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The SEC comes for private funds

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Good morning. Federal Reserve chair Jay Powell gave markets a comfy bump yesterday, just by saying what they already believed — that the Fed will begin increasing rates in March. He still thinks a soft landing can happen. Maybe we’ll write about that sometime. Today, we look at what the Securities and Exchange Commission is up to and ponder the difference between divestments and boycotts. Email us: and

Pay attention to the SEC’s overhaul of private capital

Nothing short of a 1930s moment for private capital — that’s how one source described the SEC’s proposed rules for hedge funds and private equity. But since the proposals dropped, the buzz has died down. Plenty else is going on.

Still, the changes are sweeping, and we’ll probably be living with some version of them sooner or later. There are four buckets of rules, proposed during the past few months, that matter.

  1. Public disclosure of the big swap positions made famous by last year’s Archegos implosion.

  2. For all private funds, standardised disclosure to investors of fees, expenses and performance; bans on certain fees and side deals with investors; and mandatory audits.

  3. For private equity, extra reporting to the SEC on holdings, pay and financing.

  4. For hedge funds, one-day turnround reporting to the SEC of major business events such as spiking borrowing costs or abrupt losses.

Start with swaps. These are instruments that let you wager on the direction of a stock without actually holding the stock. Anyone, private fund or no, who owns a healthy chunk of them (generally about $300mn) will have to disclose. The rule fits a theme SEC chair Gary Gensler has emphasised: private investments can have public consequences. The Archegos meltdown began in a family office, but rippled through markets and triggered fire sales. The idea is to make these risks easier to spot.

The other three buckets, applying to private funds only, are partly about ferreting out hidden risks and partly about protecting investors. Take the fourth bucket — asking hedge funds to tell the SEC about business shocks. The goal is more oversight, with the 2020 Treasury market breakdown as a likely motivator. Hedge funds trading Treasuries with leverage reportedly took big losses fast. The SEC wants an early warning signal.

Investor protection, another Gensler theme, is the focus of bucket two. The rules are complicated, but straightforward in their aims. The SEC wants private funds to look more like mutual funds, setting disclosure standards and banning practices the agency frowns upon — like “side letters” which let bigger investors cut better deals. One theory reckons the agency wants to nudge more funds into public markets.

Is any of this a good idea? Hedge funds don’t think so. Bryan Corbett, head of the Managed Funds Association industry group, said “these proposals are solutions in search of a problem, pushing transparency for transparency’s sake”.

Is the SEC solving a real problem? In terms of protecting investors, a top finance lawyer I spoke with thought not:

I’m not one of those lawyers who automatically assumes that the SEC is wrong . . . But here, it’s just hard for me to see much justification for what the SEC is proposing. These would be pretty burdensome ongoing requirements that managers of these private funds would have to follow. And there’s just no record out there that this is really a problem that needs a solution.

By definition, you have to be a sophisticated investor to invest in these funds. The traditional regulatory mindset has been that products for sophisticated investors deserve a lighter touch than a retail product.

How much you like the investor protection rules hinges on how you view institutional investors. Many assume they can fend for themselves. But Andrew Park of Americans for Financial Reform, one of the best-informed advocates, is more pessimistic:

The whole argument that these are sophisticated investors [is misleading]. Part of the problem is that they get coerced into what I consider to be exploitative [limited partnership] agreements. I’ll give you an example of one. One of them makes it a violation of the LP agreement if you talk to other limited partners.

That is an absurd restriction. All that’s trying to do is prevent fund investors from talking to each other to collectively push back on terms . . . It’s not a functioning market. If we think about other non-functioning markets, in healthcare it’s the same problem. You can’t negotiate because you have no idea what you’re supposed to be paying.

The backdrop here is low yields. To many (though not to Unhedged) private markets are the only place to go to beat the S&P 500. That lets funds extract concessions from investors, Park added.

What about exposing hidden risks — are the rules any good for that? Hard to tell. They would certainly give the SEC more data. Maybe too much. Park (who supports the rules) worries that without more resources, all the new disclosure could overwhelm short-staffed regulators. Hedge funders complain that one-day turnround reporting would be an expensive pain in the neck.

