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Hedge Fund News

Just as the regulatory mists were beginning to dissipate under President Trump’s Sharpie and the House’s legislative action, a new fog is rolling across the financial sector—MiFID II. Although driven by European regulators, it cannot be ignored by any financial organization that engages the European markets, and this includes the hedge fund industry.

What Is MiFID II?

This acronym stands for the Markets in Financial Instruments Directive-Two, the second phase of MiFID, which has been in force across the European Union (EU) since 2007. Its stated goal is to provide a uniform regulatory framework that protects EU investors. MiFID’s first iteration was limited, primarily focused on over-the-counter transactions. However, following the penchant of all regulatory bodies, enough was not enough, and that has brought us to MiFID II, which is scheduled to take effect in January of 2018.

It’s important to note that, while this directive is driven by European regulators, MiFID II will reach deeply into the global financial industry, affecting all financial organizations that deal with the European markets.

The Goals of MiFID II

The high-level goals of MiFID II seem innocuous. They include increased market transparency, a shift toward structured marketplaces, lower cost market data, improvements in execution, trading uniformity, and removing any ambiguity regarding the costs involved in trading and investing. However, the price of achieving full compliance is likely to be dear.

The Cost of Compliance

The high cost of compliance is a result of the technological implications inherent in reporting, transparency of trading expenses, and recording telephone calls (cell & landline), texts and face-to-face meetings.

The issue of reporting seems the least daunting of these challenges. The issues of trading expenses and recording interpersonal contacts are the most intimidating challenges and this is why.

In the current scheme of things, trading costs are less than transparent. MiFID II requires separate disclosures for trading commissions and investment/research fees. If free market principles bear out, when the actual costs of an analyst’s time and work are revealed, investors will become increasingly selective with regard to what they are willing to pay for. The likely result will be a fall in demand from previous levels when such research was perceived as free.

Recording all these interpersonal contacts is without precedent in the United States. Not only does this give rise to privacy concerns, it also raises the bar to new levels in terms of cyber security. Then, one needs to determine where and how all these petabytes of data will be securely stored!

What about Hedge Fund Jobs?

Clearly, the small-sized hedge fund firms will face the biggest challenges. Funds available to address compliance costs are a function of management fees and small funds necessarily have the least financial flexibility. Of course, these small firms could choose to avoid transactions that trigger MiFID II requirements, but such a move would impose serious limitations on the fund.

Research analysts in funds of all sizes could face layoffs if demand falls as predicted. The banking sector has already trimmed its analyst staff and expectations are high that further reductions are in the pipeline. When one considers the fact that the position of research analyst is the gateway to employment for many in the hedge fund industry, the jobs picture is looking somewhat faded…thanks Europe!

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A child born in 2007 can look forward to a lifespan in excess of 100 years. Although this is marvelous news for those born in this millennia, it only adds to the woes of pension fund managers struggling with monumental shortfalls, estimated to be in the range of $400 trillion worldwide. The U. S. share of that $400 trillion is a staggering $137 trillion, more than one-third of the global shortfall. This sum makes the U.S. national debt look like a rounding error.

The solvency of pension funds is predicated on investment returns, which keep pace with future retiree demands and concurrently ensure reasonable contribution requirements for new members participating in the plan.

What’s Gone Wrong?

Several factors are in play, all of which have contributed to the crisis. First, as mentioned earlier, people are living longer, which increases the total payout for the pension fund.

Second, declining birth rates, especially in developed countries, have effectively reduced the numbers for those supporting an individual retiree. The ratio of those in the workforce to those in retirement is currently 8:1. However, by 2050 the ratio is projected to be 4:1.

Third, pension funds have over-estimated their future value because long-term investment returns have fallen short of historical averages. For example, 3 to 5 percent lower for equities and 1 to 3 percent lower for bonds. Because of smaller returns, future liabilities have increased, exacerbating pension shortfalls.

Additional contributing factors include a general lack of financial literacy and a lack of access to structured pension plans—globally, 48 percent of retirees have no pension.

What Is the Solution?

Policymakers are going to have to take the lead. Increased longevity and declining birth rates are not in the purview of the hedge fund industry. Pension funds, public and private, and the Social Security Administration must grapple with these issues. The most practical approach is to increase the retirement age to reflect corresponding increases in longevity. Life expectancy has increased 3 years per decade since 1947. However, no legislation has been passed in the U. S. regarding this issue since 1983. Other possible strategies include “needs” testing and raising the maximum earnings subject to the Social Security tax.

How Hedge Funds Can Help

To state the obvious, the best thing hedge funds can do for pension fund managers is to provide them with outstanding gains. Beyond that, hedge funds, many of which are staffed with some of the best minds in the mathematics field, are uniquely positioned to consult with pension fund managers regarding vesting, retirement age and other actuarial factors that affect the solvency of the fund.

Hedge fund firms might also consider funding seminars to educate young people on matters of finance, improving children’s overall financial literacy. In short, create public/private partnerships to foster better retirement outcomes for all. Not only would this benefit the public at large, it could also help to polish the tarnished image of the hedge fund industry.

What About Jobs?

The hedge fund industry plays a vital role in the overall economy and impacts far more lives than the average individual realizes. As the industry continues to evolve and innovate, the number and variety of jobs in the industry will grow.

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Trump Executive Order Puts Dodd-Frank in the Cross Hairs

May 1, 2017

President Trump’s executive order, signed January 30 of this year places Dodd-Frank squarely in the administration’s cross hairs. The impact of this executive order would not be so daunting if the legislative process had not been outsourced to the Federal agencies charged with implementing the legislators’ perceived wishes through regulation—a defect that future lawmakers might […]

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Hedge Fund Jobs and the Rise of the Machines

April 3, 2017

Robots, once the bane of blue-collar workers, may now threaten the livelihoods of hedge fund professionals. Taxi and Uber drivers are menaced by driver-less technology, fast food workers are marginalized by robots capable of making a burger in less than ten seconds, and BlackRock, Inc. is implementing data-driven, artificial intelligence (AI) programs that will ultimately […]

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Surprisingly Investors Remain Bullish on Hedge Funds

March 5, 2017

After an inglorious 2016, many pundits jawbone about a continued investor exodus from the so-called overpriced and underperforming hedge fund industry. However, the facts are in stark contrast to the rhetoric. January 2017 redemptions total $5.2 billion, about one-quarter of the $19.3 billion outflow the hedge fund industry experienced in January 2016. Furthermore, a substantial […]

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Will Trump’s Core Regulatory Principles Favor Hedge Funds?

February 20, 2017

On February 3, 2017, President Trump signed an executive order that outlined his administration’s core principles for regulating the U.S. financial system. They are: (a) empower Americans to make independent financial decisions and informed choices in the marketplace, save for retirement, and build individual wealth; (b) prevent taxpayer-funded bailouts; (c) foster economic growth and vibrant […]

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Little Rhode Island Delivers Devastating Blow to Hedge Funds

October 31, 2016

According to a recent article published in FINtech, the Rhode Island State Investment Commission has announced its decision to redeem $534 billion invested in seven hedge funds. This enormous sum does not include the $51 billion it plans to redeem from Viking Global. This reduces Rhode Island’s exposure in Viking Global by 50 percent and […]

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