Transcript ADMINISTRATION PROPOSAL FOR FINANCIAL REGULATORY …

REGULATORY CHALLENGES AND OPPORTUNITIES
FOR HEDGE FUNDS IN THE U.S. AND EUROPE
PATRICIA A. POGLINCO • ROBERT VAN GROVER
ONE BATTERY PARK PLAZA
NEW YORK, N.Y. 10004
TEL 212•574•1200
FAX 212•480•8421
www.sewkis.com
1200 G STREET, N.W.
WASHINGTON, D.C. 20005
TEL 202•737•8833
FAX 202•737•5184
Administration Proposal for Financial
Regulatory Reform
• Released on June 17, 2009
• Designed to restore confidence in U.S. financial system following
financial crisis
• Proposed reforms target all aspects of financial system – including
hedge funds and derivatives
• Most comprehensive proposed financial services legislation since
the passage of the securities laws
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Five Key Objectives
• Promote robust supervision and regulation of financial firms
• Establish comprehensive supervision of financial markets
• Protect consumers and investors from financial abuse
• Provide the government with tools needed to manage financial
crises
• Raise international regulatory standards and improve
international cooperation
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Robust Supervision of all Financial Firms
• Creation of Financial Services Oversight Council (FSOC)
– Replaces the President’s Working Group on Financial Markets
– Mandate is to identify emerging risks and advise Federal
Reserve on potential problem firms
– Chaired by Secretary of Treasury; members of council should
include: Chairman of the Board of Governors of the Federal
Reserve, Director of the National Bank Supervisor, Director of
the Consumer Financial Protection Agency, Chairman of the
SEC, Chairman of the CFTC, Chairman of the FDIC and Director
of the Federal Housing Finance Agency
– FSOC to have permanent staff at Treasury Department
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Consolidated Supervision and Regulation
of Certain Financial Firms
• All financial firms found to pose a threat to financial stability based
on size, leverage and interconnectedness will be classified as Tier 1
FHCs and subject to consolidated supervision and more strict
regulation
• The Federal Reserve will identify those firms that should be
classified as Tier 1 FHCs (based in part on recommendations from
the FSOC)
• Tier 1 FHCs will include those private pooled vehicles (individually
or collectively) that meet the established criteria
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Consolidated Supervision and Regulation
of Certain Financial Firms
• Congress will be directed to establish factors that the Federal
Reserve must consider when making the determination that a
financial firm should be classified as a Tier 1 FHC including:
– Impact firm’s failure would have on the financial system and the
economy
– Firm’s combination of size, leverage (including off-balance sheet
exposure) and degree of reliance on short-term funding
– Firm’s importance as source of credit for households, businesses
and state and local governments and as source of liquidity for
financial system
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Additional Federal Reserve Powers
• To collect information (periodic and other reports) from all
financial firms that meet certain size thresholds
• Access to financial firm reports submitted to other regulators
(e.g., SEC or CFTC)
• Authority to require reports and conduct examinations of
Tier 1 FHCs and their subsidiaries even though the entities
may be supervised by other regulatory agencies
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Prudential Standards for Tier 1 FHCs
In consultation with the FSOC, the Federal Reserve will establish
“prudential standards” for Tier 1 FHCs
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Capital requirements
Prompt corrective action
Liquidity standards
Overall risk management
Market discipline and disclosures
Restrictions on non-financial activities
Rapid resolution plans
Restrictions on Non-Financial Activities
• Tier 1 FHCs would be subject to the nonfinancial activities
restrictions of the Bank Holding Company Act
• Such restrictions may include a prohibition that prevents a Tier 1
FHC from acquiring more than 5% of the outstanding shares of a
company unless such company is engaged in financial activities or
activities incidental to a financial activity
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Registration of Advisers to Hedge Fund
and Other Private Pools of Capital
• Proposal would require all advisers to private pools of capital
whose assets exceed a modest threshold to register with the SEC
– hedge funds
– private equity funds
– venture capital funds
• Possible required disclosures to investors, creditors and
counterparties
• SEC recordkeeping requirements would extend to investment
funds managed by SEC-registered advisers
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Reporting Requirements for
Registered Advisers
• Registered Advisers would be required to report information
about the private funds that they manage sufficient to enable
regulators to assess the threat to financial stability
• Reporting should be confidential and include:
