The Committee convened in closed session at the Hay Adams Hotel at 11:30 a.m. All Committee members were present. Assistant Secretary for Financial Markets Mary Miller, Deputy Assistant Secretary (DAS) for Federal Finance Matthew Rutherford and Director of the Office of Debt Management Colin Kim welcomed the Committee. Other members of Treasury staff present were Fred Pietrangeli, Jennifer Imler, Amar Reganti, David Chung, Ernest Zhu, Brian Zakutansky, and Alfred Johnson. Federal Reserve Bank of New York members Dina Marchioni and Mark Cabana were also present.

DAS Rutherford began with a review of the fiscal situation noting that the economy posted a 2.8 percent growth rate in the fourth quarter of 2011. Rutherford presented a series of charts showing recent trends in receipts, outlays, and deficits. DAS Rutherford noted that the Administration’s new budget numbers are expected to be released in early February 2012.

Director Kim proceeded to discuss Treasury’s marketable debt portfolio. Using OMB deficit projections from the September 2011 report, “Living Within Our Means and Investing in the Future” and assuming no changes to the current issuance strategy, Treasury looks to be under financed in FY2012. With the same assumptions, Treasury would be over financed from FY2013 to FY2016. Any financing shortfalls in FY2012 are expected to be made up with increased bill issuance.

Director Kim next reviewed several debt metrics. As of December 30, the average maturity of the portfolio was approximately 62.4 months. In the chart presentation showing the projections for Treasury’s weighted average maturity, Director Kim adjusted future note and bond issuance on a pro-rata basis to match financing needs. The projections show that average maturity continues to extend.

Director Kim emphasized that the average maturity projections and the associated underlying assumptions for future issuance were hypothetical and not meant to convey future debt management policy or an average maturity target. He reiterated that Treasury will remain flexible in the conduct of debt management policy.

Director Kim then turned to demand characteristics within the primary market for Treasury securities. He noted that bid-to-cover ratios for TIPS auctions were at high levels across most maturity points. Director Kim noted that Treasury plans to gradually increase the size of TIPS issuance in 2012. This year, Treasury will issue approximately $150 billion of TIPS. The majority of the incremental new issuance will likely be at the 5- and 10-year tenors.

He also noted that bid-to-cover ratios remained at healthy levels for all Treasury securities, with particularly high demand for 4-week bills. The elevated bid-to-cover ratios in 4-week bill auctions in late December were related to the rule that bounds bill auction stop-out rates at zero. The question was asked if it made sense for Treasury to permit bids and awards at negative interest rates in marketable Treasury bill auctions. DAS Rutherford noted that there were operational issues associated with such a rule change, but that the hurdles were not insurmountable. It was the unanimous view of the committee that Treasury should modify auction regulations to permit negative rate bidding and awards in Treasury bill auctions as soon as feasible. Rutherford noted that any decision on this policy change would likely be made at the May refunding.

The Committee next turned to the question in the charge regarding Floating Rate Notes (FRNs).
Treasury continually seeks ways to minimize borrowing costs, better manage its liability profile, enhance market liquidity, and expand the investor base in Treasury securities. Market participants and the Committee have previously suggested that FRNs could help Treasury meet these objectives. Treasury asked the Committee to comment on the viability of such a product, along with the optimal maturity, reference index, reset frequency, payment period, and distribution mechanism. Treasury requested a specific recommendation for the structure of a Treasury FRN and for the Committee to help determine whether such a security would be additive to Treasury’s current mix of products.

The presenting member opened by discussing the demand backdrop for U.S. Treasuries, noting structural declines of high-quality assets over the last five years. Furthermore, regulatory changes could result in incremental Treasury demand. Additionally, money market funds may have demand for a Treasury FRN, especially if the final maturity were two years or less. The Committee member also noted that other short-end investors that are not constrained by money market fund regulations, such as securities lenders, municipalities, GSEs and corporations, would be a source of potential demand.

