The Obama administration on Wednesday sent Congress legislation that would pry open hedge funds to wider scrutiny, requiring those with more than $30 million under management to register with the government and greatly boost disclosure.
The bill language, released by the Treasury, calls for registered funds to submit regular reports detailing their assets, their use of leverage, off-balance sheet and counterparty risk exposures as well as trading and investment positions and practices.
If approved by Congress, the bill would give regulators a powerful microscope to peer into the secretive hedge fund industry to identify potential threats to the financial system.
The bill aims to discourage excessive risk-taking among the biggest financial concerns, said Michael Barr, U.S. Treasury assistant secretary for financial institutions.
Hedge funds found by regulators to be so large, leveraged or interconnected that they pose a threat to financial stability will be regulated as Tier 1 financial holding companies and will be subject to more stringent requirements for capital, liquidity and risk management, Barr said.
Our proposal would require more exacting forms of prudential supervision, including higher capital requirements for those firms and higher capital still for conduct within those firms that poses the most risk to the system, he said.
The plan aims to counteract any incentive for the largest firms gambling with their size, he added.
However, there is no size-threshold for a firm to be classified as a Tier 1 institution, Barr said, adding that leverage, interconnections to the financial system and risk profiles will all be factors in making such determinations.
The bill would require all registered hedge funds to establish a compliance program for conflicts of interest and anti-fraud prohibitions and record keeping requirements.
It also aims to prevent funds from moving offshore to escape registration, deeming that all firms with more than 15 U.S. clients or more than $25 million in assets attributable to Americans were subject to the proposed rules.
(For full bill language, please click here: http://www.treasury.gov/press/releases/reports/title%20iv%20reg%20advisers%20priv%20funds%207%2015%2009%20fnl.pdf)
The plan drew mixed reviews from hedge fund and private equity managers who testified in a U.S. Senate hearing on Wednesday.
Mark Tresnowski, managing director and general counsel of private equity firm Madison Dearborn Partners, said the regulation was arguably unnecessary, and would be a particular burden on smaller firms.
Meanwhile, the Managed Funds Association, a hedge fund lobbying group, said it was ready to work with congressional leaders on the legislation.
We support the administration's efforts to provide greater transparency in the financial markets, the group said in a statement.
Barr said while hedge funds do not appear to have been at the center of the current financial crisis, their de-leveraging contributed to strains in financial markets and a lack of transparency contributed to market uncertainty and instability.
These firms continue to present unknown risks, and that lack of transparency is no longer tenable, Barr said. We need a system that's flexible enough to adapt to the emergence of other institutions that could pose a risk to the system. And we need a system that lets regulators see risks as they emerge across the financial system.
He also said the Obama administration's goal in revamping regulation was not to limit the activities of financial firms, but to limit the risks posed by those activities.
Higher capital charges can insulate the system from the build-up of risk without limiting activities in the markets, Barr said.
That's why we have launched a review of the capital regime and have proposed raising capital standards across the board, including higher standards for financial holding companies, and even higher standards for Tier 1 financial holding companies, he added.