Hedge Funds Best Practices Outlined by President's Financial Working Group

Eze Castle Integration recently hosted a roundtable discussion about the April 2008 Hedge Fund Best Practices Peport from the Asset Managers' Committee to the President's Working Group on Financial Markets. A panel of hedge fund industry executives from Equinox Partners, Ernst & Young and the law firm Bingham McCutchen joined Eze Castle Integration in discussing the Asset Managers' and Investors' Committee reports. This blog is the first of two that discusses the reports and requirements for hedge funds, as well as the panel discussion and recommendations.The Asset Managers' Committee issued the report to set a new standard of best practices to answer the call of the President's Working Group to reduce systemic risk and foster investor protection. "This call to develop best practices comes at an important time in the hedge fund industry," the report stated. "Over the past three decades, the hedge fund industry has evolved from a niche business consisting primarily of single-strategy, single-geography firms serving high net worth individuals into an important participant in global markets, consisting primarily of global multi-strategy firms serving a wide variety of institutional investors. The industry has grown to 8,000 firms and $2 trillion in assets under management and has become an increasingly important participant in the financial markets."

The reports outline the following: -- Calls for hedge funds to adopt comprehensive best practices in all aspects of their business including the critical areas of disclosure, valuation of assets, risk management, business operations, and compliance and conflicts of interest; -- Recommends innovative and far-reaching practices that exceed existing industry-wide standards; and -- Increases accountability for hedge fund managers.

Panel participants spoke about how hedge funds can meet these best practices today and how to prepare for future requirements. These reports are intended to clarify and heighten industry standards to protect investors, curb systemic risk, and ensure financial marketplace stability. The reports do not yet mandate managers or investors, however, as the hedge fund industry's AUM continues increases every year, it seems inevitable that in the near future, regulations are indeed around the corner.

Again and again, conversation amongst the panelists turned to how these best practices are recommended as a means to clarify what managers should expect from their investors, specifically, how to maintain this relationship's strength and ensure transparency in communications. The report, and our panel discussion, addressed five key areas for Best Practices including disclosure, valuation, risk management, trading and business operations, and compliance, conflicts and business practices. These areas, as outlined in the Asset Managers' report, are:

1. Disclosure - Strong disclosure practices that provide investors with the information they need to determine whether to invest in a fund, to monitor an investment, and to make a decision whether to redeem their investment.

2. Valuation - Robust valuation procedures that call for a segregation of responsibilities, thorough written policies, oversight and other measures for the valuation of assets, including a specific focus on hard-to-value assets.

3. Risk Management - Comprehensive risk management that emphasizes measuring, monitoring and managing risk, including stress testing of portfolios for market and liquidity risk management.

4. Trading and Business Operations - Sound and controlled operations and infrastructure, supported by adequate resources and checks and balances in operations, to enable a manager to achieve best industry practice in all of the other areas.

5. Compliance, Conflicts and Business Practices - Specific practices to address conflicts of interest and promote the highest standards of professionalism and a culture of compliance.

The next blog in this series features the major discussion points from our panelists surrounding these five key topics.

Guest blog contribution from Bob Guilbert, managing director, Eze Castle Integration Greg MacSweeney is editorial director of InformationWeek Financial Services, whose brands include Wall Street & Technology, Bank Systems & Technology, Advanced Trading, and Insurance & Technology. View Full Bio