Turning next to the arguments in support of FRNs and the estimated benefits of Treasury issuing such securities, the presenting member revisited the case for extending the average maturity of Treasury’s debt portfolio. The Committee member stated that FRN issuance would reduce Treasury’s roll over burden. In addition, FRN issuance, in lieu of fixed-rate term issuance, would allow Treasury to avoid paying an interest rate risk premium. This product would allow the U.S. government to extend the maturity of its funding while reducing interest expense, depending on what securities would be replaced by FRN issuance.

The presenter discussed how the cost savings of FRNs would depend on the pricing spread versus the cost of maturity extension and the interest rate risk premium. The Committee member noted that the cost of maturity extension can be determined by using an asset swap spread of term Treasury debt over bills. In near-zero asymmetric rate regimes the member noted that interest rate risk premium can be approximated by observing the sum of at-the-money interest rate caplet costs for the tenor of the FRN.

Next, the presenting member discussed choices of reference indices and sample structures. The member noted that the majority of the floating rate securities issued by the GSEs are indexed to either LIBOR or the federal funds rate. The size of this market currently stands at $152 billion. Moreover, the majority of corporate FRNs are also linked to LIBOR. The presenter noted that LIBOR would be disadvantageous to Treasury as it would subject the government’s financing costs to bank funding risks.

The Committee member noted that issuance in the FRN market primarily occurred at maturities of 5-years and under. Additionally, the presenter stated that a higher reset frequency will result in shorter interest rate duration and lower price volatility. This characteristic may make the asset more attractive for stable-value buyers. The presenter went on to recommend that Treasury floor the coupons at zero.

In conclusion, the presenting member noted that the examination of alternative forms and structures of debt issuance is consistent with Treasury’s mission of financing the government at the lowest cost over time. It was suggested that Treasury begin by issuing a 2-year FRN with a floating rate index reset daily. This would appeal to both money market participants and investors looking for a stable-value asset.

An active discussion ensued. One member noted that FRNs would be a more cost effective way to extend maturity. Another member stressed the importance of this program becoming both large and liquid to appeal to a broad investor base. One member asked what distribution mechanism would best fit this issuance: an auction or a window. The discussion concluded with the Committee unanimously favoring FRN issuance, while noting that more work remains to be done to explore various structural considerations.

The meeting adjourned at 1:00 p.m.

The Committee reconvened at the Department of the Treasury at 6:00 p.m. All Committee members except Walter J. Muller and Stephen Rodosky were present. The Chairman presented the Committee report to Secretary Geithner.

A brief discussion followed the Chairman’s presentation but did not raise significant questions regarding the report’s content.

The Committee then reviewed the financing for the remainder of the January through March quarter (see attached).

The meeting adjourned at 6:30 p.m.

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Private fund adviser registration is here, meaning a whole new world of compliance risk has become a reality. Successful registration means more than just filling out a form and the March 2012 deadline is fast approaching.

Remember, in order to be registered by the deadline, you must file by February. If you haven’t already taken the steps necessary to protect your firm, you’re out of time.

Hedge fund compliance firm NRS has put together some tools to help your firm prepare for registration:

• The NRS Private Fund Registration and Compliance Intelligence Center, a collection of 15 insightful, easy-to-understand articles and how-tos designed to help your firm find its footing when it comes to registration tasks and strategies.

• Back by popular demand, a free Webinar entitled “Private Fund Registration and Compliance: What you need to know now”. Limited to the first 100 respondents, this online seminar is hosted by Mederic Daigneault, NRS’s Director of Hedge Fund Services, and will provide answers to frequently asked questions regarding registration requirements, timelines and the specifics of an ongoing compliance program.

NRS also recommends that you build your compliance program and complete registration documents now even if you don’t file until the 11th hour, avoiding the risk of operating as an unregistered investment adviser.