The swaps rule makes the most sense to me. Trades that can spread heavy losses to other firms should probably be public knowledge. The rule asking hedge funds to report instability makes sense too, though I doubt it is enough to fix the Treasury market. I’m not sure about the others; write in if you have an opinion.

Everyone is understandably preoccupied, but this topic deserves more attention. A 1930s moment calls for lively debate. (Ethan Wu)

ESG and sanctions

Lots of companies are getting out of Russia, completely or in part, and in various ways. Examples:

  • BP plans to divest its stake in Rosneft. How exactly they will do this is unclear, but it may lead to a $25bn writedown.

  • Shell plans to end its participation in several joint ventures with Gazprom, potentially sacrificing $3bn in assets.

  • ExxonMobil will discontinue operations in the Sakhalin-1 project, a partnership with Rosneft, possibly stranding some $4bn in assets, and will halt new investments in the country.

  • The accountant Grant Thornton has cut ties with its Russian Member firm FBL.

  • Daimler trucks has ended its partnership with the Russian company Kamaz and will no longer do any business in the country. Volvo trucks has halted production at its Russian factory. Volvo cars, Jaguar Land Rover and BMW have halted deliveries to the country.

  • MSC, Maersk and other major shipping companies have stopped shipping to Russia (with exceptions for food and medicine).

  • Siemens has suspended its Russian operations, where it has contracts to build and maintain trains.

  • Apple has suspended sales to Russia.

None of this has anything directly to do with ESG investment principles. As far as I know, none of these companies were forced out of their Russian operations by investor demands, or by any explicit commitment to particular ESG principles.

But the situation does raise some important points about ESG. The first is that the corporate actions above can reasonably be expected to put real pressure on Moscow. Having to buy their iPhones abroad will make Russians aware of their country’s pariah status and increase resentment of the regime. Not having companies such as Siemens in the country will mean a less-efficient manufacturing base, and the absence of Exxon’s expertise will reduce the productivity of Russia’s energy industry. If all the big auditors refused to work in Russia, it would be hard for any global company to operate there, because it would be difficult to get a reputable audit of a Russian subsidiary. All this raises the costs of the country’s monstrous war on Ukraine.

That makes these corporate actions very different from a bunch of investors, however large, deciding they won’t own Russian stocks or bonds. Such divestment wouldn’t make a speck of difference to Putin’s regime, in the same way that a bunch of investors deciding they don’t want to own the shares or bonds in oil companies does not make a speck of difference to global warming (as I have argued it does not, at tiresome length, many times before). The world is awash in capital, and the virtuous investors will be replaced by others, who will make lots of money buying the dirty companies cheap and collecting dividends.

A big difference exists between divestments and boycotts. Changes to supply and demand for goods and services, instigated by boycotts, can have a major effect on corporate and even national behaviour. Shifting the ownership of assets around cannot.

But what about the oil companies’ divestments? Don’t they just amount to shifts in ownership? Probably. If the oil companies sell their Russian assets back to their Russian partners, or to someone else, the divestments themselves won’t make a difference. It’s only the departure of the global companies’ expertise that will hurt. If the global companies simply walk away from their investments, it is even worse: they are making a gift of their assets to Russia.

It is possible enough global capital flees Russia — all of it, effectively — that the country’s total productive capacity could be constrained and it would become poorer. This is how many ESG believers think they can create change: by making capital scarce and prohibitively expensive. And I could imagine this happening in Russia. It may be happening now. Is this, then, proof that ESG investing, at scale, could in fact have dramatic, world-improving effects?

No. The reason it is possible to imagine Russia becoming capital constrained is because governments have leaned hard into financial sanctions. The idea that large well-meaning coalitions of investors, without this muscular backing by government, could have dramatic environmental or political effects is hopelessly naive. Because, again, there is always someone who will take the other side of the trade, buy the dirty assets and get rich. What is happening in Russia is not evidence that ESG investing can make a difference.

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