In a split vote earlier this week, the SEC published a proposal to amend Form PF, the confidential reporting form that the Financial Oversight Stability Council (FSOC) uses to monitor systemic risk. As this Simpson Thacher memo explains, if approved, the proposal would have a significant impact on private equity sponsors, because it would require accelerated reporting by advisors to private equity funds and large hedge funds of certain “key events” about their operations and other matters. For large hedge funds, that would include extraordinary investment losses, significant margin and counterparty default events, operations issues and other events. The proposed amendments would also capture more detailed info about fund strategies and about leverage and capital structure details relating to portfolio companies that could create risk.
The idea behind the proposal is to alert the Council and the Commission to events that could signal stress at the fund – and in the broader financial system. The proposal would also:
“… decrease the reporting threshold for large private equity advisers and require these advisers to provide additional information to the SEC about the private equity funds they advise. Finally, we are proposing to amend requirements concerning how large liquidity advisers report information about the liquidity funds they advise. The proposed amendments are designed to enhance the Financial Stability Oversight Council’s (‘FSOC’) ability to monitor systemic risk as well as bolster the SEC’s regulatory oversight of private fund advisers and investor protection efforts.”
Commissioners Lee, Peirce and Crenshaw issued statements, each telling in their own way.
Commissioner Peirce focused the form’s original purpose:
“As we described at the time of its adoption in 2011, Form PF is primarily intended to assist [FSOC] in its monitoring obligations under the Dodd-Frank Act… to facilitate FSOC’s monitoring of system-wide stability…” She said “Congress did not conceive of Form PF to facilitate the Commission’s desire to inoculate well-heeled investors against downturns, losses, or fund failures.” Form PF “was not to inform the Commission about isolated trigger events affecting individual private funds.”
Turning to the need for information sought by the amendment, she said “The release provides scant evidence that the amendments to Form PF would enhance FSOC’s ability to monitor for systemic risk. Rather, the enhanced reporting seems intended primarily to provide the Commission with additional information to support its regulatory and enforcement programs. A regulator’s desire for data is insatiable, but more data is not always better. Before we seek additional information through Form PF, we must show what we have done with the information we already require and show that it is insufficient to allow FSOC to monitor for systemic risk. I do not think we have done that.”
Commissioner Lee looked more prospectively:
“Form PF data has informed policy-making and delivered much-needed transparency in this area to the public. However, while we have worked to bolster our oversight program since the first filing requirements over a decade ago, we now know more tools are needed to effectively examine and monitor the private fund space. Today’s proposal would provide critical tools to help the Commission and the FSOC, including its reconvened Hedge Fund Working Group, in making timely determinations as to whether certain events could pose systemic risks. Monitoring for systemic risk is a key pillar of the FSOC’s mission, and it is important to support that mandate.”
Commissioner Crenshaw seemed to consider the modifications more for the SEC’s benefit than the FSOC’s:
“If we continuously evaluate the threats that our markets and investors may face, it should help us promote market resilience and appropriate investor protections, even when destabilizing events inevitably occur. That process is critical, but must begin with reviewing and analyzing accurate and sufficient data. With regard to the private funds market, the Commission historically has had little data about the economic activities of private funds and any risks they may present to both investors and to the larger financial system. Consequently, as part of the Dodd-Frank Act reforms, the Commission adopted Form PF. It was a good step forward, providing both the Commission and the FSOC with data about private funds to help assess risks.”
At this point, you may notice that the word “climate” has not been mentioned. It isn’t in the proposal or in statements from Commissioners Peirce or Crenshaw. But it is in the final footnote in Commissioner Lee’s statement, and those who follow U.S. financial policy matters probably already perked up with the mention of the FSOC at the outset.
Climate Is a Hot Topic for the FSOC
Way back in October 2021, the FSOC published the document referred to in Commissioner Lee’s statements: “The Report on Climate-Related Financial Risk 2021.” In the report’s preamble, the FSOC laid the foundation for its interest and concern about economic impacts of climate matters:
“The Council first discussed climate-related financial risks at its March 2021 meeting, at which members highlighted a broad set of work underway, or beginning, at individual agencies and organizations. The Council views climate-related financial risks as an emerging threat to the financial stability of the United States. By working together, Council members can accelerate their understanding of climate-related financial risks and take necessary steps to ensure the resilience of the financial system to such risks… Economic and financial decisions that account for climate-related financial risks contribute to greater stability and resilience to climate risks across the broader economy, and help promote alignment of financing and capital towards a future with lower greenhouse gas emissions. This report is issued in response to the directive in Executive Order 14030, Climate-Related Financial Risk, to the Secretary of the Treasury to engage FSOC members on this topic and report on FSOC’s activities.”
Commissioner Peirce questions why data the government already has can’t be used to monitor systemic risks in the private investment industry, rather than adding reporting burdens. The FSOC has an entire chapter (chapter 3) in its report dedicated to its review of currently available climate data:
“While a large amount of potentially relevant data for climate-related physical risks currently exists, more work is needed to improve access to this data and incorporate it into financial risk assessments. These data were not created to be used within a financial risk management framework and, as such, public sector custodians of environmental data have generally not invested in the capacity to integrate environmental data into financial analysis, such as standardized formats tailored to the needs of entities engaged in financial risk analysis… This data is not standardized in a way that facilitates the aggregation of datasets across entities or industry sectors and may require extensive work before it is usable.”
When it comes to transition risk, the data picture is markedly different:
“Transition risks refer to disruptions that may arise from the shift to a low-GHG economy. Potential risk drivers include policy changes that may impact the value of different economic activities and related assets and liabilities, especially if such policy changes are introduced in a disruptive manner, without adequate time to anticipate constraints and changing costs. Other risk drivers include technological innovations and changes in business models that address climate change risks but disrupt existing economic activities. Shifts in consumer behavior and investor preferences similarly alter the value of economic activities, assets, and liabilities.
By their nature, transition-risk drivers require consideration of prospective changes in conditions. The forward-looking nature of transition risks requires the analysis of different climate-related scenarios. Therefore, one of the data inputs required to assess transition risks are scenarios that relate to the drivers discussed… Consideration of such scenarios likely requires that financial institutions and regulators understand and maintain data on factors related to these scenarios that cover past experience.”
What This Means
This is only a proposal at this time, and this Paul Weiss memo notes that significant pushback from the private funds industry is anticipated during the 30-day comment period (which runs from the date of publication in the Federal Register). While some practitioners question whether Form PF is capable of providing any actionable info to the SEC, if additional reporting obligations are approved, it would suggest that the SEC may be planning to use Form PF to enhance its oversight of private equity and risks that affect that industry. That also seems to also be Commissioner Crenshaw’s take on the matter. The release states that “the proposed amendments also are designed to collect additional data for the Commission’s use in its regulatory programs, including examinations, investigations and investor protection efforts relating to private fund advisers.” There appears to be an enforcement aspect to this statement.
Coupled with the FSOC’s focus on transition risks, Commissioner Lee’s comment that this proposal is a step in reinvigorating the FSOC, and SEC Chair Gary Gensler’s previously expressed interest in enhancing registered fund disclosures about ESG assets and bringing transparency to the $11 trillion private fund market, this is yet another signal that the Commission is taking a broad view of its role in strengthening financial markets, and the agency is approaching that mission from multiple angles.
Whenever investors are subjected to additional reporting requirements, that seems to come back to portfolio companies sooner or later, either by spurring investors to demand more transparency, or to apply screens that rule out investments in areas deemed risky. According to the FSOC report, that could include investments in carbon transition opportunities. We will be watching for further signs about fund disclosure and the resulting impact on companies.
