A recent regulatory brief from PwC focused on liquid alternative funds, specifically focusing on the SEC’s upcoming sweep examination and how fund firms offering these products can prepare for the increasing regulatory scrutiny. The brief highlights liquidity, leverage, investor allocations, governance, and sub-adviser oversight as the areas likely to be the focus of the SEC’s sweep exam.
The regulatory brief highlights the liquidity challenges present in alternative funds, cautioning that the 1940 Act requirements can result in “significantly watered down versions of true alternative funds.” The brief recommends that firms offering liquid alternative funds “be ready to demonstrate a thorough understanding of the 1940 Act liquidity requirements, and the appropriate compliance procedures and risk controls to manage the fund in a range of market conditions.”
Like the liquidity challenges, the brief also points out that firms new to 1940 Act regulation can have difficulties adjusting to the Act’s leverage requirements. The brief emphasizes the importance of focusing on compliance policies and testing related to leverage. Further, the brief recommends that firms give presentations to fund boards “to explain the leverage compliance methods in the context of liquid alts.”
The brief identifies challenges posed by the conflicts inherent in allocation decisions as well as the difficulties related to drafting and administering policies and procedures designed to address these conflicts. The brief posits that the SEC’s examinations of alternative funds will pay particular attention to situations where it appears that unfair investment allocation policies appear to result in sub-par performance for the registered fund compared to its private fund counterpart.
PwC’s brief highlights governance difference between private funds and registered funds, noting in particular the involvement of fund boards in oversight of registered funds. In addition, the brief suggests that fund boards with experience in traditional mutual funds also need to get up to speed on the investments and strategies used in liquid alternative funds. The brief recommends that board minutes and other materials “reflect coherent communication and understanding of the alternative investment risks and control framework, as well as the conveyance of sufficient information to permit directors to make informed investment decisions.”
PwC ‘s regulatory brief reminds firms of the importance of conducting due diligence on fund sub-advisers, noting OCIE’s Risk Alert Bulletin regarding advisers’ due diligence activities. In addition, the brief underscores the need for advisers to develop infrastructure to monitor a liquid alternative fund’s compliance with 1940 requirements.
The regulatory brief is available here.