On September 27, 2021, the Securities and Exchange Commission (“SEC”) and its Asset Management Advisory Committee (“AMAC”) published their final report and recommendations for private investments. This article offers a summary of the update.
On September 27, 2021, the Securities and Exchange Commission (“SEC”) and its Asset Management Advisory Committee (“AMAC”) published their final report and recommendations for private investments, available here . This report comes at a time where interest rates, for now, remain low and the hunt for yield is pushing investors towards alternative asset classes, generally seen as generating higher returns, although asymmetrical, but less accessible to retail investors.
The attractiveness of illiquid assets results in their apparent superior returns and lower correlation against other asset classes. The AMAC summarized the interest of each asset class and its key observations below:
There are certain factors that are pushing investors to want access to more asset classes:
With an increase in demand for retail products countered on one hand, countered by public markets that no longer offer a diversified source of risk on the other hand, investors have begun turning to private investments.
Two of the Design Principles, the chaperoned access and disclosure items would be covered under a RIC framework.
Review Accredited Investor and Qualified Client rules
RIC rules already provide sufficient investor protections.
Allowing more investors may help create liquidity in a secondary market
Ease listing conditions for private funds
May provide secondary market liquidity while allowing closed-ended funds to invest in illiquid assets.
Additional flexibility for interval and tender offer funds
Interval funds: More flexibility on the initial investment period before the first repurchase and allowing flexible repurchase dates based on underlying liquidity instead of a fixed schedule.
Tender offer funds: allowing the more flexible repurchases fund to be undertaken in a similar manner to interval funds, e.g., alignment of Form N-23 with Schedule TO requirements.
Standardized disclosure of fees, risks, key terms and returns as well as liquidity constraints of private investments that retail investors have access to.
RIC diversification requirements
Consider whether diversification requirements should be required for RICs investing in private investment funds that retail investors can invest in. Examples:
Mitigation of potential additional fees from RIC investment advisers by allowing large sponsors to also act as investment adviser to closed-end funds. Conflicts of interest would need to be disclosed and managed.
Allowing closed-end funds to invest only in “approved” private funds. The approval status would be based on size/diversification of investments and potentially a majority of commitments coming from Qualified Purchasers or large institutional investors. Consideration on whether such “approved” funds could be invested directly by retail investors without the need for the additional layer of an investment adviser.
Democrat administrations, such as that of President Biden, have traditionally been more hostile to capital formation, especially private capital. The administration and its supporters have already proposed higher taxes on private funds. Elizabeth Warren, a main ally of the Biden administration in the U.S. Senate who sits on the Banking Committee (the main Wall Street oversight body in the Senate), has expressed wariness of the private fund industry at least since her chairmanship of the Troubled Asset Relief Program (“TARP”) in the wake of the great recession. She recently sponsored a bill, along with Senator Sherrod Brown (Chair of the Banking Committee), targeting certain private equity practices — called the “Stop Wall Street Looting Act”.
The proposal seems to run counter to regulatory trends that have limited access to private funds in the U.S. For example, the Qualified Client standard has risen twice in recent years, and the Accredited Investor standard appears overdue. Even the recent attempt to liberalize private fund marketing via the new 506(c) exemption, only reinforced the Accredited Investor standard. Moreover, with retail investor money largely lying in highly regulated retirement accounts, tax and ERISA law may have to be rewritten to accommodate private fund allocations in those accounts. Current ERISA fiduciary standards (which already make it difficult to find a custodian to hold private paper), as well as stringent conflicts and diversification rules applicable to retirement accounts may otherwise present too great a risk of liability.
Gary Gensler, President Biden’s appointment as head of the SEC, has been a strong voice for greater regulation of the financial industry. Chairman Gensler has also expressed concern about the growth of the private fund industry and the SEC’s ability to keep pace, an issue that would only be exacerbated by the proposal.
It may be fair to ask whether there is truly a market being filled by this proposal. Top institutional advisory firms already capture the lion’s share of assets and consolidation has only accelerated this in the last few years. Fewer, larger firms with plentiful institutional money may see no need to access small retail investors in this way, which may also only cannibalize their pre-existing retail products, such as their numerous ETFs. The growing ETF market also seems to reflect retail investor appetite for cheap, indexed products over more actively managed mutual funds, let alone hedge funds or private equity funds.
Interest in retail investors accessing private assets is not limited to the U.S. market.
In the UK, the FCA just released a Policy Statement on the creation of the Long-Term Asset Fund (“LTAF”) regime. The recent paper issued by the Productive Finance Working Group notably recommends offering liquid assets to Defined Contribution (“DC”) schemes and retail investors through an FCA approved LTAF product. Another way being explored is the removal of the 0.75% charge cap on DC pension funds to allow them to invest in traditionally more expensive – and presumably more lucrative – private funds.
The European Union has been looking to amend its European Long-Term Investment Fund (“ELTIF”) framework with one of the main features of this framework being its ability to be marketed to retail investors.
Overall, private markets continue to attract more capital from a wider range of sources. A key challenge for regulators around the world will include liquidity management and investor protections in a market that has already seen record valuations.