CSC on the future of private fund regulation

The private capital industry has reached a crucial juncture, says Anne Anquillare, CFA, CSC’s head of fund services, North America.

This article is sponsored by CSC®.

Anne Anquillare, Head of fund services, CSC

Earlier this year, I wrote a blog series exploring the implications of the SEC’s proposed regulations on private funds. Given that the rules had yet to be finalized, some of my peers wondered whether I had jumped the gun. When the other shoe dropped on August 10, 2022 bringing more proposed rules, it became clear that addressing these issues quickly is the only way forward. 

Much more might change by the time this article is published, but we, as an industry, need to work toward solutions. These solutions will require four things: data, conversations, planning, and action.

The private capital industry is at an inflection point. While regulators, investors and fund managers may all have different priorities, we share two overriding goals. The first is to grow capital (both inflows and fund value). The second is to protect investors and markets with the rules and data required to make proactive, accurate decisions. 

Investor reporting

Let’s start with the data. The proposed rules, which referenced exam findings, reports, articles, and letters from investors, highlighted a lack of data as an industry shortcoming. This resulted in several proposed rules that relate to investor reporting. These requirements are listed in Chart 1, which ranks the perceived degree of value to investors and degree of effort required based on survey data.

This data points us in the direction of proposals 1, 3, and 4 – those that deliver higher value to investors while being easier to implement. 

The best place to start the conversation around industry solutions is proposal 1: providing reports to investors within 45 days from quarter’s end. Having prompt access to this information would be very helpful to investors. Q&A sessions with managers would happen on a timelier basis and be more thoughtful and focused. Reporting to investors’ management and constituents would also be timelier. And our asset class wouldn’t be seen as such an outlier by investors and wealth managers. (No mutual funds report on a 60-day lag.) 

While specific situations, such as emerging manager funds with limited resources or the need for timely information for valuations from underlying investments, will require more conversations and planning, this is a good target for all. Fortunately, the required investments in technology and adoption of reporting standards are already well underway, which reduces the level of difficulty in achieving this target.

Similarly, proposals 3 and 4 expand the range of reporting data and the speed with which it is delivered, thereby adding to the need for better technology and standards. I’m confident our industry is already moving through planning and action on these items. I know we are, as a company, on behalf of our clients.

Performance metrics

Performance is also attracting regulatory scrutiny. The lack of consistency in the way performance is calculated means that virtually every fund can be classed in the top quartile. This is one of the reasons investors and regulators don’t trust the numbers and spend a lot of time recalculating and asking for more data. The proposed rules include performance metrics as part of the quarterly reports, as are listed in Chart 2.

Survey data suggests that proposals 1 and 2 (both fund-level metrics) will deliver higher value to investors while being easier to implement. 

Here, the conversation can begin with proposal 1: providing net internal rate of return and multiple on invested capital (MOIC) – also known as total value to paid-in (TVPI). 

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Most investors are already receiving net IRR as part of their annual audited financials. Shifting to a quarterly reporting of this metric would not be difficult, and if you have the data for IRR, you have the data for TVPI/MOIC. Investors need both IRR and TVPI to assess the performance of the fund, and when distribution to paid-in (DPI) and residual value to paid-in (RVPI) are also included, investors can appreciate how much of the performance is realized vs. unrealized. 

Providing access to the data used in these calculations would go a long way toward building the trust in our industry’s numbers. Adopting the Global Investment Performance Standards (GIPS®), a global standard for all major asset classes, would also be a great step forward in building trust. 

Proposal 2 – gross IRR and TVPI/MOIC – is reported less frequently. Usually, gross returns are a focus when a manager is fundraising. Reporting both the net and the gross performance metrics on a quarterly basis tends to elicit questions from investors (and regulators) about the spread between the two. There are two ways to calculate gross returns: bottom up (all investor-level cashflows, with fees and expenses added back in) and top down (all investment-level cashflows). The main difference between the two is how the investment manager handles cash and lines of credit, which wraps in proposal 4. (You see where this is going.) 

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Once we tackle performance metrics for fund-level net and gross and details on the spread, we will be doing the same at the investor level. (These metrics were not in the SEC’s proposal but were included as a question for the comments.) Bottom line: the best way to provide standard performance reporting across all levels is still in the conversation stage. I strongly recommend including the GIPS in this conversation. 

From data to action

The SEC’s proposed regulations have created no small measure of apprehension in the private capital industry, but there is good news here. As a fund manager, you have the data you need to prioritize your efforts and kick off conversations with your team and investors. You have access to a robust network of service providers to help transition your firm to the next level for your investors. And the industry is, albeit gradually, moving toward standards and – mostly through service providers – adopting technology solutions that can help them align with other asset classes. 

Everyone, including the SEC, wants our industry to survive and thrive, and that means ensuring capital growth and investor and market protections. As we work together to achieve these goals, let’s keep the data, conversations, and planning going. And bring on the action.