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Hedge Funds Faces Higher Compliance Standards

Though much of the financial industry has accepted and instituted stronger compliance and oversight measures following the financial crisis, a recent report from Risk.Net leaves many wondering if the hedge fund industry is on the same page. According to a Corgentum Consulting survey of Operational Due Diligence (ODD) analysts, a large majority of risk professionals indicate that compliance and regulatory issues are the leading risks facing hedge funds today. This was followed by accounting and financial statement reviews, legal issues and business continuity risks.

Changes in financial regulation in the United States and around the world have brought increasing regulatory pressure and oversight to an industry that largely operated under the radar in the past. As a result, many firms have little experience in dealing with the complex rules and requirements of the new oversight practices. And the pressure keeps growing. Approximately 1,500 hedge fund managers were forced to register with the Securities and Exchange Commission in 2012 due to provisions under the Dodd-Frank Act, and along with this registration came increased regulatory burdens. These burdens are also not static and therefore require ongoing monitoring and analysis to ensure that firms stay up-to-date with the compliance practices necessary to avoid significant regulatory penalties.

Adding to the complexity, regulation is not uniform worldwide. In fact, the landscape is dramatically shifting in nearly every geographic environment. This creates a very dynamic environment in which hedge funds must constantly evaluate practices to ensure full compliance with complex and changing rules. The implementation of the European Union’s alternative investment fund managers (AIFM) directive is one such change that will bring significant risk to hedge funds operating in the region. Along with these changes, similar regulatory developments are occurring in some Asian markets. This requirement for cross-jurisdictional compliance in such a dynamic environment adds a significant challenge for traditionally small hedge fund management teams.

Most Hedge Funds Poorly Positioned Today to Deal with Regulatory and Compliance Risks

Due to the organizational realities of most hedge funds, regulatory and compliance management are generally not seen as strengths for most organizations. The small team nature of most firms has generally meant in the past that accountability for compliance has been spread out through the organization, with most individuals responsible for ensuring their segments complied with relevant rules and regulations. In the modern compliance environment, however, this is simply insufficient. Investors are pressuring funds to adopt comprehensive compliance management frameworks, with firms reluctant to change being left behind by proactive managers.

Increased Compliance Represents Opportunity for Job Seekers in the Hedge Fund Industry

As late adopters of integrated compliance frameworks, hedge funds will be actively seeking compliance and risk management professionals in order to get their firms  up-to-speed. This issue is of extreme importance, with investors anxious that funds in non-compliance could put themselves in regulatory danger. As a result, financial professionals with experience in compliance and regulatory matters will find themselves in demand over the coming years as hedge funds begin to shift in line with the broader financial industry.

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Asian Hedge Fund Market Struggles Into New Year

According to a recent Bloomberg report, all is not well in the Asia hedge fund job market. Many high performing professionals that joined the rush to the promising boom in Asian hedge funds are now returning to the United States or Europe, or are alternatively leaving the industry for other areas of finance. Funds in the area have struggled to grow their asset bases, and regulatory changes certainly are not allowing for a positive outlook.

Asian Hedge Funds Continue to Struggle to Attract Assets

Following the 2008 global financial crisis, many overseas hedge funds saw a flight of capital returning to traditional destinations such as the United States. Unfortunately for the hedge fund desks of Hong Kong, Singapore and Malaysia, this capital has failed to return in the subsequent rebound. Currently, Asian hedge fund assets sit 28 percent below their 2007 peak, putting real pressure on firms to reduce costs in these jurisdictions. Globally, the opposite has been true, with hedge funds seeing a 21 percent increase in total assets to a new high of $2.3 trillion in December of 2012. This represents a real shift in assets back to traditional investment markets.

Performance has also been an ongoing issue in the region, with only 39 percent of Asian hedge funds entitled to performance fees for being above their high-water marks at the end of 2012. Without stronger bottom line results for investors, the attractiveness of investing overseas will certainly continue to decline, putting even greater pressure on hedge funds in the region.

Promise Not Living Up to Expectations

For many hedge fund professionals that made the move to Asia, the promise of expansive opportunity and high compensation has remained unfulfilled. According to Will Tan, Managing Director of a leading Singapore financial recruiting firm, “five years on, many of these guys are tired of the huge swings in hedge-fund compensation and some have not tasted the sweet promise of hedge-fund payouts.”

The dissatisfaction with results in Asia has led some individuals not only to reconsider their careers geographically, but leave the hedge fund industry altogether. According to Tan, many “long-time veterans (are) leaving the hedge fund space for more stable careers in finance.”

Smaller Funds Comprise the Majority of Asian Hedge Funds

One major shift over the last several years has been the emergence of smaller hedge funds in the Asian market. Currently, 54% of Asian hedge funds manage less than $50 million, which is up considerably from 39 percent just 5 years ago. Unfortunately for the smaller funds, the risk management policies of large investors sometimes prohibit allocating investment to those managing less than certain critical hurdle amounts, further reducing the number of interested investors.

Uncertainty and Volatility to Remain

While the story surrounding Asian hedge fund employment certainly does not appear too optimistic today, it’s important to keep the region in perspective. The geographic area contains several of the world’s fastest growing economies and is also home to an increasing amount of privatization of traditional government monopolies. These trends bode well for the investment industry, and there may be a cyclical rebound in future years. That said, increasing regulation and concerns over risk management from investors based in traditional markets will continue to weigh on the industry. As a result, uncertainty and volatility will continue to be underlying attributes to the Asian hedge fund market for the foreseeable future.

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