New US disclosure rules may ripple to S-E Asia’s private funds

NEW regulations mandating greater transparency from US private fund managers could prompt Asian funds to improve their disclosure practices, as more managers here target US capital.

The US Securities and Exchange Commission (SEC) on Aug 23 passed new rules for managers of private funds in the United States. The move aims to address longstanding concerns about investor protection in the opaque industry.

The rules, among the SEC’s most far-reaching to date, will require managers to be more detailed in quarterly disclosures of performance, fees and expenses.

Managers will also be subject to limits on “side letters”, which give certain investors preferential terms.

The new rules will not apply to non-US investment funds managed by non-US managers. Nevertheless, experts believe that evolving market conventions could prompt Asia-based managers to adapt their practices in the long term.

A boom in South-east Asia’s alternative assets industry over the past five years has sparked a wave of fund managers seeking capital from overseas institutional investors.

Jason Nelms, a partner at law firm Morrison Foerster, said that US limited partners (LPs) – the investors in private funds – are likely to push for Asia managers to agree contractually to comply with some of the new rules.(See *Amendment Note)

Side letters are prevalent in South-east Asia’s fund management industry.

They may give some investors the right to pay lower fees, award priority in co-investing with the fund, or give the right to consult with a fund’s investment committee on its investment decisions.

Under the SEC’s new rules, preferential terms are unlawful if they have a material negative effect on other investors. In all other cases, fund managers must make certain disclosures about preferential terms to all current and prospective investors.

Such disclosures, alongside other new requirements, could add to the complexity of producing quarterly and annual reports.

Periodic reports are already the norm in South-east Asia, but the new reporting requirements require a level of detail beyond market standards.

Morrison Foerster’s Nelms expects compliance costs and administrative burdens to increase, to address both legal risks and evolving market practice.

“The SEC has historically extended the application of rules that nominally only apply to SEC-registered advisers to all private fund managers, particularly those that have any US-based LPs, under the general ‘anti-fraud’ rules of the US securities laws,” he added.

“Although there will be grey areas, some South-east Asia-based managers that raise US capital will follow a conservative approach and comply with the new rules even where not strictly required.”

Investment flows into South-east Asia have been increasing amid the economy’s rapid rise. The region is now seen as the second-most attractive emerging market after India, according to alternative assets data company Preqin.

As the inflows rise, standards will have to rise too – to meet the expectations of foreign investors.

Angela Lai, head of Asia-Pacific for Preqin’s Research Insights team, said that some alignment of transparency practices is expected for funds operating outside the US.

“Especially for South-east Asia, which is a relatively new market for some investors, funds with better disclosure practice should help investors understand their investments as well as the general partner better, and be more favourably considered,” she noted.

Industry players are also watching for regulatory shifts in the US to influence global market practice in the long term.

A spokesperson from the Monetary Authority of Singapore (MAS) said that MAS aims to ensure that capital markets intermediaries conduct themselves in a fair and transparent manner.

“As part of our ongoing supervision, we regularly monitor regulatory developments in other jurisdictions, and we will consider enhancements to our regulatory framework where appropriate, in close consultation with the industry,” the spokesperson added.

On top of raising their game in transparency, Asian fund managers may also have to adapt to a new pace of fundraising and depth of due diligence.

“This may have ripple effects down the line as we see more local and regional funds looking to raise larger vintages, and potentially look to more mature markets like the US for investors,” said Tan Yinglan, founding managing partner at venture capital firm Insignia Ventures Partners.

“For any GP-LP relationship, communication is key; and maintaining that will be foundational to navigating these changing expectations of the financial industry, which go beyond these new market norms in the US.”

* Amendment Note: Morrison & Foerster has been rebranded to Morrison Foerster. The article has been updated to reflect the correct name.