Hedge fund business models adapt to keep up with new regulation
• 50% of large hedge funds (AuM >$1bn) are expanding their internal legal and compliance teams
• Over 40% of smaller hedge funds (<$250m) plan on increasing their outsourcing compliance functions
• The SEC’s upcoming regulation is generating the most concern from managers of all sizes
Hedge funds are investing an increasing amount of time, effort and money into dealing with legislation requirements, with new Hedgeweek research charting the extent that larger managers are leaning into recruitment and smaller managers into outsourcing.
A survey from June – which informed Hedgeweek’s latest Insight Report, Regulatory Risk: Confronting the new global hedge fund compliance challenges – found that 50% of larger hedge funds (AuM >$1bn) are looking to expand their internal legal and compliance teams, and 44% of smaller hedge funds (AuM <$250m) planning to increase their outsourcing of compliance functions.
Since the economic crisis of 2007/8 the hedge fund industry has undergone a regulation transformation, with legislation from the Financial Conduct Authority (FCA) and the US Securities and Exchange Commission (SEC) seeking to professionalise the industry.
“Hedge funds now have to really think about what they outsource, and how, because burdens are increasing. There is a lot more compliance oversight required – striking the right balance between outsourcing, yet maintaining control is key,” says Kavita Devani, head of compliance operations at Coremont.
The challenges engendered for smaller funds, in particular, are proving difficult to mitigate. With a lack of funds, resource, and staff to handle the operations side of a fund, emerging managers are struggling.
But there are solutions.
“For emerging managers, although funding is always going to be an issue, they do want to outsource a lot of the procedural day-to-day tasks. Of course, they keep the regulatory obligation, and therefore need to be in control of what is being done, how it’s being monitored, who is looking at it, to ensure they have oversight at all times,” says Devani.
However, it isn’t only smaller and younger managers who are struggling – funds who have access to compliance teams and advisors are experiencing their own problems too.
“It’s taking up a lot of time for senior managers. The senior managers who aren’t engaging are going to get a substandard outcome – a box half-ticked – and, while there may be a document in place, whether it’s actually doing what the FCA envisages it to do is another matter. That’s one of the biggest issues for managers right now,” comments Gary Pitts, founder and managing partner at Tetractys Partners.
Firms of all sizes are seeking advice from external legal experts on compliance costs, with 36% of smaller (<$250m) and larger (>$1bn) hedge funds seeking guidance and 41% of mid-sized ($250m-$999m) hedge funds looking for guidance, according to Hedgweek data.
There has also been a boom in small boutique compliance consulting firms as managers come under pressure to balance both compliance requirements and delivering on returns.
Key Implication | Managers: Increasing regulatory demands mean that managers of every size need new solutions for the mounting regulatory burden. For larger managers, that means engaging in the competition for talent. For smaller managers, submitting to potential hikes in outsourcing costs.