The need for change

In a US Securities and Exchange Commission report in September 2003, the Hedge Fund market in the United States was tipped to grow beyond $1 trillion in five to ten years time. According to Hedge Fund Research, with global asset growth of more than 50% in the last year, the global market should exceed $2 trillion in 2008.
Accompanying this growth has been the usual performance spectrum you would expect in a growth market, from the truly excellent to the over-publicised abuses and failures.
As success breeds more, the institutionalisation of the industry puts pressure on boutiques and star traders to bureaucratise their organisations to reflect demands for transparency.
The cynicism this climate has generated over time means change is inevitable and recent developments from the Hedge Fund Working Group (HFWG) and the Alternative Investment Management Association may augur new, stronger attitudes.

Best practice in the UK

The 14 hedge funds that make up the HFWG issued their view of best practice, with guidelines to support it, in a 140 page report last month. They believe that the standards they have set will create an international benchmark.
The key conclusions of their report relate to better management and greater transparency in relation to disclosure, valuations and risk management, but there are further recommendations on fund governance and shareholder conduct. Specifically, the report states:

• Managers should be transparent about fees, investment risks and dealings with lenders and prime brokers
• Ideally, fund valuation should be performed by an independent and competent outside body. If that is not possible, the Standards have been drafted to ensure that in-house valuation is conducted by a segregated function with full disclosure
• Additional guidance now recommends that portfolio risk disclosure should be more frequent, for example quarterly. A new Standard requires legal and regulatory risk to be addressed in an operational risk context

What are the implications for your infrastructure?

The new developments highlight the need for systems that control processes and capture pertinent information – like trading activity, investment valuations and fee calculations. By ensuring such systems are in place, operational processes can be structured and audit controls put in place that demonstrate compliance.
Investors should be able to view their fund activity, so there is also the need to create new reports and regular or remote access mechanisms to those reports.

What steps need to be taken?

One of the reasons that the industry has been slow to regulate its own activities is down to the broad and increasing range of instruments and the consequent lack of obvious or repeatable standards.
It means that in order to comply with the HFWG recommendations each fund must be viewed according to its current circumstances – performing an operational review of best practices and determining the gaps in each case prior to articulating the requirements and making appropriate recommendations.