– amount of assets under management
– borrowings
– off balance sheet exposures
• SEC should share information with the Federal Reserve to be
used to determine whether any fund or families of funds meet the
Tier 1 FHC criteria
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Strengthening Regulation of Core
Markets and Market Infrastructure
• Strengthen supervision of securitization markets
• Originator of securitized loan (or sponsor of securitization) must
retain 5% of credit risk of securitized exposures
• SEC will have the authority to require robust reporting by ABS
issuers
• SEC will continue to tighten regulation of credit rating agencies
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Comprehensive Regulation of Markets
for Over-the-Counter Derivatives
(including Credit Default Swaps)
• Transparency for all OTC derivatives trades through recordkeeping
and reporting
• Standardized OTC derivatives to be centrally cleared and executed
on exchanges and other transparent trading venues
• Higher capital charges for customized OTC derivatives
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Harmonized Futures and
Securities Regulation
• SEC and CFTC must make recommendations to eliminate
differences in statutes and regulations with respect to similar types
of financial instruments
– For example, many financial options and futures products are
similar, yet options are regulated by the SEC whereas futures
contracts on the same underlying security are regulated jointly
by the SEC and CFTC
• Provide joint report to Congress by September 30, 2009
• If SEC and CFTC cannot agree by September 30, 2009 the
Financial Services Oversight Council will make recommendations to
resolve the differences within 6 months of its formation
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Providing Government with Tools to
Effectively Manage Financial Crises
• More stringent capital, activities and liquidity requirements will be
imposed on Tier 1 FHCs
• Prompt corrective action will be required from Tier 1 FHCs to
address declining capital levels
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Special Resolution Regime
• Tier 1 FHCs to maintain rapid resolution plans to be implemented in
the event of severe financial distress
• Federal Government to be given emergency authority to resolve Tier
1 FHCs in an orderly manner
• Treasury Department would invoke this authority in consultation with
the President and written recommendation of 2/3 of the members of
the Federal Reserve Board and the appropriate regulatory agency
that supervises such Tier 1 FHC
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Special Resolution Regime
• Treasury Department authority would include appointment of a
receiver or conservator
• Generally, the Treasury Department should appoint the FDIC or
SEC as the receiver or conservator
• Receiver or conservator should have the authority to take control of
firm operations, sell or transfer firm assets, transfer a firm’s
derivative transactions, renegotiate or repudiate firm contracts and
borrow from the Treasury Department
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Strengthening Consumer Protection
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Creation of Consumer Financial Protection Agency (CFPA) with authority to
protect consumers of credit, savings, payment and other consumer financial
products and services and regulate providers of these products and
services (other than those regulated by the SEC or CFTC)
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CFPA would be authorized to reform mortgage laws
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Place banks, nonbanks and independent mortgage brokers on a level
playing field – activities would be regulated regardless of whether it is a
financial institution
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Consumer Financial Protection Agency Act of 2009 establishing the
Consumer Financial Protection Agency referred to House Committee on
Financial Services and Committee on Energy and Commerce on
July 8, 2009
SEC Focus on Transparency, Fairness
and Accountability
• SEC should be authorized to require certain disclosures to investors
at or before certain sales of financial products
• Harmonize regulation of broker-dealers that offer investment advice
and investment advisers
• Improve accountability of financial firms and public companies
• On July 10, 2009, the Administration proposed the Investor
Protection Act of 2009
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Improve International Regulatory
Standards and Cooperation
• Subject foreign firms operating in the U.S. to the same regulation
and oversight as U.S. firms that pose a risk to the U.S. financial
systems
• Reach an international consensus regarding capital standards,
oversight of OTC derivatives markets, supervision of internationally
active financial firms and crisis prevention procedures
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What Does it All Mean?
• Unprecedented authority proposed for the Federal Reserve
• “Power Grab” by Federal Banking authorities?
