Hedge fund firms should continue to improve their infrastructure and resources—including personnel—to support regulatory compliance, according to a study by Ernst & Young. Merely having compliance policies in place is not enough, as processes can be easily misunderstood, the report states. It predicted an increased emphasis on regulation because institutional investors, which account for 75% of hedge fund assets under management, are demanding transparency regardless of government action.
Hedge funds are challenged by a lack of compliance infrastructure, as well as unrealistic estimates of the costs of having an adequate compliance program, according to the survey. Of the respondents, 73% spend around $500,000 on compliance and only 10% spends around $1 million. “As the culture of compliance continues to mature, hedge fund managers will continue to make increased investments in people, processes and technology,” said Alan Fish, partner in global financial services.
Although the 2005 “Hedge Fund Rule,” which required hedge funds to register with the Securities and Exchange Commission, was recently eliminated, more than three-quarters of hedge fund firms that had registered will stay registered because it assures investors they are in line with compliance practices. Some (28%) expect a potential new law from the SEC may subject managers to register again, which is highly likely according to Fish. The 5% planning to deregister are doing so to avoid audits. Survey respondents viewed registering with the SEC as their biggest compliance challenge (76%). Other difficulties include best execution monitoring (47%), valuations (47%), side letters (29%) and increased competition for institutional assets (25%).
Of those surveyed, 88% has a full-time compliance professional, down from 93% in 2005.Fish was surprised by the decline, but he expects this percentage to rise as managers continue to learn about compliance.