web application and downloaded as a pdf-file.
Third party services
Another alternative to further investment in-house is the use of a hedge fund infrastructure provider, which offers non-core services to hedge funds to enable them to get on with focusing on managing returns. In response to the more onerous transparency requirements of hedge funds, PCE Investors, an independent services agency, has recently installed Aquin’s MIG21 investment compliance system to offer middle and back office operational and risk management services to hedge funds. Additionally, PCE’s investment framework provides security and facilitates fund raising and investor relations.
Currently, 15 fund management strategies are supported by PCE’s infrastructure. These funds can now realise the advantages of MIG21 as an integrated component of their infrastructure provision. The enhanced transparency, through thorough investment compliance monitoring, gives PCE’s clients a competitive edge and reduces related costs, at a time when the fund industry is seeing challenging circumstances.
Just as the financial services industry can no longer afford to treat hedge funds as alternative investments, away from the mainstream, neither can hedge funds ignore the increasing push for greater transparency and investment compliance if they are to remain credible to their target market. The changes that the hedge fund industry will undergo in adopting the current recommendations and guidelines will hopefully see the industry emerge as a more stable and robust investment class, without damaging investment returns through more onerous regulation.
No one wants to see direct regulatory supervision of the hedge fund industry to a level that could stifle innovation and returns but the fund management industry agrees that investors need improved transparency and the pressure is building to find cost-effective, manageable solutions for compliance and disclosure. Aquin has some of the shortest times to market of all compliance vendors. Installations at hedge funds can, and have, taken a little as eight weeks, and no more than three months.
The most recent issue that has worried regulators, post credit-crunch, is the growing realisation that hedge funds lack the ability to evaluate assets that they hold. Furthermore, the increasing use of more and more complex instruments is making disclosure to investors less clear.
This is not a problem that is going to diminish over time. As the hedge fund industry grows – it was last valued at $2.5 trillion of assets under management at the end of 2007 -- it is getting harder to ignore and the regulators’ biggest fear is the systemic risk that these funds could carry, as well as the unprecedented influence activist funds were having within organisations. This has prompted a call for a database in which hedge funds would have to register their interests for full public disclosure.
Aquin’s award-winning investment compliance technology has been built to provide solutions for both the hedge fund managers and their clients by taking the burden off the hedge fund manager and letting them get on with focusing on what they do best, while still enabling compliance with the world’s main jurisdictions and allowing hedge funds to customise the rules contained in MIG21 quickly, onsite, to adhere to current transparency recommendations to keep investors, regulators and corporate chief executives, happy. Thus, complex risk and hedge controls can be established and thus every client demand satisfied.
