Regulatory Initiatives, Liquidity Trends, and AI in Relationships

Industry Insights:

Our newsletter, Jack-of-all-Reads, shares the latest and greatest insights in a brief read on a monthly basis. Please let us know of any comments or questions – we welcome and appreciate your continued partnership.

Industry Insights:

1. Progressively Unique Fee Structures. The team has noticed managers become increasingly flexible to cater to investors’ needs by creating unique share classes. For example, managers have been more likely to include multiple fee ranges based on an allocator’s ticket size, choosing to input this information directly into their prospectus rather than through side letters to provide additional transparency to all investors.
   • Commonly seen trends include:
     • Managers presenting a menu of options, most typically with sliding scale structures and liquidity restrictions based on ticket sizes.
     • Monthly and quarterly redemptions are still the most common liquidity windows, however, additional gates and lock ups are often included as well. Longer lock ups are regularly associated with allocators’ paying lower fees or opting into periodic distributions.
     • Hurdles are becoming a more common occurrence. A recent study by Seward & Kissel noted that hurdles are used for over 20% of all established managers and 40% of emerging managers.
2. Cybersecurity: Regulatory and Compliance Trends. With cybersecurity regulations changing rapidly, which requires managers’ best practices to evolve in tandem, a fund’s annual exercise should no longer be a generic program. The SEC has been discussing cybersecurity for almost a decade, and now this is also a European regulator focus. The EU’s DORA regulation is expected to demand a more proactive approach in the governance of the organization which may include increased employee training, in depth testing of technology systems, and assessments of infrastructure to ensure compliance.
   • 3rd Party and Operational Resilience. Funds must understand which of their service providers are material vendors to their business. Business continuity and operational resilience plans should show that managers have thought about these groups, processes, and how they would handle diminished access to them.
     • What if your service providers go bankrupt? How will you respond?
     • What if a key person leaves your business that has sensitive, proprietary IT knowledge?
     • What if the operational platform needed to run day to day tasks in your business falls?
   • Account Takeover Risk. While ransomware and phishing tend to be in the headlines, the theft of credentials and the recycling of credentials make account takeovers a more common occurrence. Some of the most fundamental requirements from all of the regulators include:
     • Who has access to the platform?
     • When they access the platform?
     • How do you prevent others from gaining access?
   • Understanding Regulators: Different regulators require different reporting, archiving, and levels of communication around cybersecurity.
     • Annual Reporting and Archiving. Regulators have different expectations of how long you are going to need to archive certain communications and data. Some may also need to be easily available for a certain period of time.
     • Incident Communications. Understanding when to communicate a breach or data loss can be difficult as regulators may expect different timelines and forms. Managers should ensure they are adequately prepared to respond to these nuances in timelines and procedures depending on the regions they operate in.
3. Non-Competes. On August 20th, a United States District Court in Dallas, Texas ruled that the Federal Trade Commission (FTC) cannot enforce its ban on noncompete agreements, which was set to be implemented on September 4th.  The court ruled that the FTC lacked the authority to enact the ban.
   • State Specific. The lawsuit against the FTC’s noncompete rule, brought by the US Chamber of Commerce and a Texas based tax firm, is the most advanced of three that challenges the FTC’s ban, with a court in Florida issuing a limited initial ruling against the ban, and a Pennsylvania court declining to do so.
   • Commonalities. With an estimated 20% of American workers subject to noncompete agreements, the US Chamber of Commerce has argued in its case that banning such agreements would put most workers and businesses at a competitive disadvantage and that in issuing the ban the FTC has gone beyond its legal authority. A spokesperson for the FTC has said they are considering an appeal.
4. ESG Taskforce Updates. In March 2021, the Securities and Exchange Commission (SEC) established a Climate and ESG Task Force in its Division of Enforcement tasked with the responsibility of identifying ESG-related misconduct, which could include gaps or misstatements related to a companies’ disclosure of climate-related risks to their businesses and products. In September 2024, it was reported that the SEC disbanded this taskforce, pointing to the continued headwinds faced by the SEC as they try to adequately enforce rules on climate disclosures, human capital, and board diversity efforts.
   • Exam Trends: SEC’s ESG Priorities. Prior to its disbandment, the SEC also removed ESG from its annual Examination Priorities Report. Despite this dissolvement, the SEC has continued to pursue action on a number of its proposed ESG-related rules.
   • ESG Priorities Globally. Concerns about ESG-related disclosures still remain top of mind globally, with the European Union recently implementing its “Greenwashing Directive,” which prevents businesses from making environmental claims that are uncorroborated, and UK’s Financial Conduct Authority (FCA) enforcing its Anti-Greenwashing Rule, which requires companies to ensure that all ESG related claims about their products are “fair, clear, and not misleading.”

Please reach out to your Jefferies contact for more information on any of the topics above.

Client Corner:

People Centric Marketing. In a world of growing AUM, large teams of analysts, proprietary algorithms, and AI utilization streamlining the investment process, do people still count in the alternatives industry? The September 16^th edition of the Prequin First Close Newsletter, which sampled responses from various senior members of large investment firms, says, yes, the industry is very much still people centric. LPs still seem to value having conversations with GPs early on in their relationship building process about terms, alignment, and governance. They also appreciate a manager’s humble admittance of fault when an inevitable error occurs. Additionally,  the article shows that LPs believe the industry is in another cycle of manager transitions, with the largest firms consolidating and working through succession plans, while also dealing with top performers spinning out to launch their own shops. As a result, some LPs say they are having to pay greater attention to manager ownership and investment team dynamics – the human factors – when performing diligence on their investments. 

Spotlight on Content and Events:

Our View on How Corporates Evolve on ESG/Sustainability. The Jefferies Sustainability & Transition Strategy team will be hosting a webinar on How Corporates Evolve on ESG/Sustainability on Tuesday October 29^th at 11am ET. This conversation will be hosted by Aniket Shah, Global Head of Sustainability & Transition Strategy and Luke Sussams, EMEA Head of Sustainability & Transition Strategy. The key challenges to be discussed include:

• Align Sustainability Strategy with Business Strategy: What are the 1-2 issues that are financially material to the business?
• How to Write a Sustainability Report: The average length of 2023 sustainability reports increased by 6%, up to 82 pages; lengths ranged from 11 pages to 262 pages. But are these reports helpful for institutional investors?
• Corporate Venture Capital and M&A Strategy related to Sustainability: How companies allocate capital to commercialize sustainability strategy
• To register for this call, please click the following link.

Mid-Year Review: A Record-Breaking 1H of 2024 for the Secondary Market | Jefferies Insights and Thought Leadership. In July, Jefferies’ Private Capital Advisory team released its mid-year review of the secondary market, consolidating discussions, surveys, and research from the market’s biggest and most influential limited partners, general partners, and secondary buyers.

This report follows Jefferies’ H2 2023 secondary market review, which predicted near-record secondary volume, higher LP pricing, and a sustained capital overhang for fiscal year 2024. The latest findings show the first half of the year largely met these expectations.

Here, Jefferies Insights shares high-level takeaways from the Private Capital Advisory team.

Interesting Service Provider Reads: Highlighting Topical Content from Industry Leaders

Akin Gump –AML and KYC Obligations (Finally) Imposed on Private Fund Managers

Citco – 2024 Q2 Hedge Fund Report – Quarterly Review

EisnerAmper – What To Do When Your Organization Is Growing Faster Than Your IT Function

RQC – The Alternative Investor

Seward & Kissel – The 2023 Established Manager Hedge Fund Study

Jefferies Prime Services Contacts:

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