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Regulators Could Order Hedge Funds to Disclose Crypto Exposure

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Regulators Could Order Hedge Funds to Disclose Crypto Exposure


The crash in cryptocurrency prices this year has left US regulators scrambling to understand the risks digital asset markets could pose to the broader economy.

They may soon bring in hedge funds in this effort.

The Securities and Exchange Commission released a proposal on August 10 that would require large hedge funds to report their cryptocurrency exposure through a confidential filing known as Form PF.

Created after the 2008 financial crisis, the PF form was designed to help regulators spot bubbles and other potential risks to stability in the otherwise opaque ecosystem of private funds that manage the money of high net worth individuals and institutions.

The potential addition of cryptocurrency data to hedge fund reporting requirements comes as the SEC and its sister agency, the Commodity Futures Trading Commission, evaluate a broader set of updates that would expand the scope of Form PF.

The two agencies agreed to the changes after consulting with the Treasury Department and the Federal Reserve on potential risks to financial stability in the private funds industry. SEC Chairman Gary Gensler noted that total private fund assets are approaching the size of banking sector assets, which grew more slowly following post-crisis regulatory requirements.

“A very important part of our financial system is growing — and growing faster, and is about to overtake the entire commercial banking system — which has a lot less regulation and a lot less transparency,” Gensler said. August 10.

The rule proposed on August 10 would add “digital assets” as a new asset class on Form PF and define the term. He seeks comments on whether funds should report detailed information about the cryptocurrencies they hold, such as identifying them by name or describing their characteristics.

In the proposal, SEC staff noted that many hedge funds have recently been created to invest in crypto, while some existing hedge funds have started adding it to their portfolios.

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Gensler, a Biden appointee, has compared cryptocurrencies to the Wild West and frequently stresses the need for more protections for investors in the market. Asked during a virtual press conference if regulators currently have enough visibility into hedge funds’ exposure to crypto, he replied, “No.”

So far, the recent price drop in digital tokens like bitcoin has been relatively limited to the crypto market. But the implosion of a crypto-focused hedge fund, Three Arrows Capital, earlier this summer created a chain reaction that sent a number of its creditors into bankruptcy.

Regulators fear that such ripple effects could spread to traditional markets if traditional financial institutions increase their adoption of cryptocurrencies before the proper safeguards are in place.

The total value of the crypto market recently hovered around $1.2 billion, down from a peak of nearly $3.1 billion in November, according to data website CoinGecko.

Beyond crypto, the proposal would require hedge funds with more than $500 million in net assets to report more information on Form PF regarding their investment exposures, portfolio concentrations and trading arrangements. loan.

“Collecting such information would help the commissions and [financial-stability regulators] better to watch how the big hedge funds interconnect with the broader financial services industry,” Gensler said.

SEC commissioners voted 3-2 along party lines to release the proposal, which will be made available for public comment before the agencies decide whether to complete the changes. Republican SEC Commissioners Hester Peirce and Mark Uyeda voted against, questioning whether the government really needed all the information the new version of Form PF would gather.

The CFTC, also controlled by Democrats, was scheduled to vote on the proposal on Aug. 10 afternoon.

Bryan Corbett, president of the hedge fund industry lobby group in Washington, said the new requirements would create compliance costs that would ultimately be borne by hedge fund investors and make it more difficult for new managers to enter. funds in the market.

“Alternative asset managers are currently providing detailed information to regulators,” Corbett said. “The SEC should focus on making better use of this information rather than imposing new burdens on fund managers that are of questionable utility.”

Write to Paul Kiernan at paul.kiernan@wsj.com

This article was published by Dow Jones Newswires, another service of the Dow Jones group

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