On March 26, 2009, Treasury Secretary Timothy Geithner outlined a framework for sweeping regulatory reform (the "Proposal") to "produce a more stable system...that protects customers and investors, that rewards innovation and that is able to adapt and evolve with changes in the financial market." While this Proposal represents only an initial outline of key principals and an overall structure for proposed regulatory reform, Sec. Geithner identified its four primary components: (i) addressing systemic risk, (ii) protecting consumers and investors, (iii) eliminating gaps in the current regulatory structure, and (iv) fostering international coordination. While Sec. Geithner indicated that he would present more details about each of these areas in coming weeks, the Administration is focused initially on the systemic risk component. While the Proposal primarily targets large financial firms, including banks, it will have a significant impact on many managers of hedge, private equity, venture capital, and other private investment funds as well.

The systemic risk component of the Proposal includes five key elements:

  1. A single independent regulator to police risk across the entire financial system, with responsibility over systemically important firms and critical payment and settlement systems;  
  2. Higher standards on capital and risk management for systemically important firms;  
  3. Registration of all hedge fund advisers with assets under management above a moderate threshold with the U.S. Securities and Exchange Commission (the "SEC");  
  4. A comprehensive framework of oversight, protections and disclosure for the OTC derivatives market; and  
  5. New requirements for money market funds to reduce the risk of rapid withdrawals.

Each of these elements is discussed in more detail in this summary.

As this proposal progresses towards more concrete legislation, managers of hedge, private equity, venture capital, and other private investment funds should stay apprised of the proposed requirement that such advisers register with the SEC.

The proposed requirement that fund managers register with the SEC will require legislative action, and additional detail, before implementation. The proposal from Sec. Geithner indicates that advisers to hedge, private equity, venture capital, and other private investment funds whose assets under management are above a certain threshold would be required to register with the SEC. Such advisers would be subject to investor and counterparty disclosure requirements, regulatory reporting requirements, and confidential reporting of information necessary to assess whether the fund is so large or highly leveraged that it poses a threat to financial stability. The SEC would share the confidential information with the new "systemic risk regulator," which would then determine whether a fund could pose a systemic threat and should therefore be subject to certain higher standards on capital and risk management for firms that are determined to be systemically important.

Sec. Geithner's announcement came in advance of President Obama's participation in the April 2 G-20 summit to discuss global efforts to coordinate international reaction to the economic crisis. Since early in the Administration, the President set this event as a target for consideration of regulatory overhaul legislation in the United States. Though the press of legislative agenda made this aggressive deadline untenable, the Treasury announcement was designed to demonstrate American leadership within the G-20 and set the stage for congressional debate on systemic risk legislation. As part of the Summit, the G-20 leaders agreed on a declaration calling for better global regulatory coordination of financial regulatory structures as well as the prevention of systemic risk through all manners of financial institutions, both public and private, including hedge funds. The G-20 declaration further called for tighter regulation of institutions that have hedge funds as their counterparties and the establishment of central clearing counterparties for credit derivatives markets.

Though the Administration's announcement has provided a blueprint for the President's vision for systemic risk regulation, the issue requires significant legislative action to become law. An issue as complex and politically sensitive as this one will likely require extended debate in the U.S. House of Representative and Senate, and debate could stretch into next year. The House Financial Services and Senate Banking Committees have both held an extensive series of hearings on this subject, and it is expected that these hearings will continue throughout the spring and into the summer. We will likely see multiple legislative products, both reflecting the Administration's proposal and providing alternatives to it.

Further updates will follow in coming weeks as more details of the Proposal are disclosed.