President’s Working Group Private-Sector Committee Provides Recommendations to Hedge Fund Managers
A blue-ribbon private-sector committee established by the President’s Working Group on Financial Markets provided the following best practices in January 2009 for asset managers to guard against systemic risk and ensure the United States remains the world’s most competitive financial marketplace:
Comprehensive Approach to Strengthening Business Practices
The committee’s report asks hedge funds to accept that they play an important role in the financial marketplace and, therefore, must take a comprehensive approach to best practices in all phases of their business:
- Disclosure: Strong disclosure practices that provide investors with the information they need to determine whether to invest in a fund, monitor an investment, and make a decision to redeem their investment.
- Valuation: Robust valuation procedures that call for a segregation of responsibilities, thorough written policies, oversight and other measures for the valuation of assets, including a specific emphasis
on hard-to-value assets.
- Risk management: Comprehensive risk management that emphasizes measuring, monitoring, and managing risk, including stress testing of portfolios for market and liquidity risk management.
- Trading and business operations: Sound and controlled operations and infrastructure, supported by adequate resources and checks and balances in operations and systems to enable a manager to achieve best industry practice in all of the other areas.
- Compliance, conflicts, and business practices: Specific practices, such as a written code of ethics and compliance manual, to address conflicts of interest and promote the highest standards of professionalism and a culture of compliance.
Innovative, Far-Reaching Protections That Exceed Current Industry Practices
- Disclosing Hard-to-Value Assets: Some of the challenges financial institutions have faced relate to the valuation of hard-to-value financial products, such as complex derivatives. New accounting standards
will be in place that require financial institutions to categorize assets in three levels based on how difficult they are to value. Hedge funds should implement these new standards and then go beyond them by disclosing quarterly
the portion of their assets and profit (or loss) attributable to assets in each of the three levels.
- Comprehensive Investor Disclosure Based on Public Company Model: Each year, public companies provide investors with an annual summary of their performance; qualitative and quantitative quarterly reports; and timely updates of significant events. The committee’s report, for the first time, draws from the key principles of the public company disclosure regime and calls for hedge funds to:
- Provide investors with a comprehensive summary of their performance, including a qualitative discussion of hedge fund performance and annual and quarterly reports;
- Make timely disclosures of material events; and,
- Produce independently audited, GAAP-compliant financial statements so investors get accurate, independently verified financial information.
- Segregating Duties to Minimize Conflicts of Interest: Having a system of checks and balances where key functions are segregated to minimize conflicts of interests is critical to all complex financial institutions. As such, these new practices should:
- Address conflicts: Because it is impossible to anticipate every potential conflict of interest relevant to the hedge fund industry, managers should establish a Conflicts Committee to review potential conflicts and address them as they arise.
- Segregate functions: Functions should be separated between portfolio managers and non-trading personnel who are responsible for implementing the valuation process.
- Assessing Counterparty Risk: Recognizing the extent to which hedge funds deal with many counterparties, managers should assess the creditworthiness of counterparties and understand the complex legal relationships they may have with these counterparties.
- Increased Accountability for Hedge Fund Managers: Both the investor and the hedge fund manager are accountable and must implement appropriate practices to maintain strong controls and infrastructure.
The Best Practices are available at: Asset Managers’ Committee, Best Practices for the Hedge Fund Industry. Report of the Asset Managers’ Committee to the President’s Working Group on Financial Markets. January 15, 2009. Available at: http://www.amaicmte.org. See also: Asset Managers’ Committee, Best Practices for the Hedge Fund Industry. Report of the Asset Managers’ Committee to the President’s Working Group on Financial Markets. April 15, 2008. Available at: http://www.amaicmte.org/Public/AMC_Report.pdf.