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The Hedge Fund Transparency Challenge

As hedge funds face an onslaught of financial regulations and data reporting requirements from regulators and investors, they're scrambling to aggregate data and calculate risk metrics.

Outsourcing Or Co-Sourcing

To save costs and comply with regulations and meet investor requests, many hedge funds are turning to outsourcing providers. "What they're finding is that the old models where they would just hire all the people and model all the technology doesn't work because it's too expensive," says Punater.

Instead, firms are looking to service providers that can manage their data and applications on a private cloud. Those not comfortable giving their data to an Amazon or Google prefer to work with a private cloud company that specializes in apps, systems and data, Punater says. Rather than spending hundreds of thousands of dollars on their own data centers, many private cloud providers that specialize in financial services offer integration of hardware, software and managed service levels. Gravitas offers these types of services. "It's a utility we manage for them. They can scale up or down," says Punater. "The trend is to move into a cloud environment so it's accessible 24/7 and maintained by a service-level agreement." For a flat fee, clients of Gravitas receive the data center, unlimited support and maintenance of their computing environments, notes Punater.

A second approach, known as co-sourcing, allows a firm to access, for example, risk technology, market data, a risk analyst, and some data warehousing and reporting technology, all bundled as a service. Gravitas provides this type of service with IBM Algorithmics, offering clients customized risk software and dedicated reporting.

To deliver its co-sourcing service, Gravitas is working with a team of risk analysts in Mumbai, India, who help clients solve their problems. Gravitas' risk analysts use IBM Algorithmics software and data as a basis for risk analytics and reporting. Their ability to normalize and analyze aggregate data from multiple sources is seen as a key benefit to using the risk services. A hedge fund with $1 billion to $5 billion in assets can save 30% to 50% on the cost structure, depending on fund complexity, Punater says.

Meanwhile, some technology providers are developing applications that may make it easier for hedge funds to comply with the steady stream of government regulations and investor requests for transparency. In 2012, Imagine Software, a provider of portfolio and risk analytics, built a platform, similar to Apple's iTunes, that lets Imagine, its clients and other third parties around the world build apps that can be extended to users' desktops or mobile devices. One such app enables hedge funds to comply with a new short sale position rule required by the European Securities and Markets Authority.

Standardized Risk Calculation

Another wrinkle for hedge funds is that many investors, confused by various ways to calculate risk, are pressuring hedge funds to use a standard methodology for their risk calculations. Some investors are supporting an industry initiative, known as the Open Protocol Enabling Risk Aggregation standard, that will enable hedge funds to report their risk numbers in the same way. The project -- backed by an industry consortium whose leaders are Albourne Partners and Thomson Reuters -- standardizes reporting procedures for collection, collation and conveying hedge fund risk information, according to its website.

[Video The Future Of Data Management ]

"The idea there is around data and consistency and also to help investors [in hedge funds] to aggregate their risks," says Steven Harrison, president and COO of Imagine, which built an app to support the Open Protocol. "Once clients put their portfolios in Imagine, we take that data and massage it into a format that is in line with the new reporting standards."

Meanwhile the list of regulations seeking information from hedge funds keeps growing. "The forms that exist or are in the process of being finalized show that regulation is not going away," says Correll of Advise Technologies. "It's been a burden for hedge funds until they can streamline the process," she says, adding, "Hopefully, their alpha generation won't be affected while they fill out these forms."

Top Regulatory Hurdles for Hedge Funds

Global regulatory bodies are issuing a slew of new regulations that require hedge funds to collect data from multiple parties, normalize it and report risk exposures.

Mandated under Dodd-Frank, hedge funds that are registered as investment advisers are required to file Form PF for private funds with the SEC. It asks for data on positions, liquidity and credit counterparty risk. Large hedge funds (with $5 billion and up in regulatory assets under management) filed last summer. Fund managers with $1.5 billion in RAUM have to file by March 1, 2013. Those with $150 million to $1.5 billion have a deadline later this year.

-- The Commodity Futures Trading Commission and the National Futures Association proposed a new reporting form for commodity pool operators and commodity trading advisers.

-- Hedge funds are bracing for reporting requirements from the EU's Directive on Alternative Investment Fund Managers.

-- The European Securities and Markets Authority will require short position reporting for hedge funds.

-- The EU regulation Undertakings for Collective Investment in Transferable Securities, known as UCITS IV, requires risk reporting such as value at risk to protect investors and detect systemic risk.

Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio

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