Interview with Daniel New (pictured), Jun Li and Danielle Ryea, Ernst & Young – As its twin regulatory pillars – Form PF and FATCA – begin to cement themselves into the bedrock of the alternatives industry, US hedge fund managers have to focus their attention on getting “mission-ready.”
Although firms with less than USD5bn in regulatory assets under management have until March and April 2013 to prepare their Form PF filing, Daniel New, executive director in the financial services office at Ernst & Young LLP, cautions that managers should not take a blasé approach.
“Over this summer, Form PF probably wasn’t top-of-mind for most managers, but now that the fall is coming we expect to see traction build,” he says. “A lot of clients are starting to gather data and put the necessary processes in place. Hopefully, this will allow them to commence mock filings before year-end.”
Danielle Ryea, a senior manager in the financial services office, adds: “Our approach to prepare firms for the 2013 filing date is to perform all essential tasks in the next few months, with the aim of carrying out a mock filing before year-end, using September 2012 data.
“These tasks include completing fund scoping, creating a data dictionary, mapping the source of all necessary data, conducting the mock filing, and drafting policies and procedures for Form PF reporting.”
New recommends that because this is the first of a recurring set of filings with the SEC, managers should think about developing a “standardised set of policies and procedures that can be repeatable”.
This involves a twofold consideration. First, regarding data processing, where is the data coming from, when is it due, who supplies it, and who reviews and approves it?
Second is interpretation. Form PF is a complex and nuanced document. Managers should decide on and document various interpretations to help in the data collection process, ensuring the right data is being used in the right sections of the report.
To facilitate this, managers should hold internal discussions, take outside counsel, read the FAQs on the SEC web site and determine “how to interpret certain questions and what kind of data needs to be provided”, New says.
Ryea adds: “The SEC will be reviewing financial and trading data over a period of filings to analyse trends and patterns that may indicate whether private funds or investment managers pose a systemic risk to the market. The manager must strive to have accurate and reliable data every reporting period.”
Having already helped clients with the first wave of filings, Ernst & Young has identified key challenges of which managers should be mindful. First, understand the questions. “Take your time prior to filing to go through the questions,” New says. “Make sure you understand them, run a mock filing and get it reviewed and filed.”
Then identify the source of the data. Invariably, there will be a data gap that will require managers to source data internally within the business, or externally through their administrators or custodians.
“It’s a case of making sure you can gather the data in the right format, and in a timely manner,” New says. “Mapping each question and being able to source where the data is to answer that question is helpful. The firms that put in the time and effort found it easier doing their first filing in August.”
At present there is no industry consensus on whether investment managers should release Form PF reports to potential investors. “The data on Form PF will be non-public and won’t be released by the regulators,” Ryea says.
“It will be each firm’s decision as to what data on Form PF will be shared with investors. However, the level of pressure that potential investors will put on managers to release such data is still unknown.”
The Foreign Account Tax Compliance Act is a significant piece of legislation that aims to prevent tax evasion by US residents holding accounts abroad and is set to affect US companies and foreign financial institutions (FFI) in equal measure.
FATCA will require FFIs to report to the Internal Revenue Service or the Department of the Treasury information on their US-owned accounts. Failure to do so will lead to a 30 per cent withholding tax on any US-sourced dividends, interest or gross proceeds.
Jun Li, a partner in Ernst & Young’s asset management tax practice, says many US hedge fund managers are currently assessing the extent to which they will need to comply with FATCA – an unwieldy piece of legislation at more than 300 pages. Rather than trying to absorb every detail, managers should use a tax adviser to simplify matters and create an “action-oriented agenda”.
Says Li: “Right now they have to focus on what is immediately due, what they have to comply with, and what the consequences will be if they don’t carry out certain actions by certain deadlines.”
For US funds, the imminent deadline is January 1 next year, at which point their investor onboarding systems must be operational for new subscriptions. For FFIs, the compliance deadline is July 1, 2013.
“The FATCA readiness assessment is vital because it will help managers scope out whether it will be a considerable burden for the firm, or one that can be dealt with over a short time period,” Li says.
The first step is simply getting the right people in the same room. Due to the legislation’s complexity, Li advises that representatives from tax, operations, accounting, investor relations and legal should all be involved, although each manager has to find the right balance.
According to Li, there are three important tasks when conducting a FATCA readiness assessment, starting with conducting a legal entity analysis. “Understand all the legal entities that the fund has a direct relationship with, or with which it has some contractual obligation, such as an investment management agreement,” he says. “That will tell you which entities are in scope for FATCA and what they have to do by a certain date to become compliant.”
Next, managers need to look at their existing investor base. Larger, more complex entities running multiple sub-funds may well need to delegate the review of investor information to a third-party adviser such as their fund administrator.
“It really depends on what the manager is currently capturing in its systems and from subscription documents,” Li says. “That will enable them to figure out where the gaps are, and what will need to change to capture that additional information.”
Third is the onboarding process. From January 1, US entities will need to make certain their onboarding process is capable of capturing all necessary information on new investors. Most clients are now focused on this because of the looming deadline, Li says.
The views expressed herein are those of the interviewees and do not necessarily reflect the views of Ernst & Young LLP.