“Nothing short of a 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. Investors have got other things to think about.

Still, the changes are sweeping, and Americans will 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.
   

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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

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 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 , 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 . 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.

Everyone is understandably preoccupied, but this topic deserves more attention. A Glass-Steagall moment calls for lively debate.

This blog is an adaptation of a newsletter sent me by Ethan Wu of the FT’s “unhedged” team.  You can sign up for these newsletters when you become an FT subscriber. There aren’t many things worth subscribing to – the FT is one of them.