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By Jay Gould –  (Pillsbury Winthrop Shaw Pittman LLP) - On October 18, 2011, the SEC released a notice of FINRA’s filing of Proposed Rule 5123 (the “Proposed Rule”) which would require FINRA members and associated persons to: 1) provide to investors disclosure documents in connection with private placements prior to sale and 2) file with FINRA such disclosure documents within 15 days after the date of first sale and any subsequent amendments. These proposed changes would significantly affect fund managers who offer or sell their funds that are exempt from registration pursuant to Section 3(c)(1) of the Investment Company Act through third party marketers, nearly all of which are required to be registered as broker-dealers.

Pre-sale requirement to provide disclosure documents to investors

The Proposed Rule would require FINRA members and associated persons that offer or sell private placements or participate in the preparation of private placement memoranda (“PPM”), term sheets or other disclosure documents in connection with such private placements, to provide such disclosure documents to investors prior to sale. The disclosure documents must describe the anticipated use of offering proceeds, the amount and type of offering expenses, and the amount and type of offering compensation. Much of this information is currently captured in the Form D filing that most fund managers file with the SEC, but under the Proposed Rule, would go directly to investors in connection with the sale of fund interests.

As a practical matter, this likely means increased scrutiny of hedge fund and other private fund offerings by FINRA, as well as the likelihood that third party marketers that sell on behalf of hedge funds may request greater or more enhanced indemnification from fund managers in the placement agency agreement between the third party marketer and the fund manager. Accordingly, fund managers who use third party marketers to market their funds must keep their fund documents updated, taking into account all changes to fund strategies, material performance issues (to the extent applicable), regulatory changes and management personnel changes, to name a few.

Post-sale requirement to notice file with FINRA

The Proposed Rule would also require each FINRA member and associated person to notice file with FINRA by filing the PPM, term sheet or other disclosure documents no later than 15 days after the date of first sale. In addition, any amendments to such disclosure documents or disclosures required by the Proposed Rule would have to be filed no later than 15 days after such documents are provided to any investor or prospective investor. To the extent these documents are provided to investors, they would also be subject to the strict liability standard of Rule 206(4)-8 under the Investment Advisers Act to which all fund managers are already subject. Accordingly, fund managers must be careful to keep all of their documents current under the materiality standards of state and Federal securities laws.

Offerings Exempted from the Proposed Rule

The Proposed Rule would exempt several types of private placements including offerings sold only to any one or more of the following purchasers:

· institutional accounts, as defined in NASD Rule 3110(c)(4);

· qualified purchasers, as defined in Section 2(a)(51)(A) of the Investment Company Act; (Accordingly, 3(c)(7) funds would be exempt from the Proposed Rule.)

· qualified institutional buyers, as defined in Securities Act Rule 144A;

· investment companies, as defined in Section 3 of the Investment Company Act;

· an entity composed exclusively of qualified institutional buyers, as defined in Securities Act Rule 144A;

· banks, as defined in Section 3(a)(2) of the Securities Act; and

· employees and affiliates of the issuer.

In addition, the Rule would exempt the following types of offerings:

· offerings of exempted securities, as defined by Section 3(a)(12) of the Exchange Act;

· offerings made pursuant to Securities Act Rule 144A or SEC Regulation S;

· offerings of exempt securities with short term maturities under Section 3(a)(3) of the Securities Act;

· offerings of subordinated loans under Exchange Act Rule 15c3-1, Appendix D;

· offerings of “variable contracts” as defined in Rule 2320(b)(2);

· offerings of modified guaranteed annuity contracts and modified guaranteed life insurance policies, as referenced in Rule 5110(b)(8)(E);

· offerings of non-convertible debt or preferred securities by issuers that meet the eligibility criteria for incorporation by reference in Forms S-3 and F-3;

· offerings of securities issued in conversions, stock splits and restructuring transactions that are executed by an already existing investor without the need for additional consideration or investments on the part of the investor;

· offerings of securities of a commodity pool operated by a commodity pool operator as defined under Section 1a(11) of the Commodity Exchange Act; and

· offerings filed with FINRA under Rules 2310, 5110, 5121 and 5122.