• Unclear how differing regulatory mandates will be handled
– SEC has mandate of investor protection and ensuring the
integrity and efficiency of financial markets
– CFTC has mandate of encouraging competitiveness of futures
markets, investor protection and ensuring integrity of the clearing
process
– Bank regulators have mandate of ensuring safety and soundness
of particular institutions
– Federal Reserve acts as the central bank and has overall
responsibility for supervising and regulating segments of the
banking industry to ensure safe and sound banking practices and
compliance with banking laws
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Related Legislative Hearings
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June 18, 2009: Senate Committee on Banking, Housing and Urban Affairs Hearing on the
Administration’s Proposal to Modernize the Financial Regulatory System
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July 8, 2009: House Subcommittee on Commerce, Trade and Consumer Protection Hearing on
The Proposed Consumer Financial Protection Agency: Implications for Consumers and FTC
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July 9, 2009: House Committee on Domestic Monetary Policy and Technology Hearing on
Regulatory Restructuring: Balancing the Independence of the Federal Reserve in Monetary Policy
with Systemic Risk Regulation
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July 10, 2009: House Agricultural Committee and Financial Services Committee Hearing on a
Review of the Administration's Proposal to Regulate the Over-the-Counter Derivatives Market
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July 13, 2009: House Committee on Financial Services Hearings on proposed Financial
Regulatory Reform (postponed)
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July 15, 2009 - July 17, 2009: House Committee on Financial Services Hearings on proposed
Financial Regulatory Reform
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July 15, 2009: Senate Committee on Banking, Housing and Urban Affairs on regulating hedge
funds and other private investment pools
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Hedge Fund Adviser Registration Act of
2009 (H.R. 711)
• Proposed January 27, 2009
• Proposal to amend the Investment Advisers Act of 1940
– Would remove Section 203(b)(3) of the Advisers Act (current
exemption for investment advisers with fewer than 15 clients)
• Result: Investment advisers with $30 million or more in assets
under management would be required to register with the SEC
• Status: Referred to the House Committee on Financial Services on
January 27, 2009
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Hedge Fund Transparency Act (S. 344)
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Proposed January 29, 2009
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Proposal to amend the Investment Company Act of 1940
– Private funds (including hedge funds, private equity funds and venture capital
funds) with $50 million or more in assets under management would be required
to register with the SEC and comply with certain requirements in order to remain
exempt from substantive provisions of the Investment Company Act
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Requirements include:
– Maintenance of books and records required by the SEC
– Cooperate with any request for information or examination by the SEC
– Establish an anti-money laundering program
– File an annual information form electronically with the SEC (to be made publicly
available)
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Status: Referred to the House Committee on Banking, Housing and Urban Affairs on
January 29, 2009
Private Fund Transparency Act of 2009
(S. 1276)
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Proposed June 16, 2009
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Proposal to amend the Investment Advisers Act of 1940
– Would replace the current private investment adviser exemption with a
more limited exemption available only to certain foreign private
investment advisers with no place of business in the U.S. and less than
$25 million in assets attributable to clients in the U.S.
– SEC would be authorized to collect risk data, records and reports from
registered advisers
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Result: All U.S. investment advisers with at $30 million or more in assets
under management would be required to register with the SEC
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Status: Referred to House Committee on Banking, Housing and Urban
Affairs on June 16, 2009
Significant U.S. Federal Income
Tax Developments
• Sen. Levin’s Bill (S. 506)
– Treats foreign corporations, including offshore hedge funds, with
gross assets of $50 million or more as U.S. corporations if
“management and control” of the corporation occurs primarily
within the U.S. (i.e., investment decisions are made within the
U.S.)
– Subjects dividend equivalent payments received by foreign
persons with respect to total return swaps and other derivatives
referencing U.S. corporation stock to a 30% U.S. withholding tax.
– Status: Referred to Senate Finance Committee on
March 2, 2009
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Significant U.S. Federal Income
Tax Developments
• Rep. Rangel’s Bill (H.R. 3970)
– Treats partnership income earned for providing investment
management services (i.e., carried interest) as ordinary income
– Status: Referred to House Ways and Means Committee on
October 25, 2007
• Administration’s Revenue Proposals
– Effective in 2011, “carried interest” (e.g., incentive or profit
allocations) would be taxed as ordinary income (likely would also
subject carried interest to self-employment tax)
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Significant U.S. Federal Income
Tax Developments
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Rep. Levin’s Bills
– H.R. 3501
• Creates an exception to the unrelated debt-financed income rules
that would allow U.S. tax-exempt entities to invest directly in
domestic hedge funds (rather than through foreign blocker
corporations) without incurring UBTI
• Status: Referred to House Ways and Means Committee on
September 7, 2007
– H.R. 1935
• Treats income from an “investment services partnership interest”
(i.e., interest in a partnership held by a person providing investment
management services to the partnership) as ordinary income and
subject to self-employment tax
• Status: Referred to House Ways and Means Committee on April 2,
2009