On February 22, the President’s Working Group on Financial Markets (PWG) released a set of 10 principles and guidelines intended to guide the approach of U.S. financial regulators toward private pools of capital, such as hedge funds. The PWG, which includes key representatives from the Treasury Department, Federal Reserve Board, Securities and Exchange Commission and Commodity Futures Trading Commission, affirmed its view that private pools provide significant benefits to the financial markets and that the current regulatory structure for private pools has proven successful. The latest principles, the first statement by the PWG on private pool issues since 1999, concentrate on investor protection and systemic risk concerns, and include the following points:
- Market discipline by creditors, counterparties, and investors inprivate pools provides the most effective mechanism for limiting systemic risk—that is, the risk that losses by certain marketparticipants might destabilize the broader financial system.
- Investor protection is addressed most effectively through acombination of market discipline and regulation limitinginvestment in private pools to more sophisticated investors.
- Concerns regarding the indirect exposure of less sophisticatedinvestors to private pools via their holdings in pension funds orother pooled investment vehicles is best addressed through thepractices of the fiduciaries managing those pooled investmentvehicles.
- Managers of private pools should have information, valuation,and risk management systems meeting sound industrypractices, allowing them to accurately provide materialinformation to other market participants in a timely manner.
- Key creditors and counterparties to private pools shouldcontinue to develop and enhance risk management practicesregarding the related credit exposure and the potential forchanges in that exposure over time.
- Sufficient historical and current information should be availableto enable a prospective investor to investigate the strategies,terms and conditions, and risk management capabilities ofprivate pools and to evaluate the suitability of an investment insuch pools for that investor.