Confidential treatment

Documents and information filed with FINRA pursuant to the Proposed Rule would be given confidential treatment. FINRA would use such documents and information solely for the purpose of determining compliance with FINRA rules or other applicable regulatory purposes, although presumably such documents would be available to the SEC in connection with examinations and enforcement proceedings of hedge fund managers. In addition, FINRA would afford confidential treatment to any comment or similar letters by FINRA and thus could not be discoverable by a litigant through a legal action.

A full text of the SEC Notice is available here (PDF).

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Exempt reporting advisers (“ERAs”) must prepare and file Form ADV Part 1A with the SEC and comply with certain other reporting and recordkeeping requirements under the Investment Advisers Act of 1940 (“Advisers Act”), such as §204A (insider trading prohibitions), §206 (anti-fraud provisions) and Rule 206(4)-5 (pay-to-play rules).

ERAs are investment advisers to hedge funds and private equity funds that avoid full SEC registration by relying on either Rule 203(m)-1 under the Advisers Act (applicable to investment advisers solely to hedge funds and private equity funds with aggregate AUM in the US under $150 million) or Rule 203(l)-1 under the Advisers Act (applicable to investment advisers that solely manage venture capital funds).

Form ADV Part 1A for ERAs became available on November 7, 2011. ERAs are required to complete several items of Part 1A of Form ADV, including providing detailed information regarding each fund advised, and file it with the SEC no later than March 30, 2012. Going forward, an ERA to a newly formed fund should file within 60 days from the date that such fund is formed.

Whether an investment adviser is considered an ERA will depend upon where the investment adviser is located. Connecticut- and California-based investment advisers to hedge funds and private equity funds with AUM under $150 million, and New York-based investment advisers to hedge funds and private equity funds with AUM between $25 million and $150 million, generally will be considered ERAs. Please contact us as soon as possible to determine whether your investment advisory firm will be considered an ERA.

For investment advisers currently registered with the SEC, the transition process to ERA status will include: 1) filing Form ADV-W (select “filing as an ERA” as the reason for withdrawing), and; 2) filing an initial Form ADV Part 1A as an ERA. Existing IARD entitlements will remain valid.

Although the SEC has indicated that ERAs will not be subject to routine examinations by SEC staff, ERAs are subject to SEC examinations for cause, such as when prompted by a tip, a complaint, or a referral from another agency or organization.

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Hedge funds are looking to expand their offerings and enhance productivity in today’s economy, and one means for this is outsourcing.

The 24-page guidebook, A Guide to Technology Outsourcing for Hedge Funds, was created by Pershing Prime Services and Eze Castle Integration to serve as a roadmap for hedge fund managers looking to understand the various options that exist in outsourcing. The guide highlights recent trends and includes practical information to help you evaluate and choose outsourcing options.

This guidebook outlines:

• Laying the foundation of an outsourcing plan
• Cloud computing
• Hosted IT environments and managed services
• Co-location
• Outsourcing FIX connectivity
• Outsourced staffing options
• Pricing Models

Register to download.

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Holland & Knight - Effective September 30, 2011, the new Treasury International Capital (TIC) Form SLT is required to be filed by certain large investment advisers.  The first filing deadline will be October 24, 2011, for any investment adviser that has $1 billion or more of reportable securities (defined below) as of the last business day of the reporting month (to the extent not filed by the account’s or fund’s custodian).

Generally the reports relate to accounts of non-U.S. investors with U.S. investments and U.S. investors with non-U.S. investments.

U.S. investment advisers and fund managers must report:

1)      All securities issued by their U.S. Funds directly to foreign residents, including e.g., a U.S. master fund issuing shares to foreign feeder funds, or a U.S. fund issuing limited partnership interests to a foreign person; and

2)      All investments in foreign securities for their own portfolio or for the portfolios of their U.S. clients or U.S. Funds.

IMPORTANT: Any U.S. custodian for the above accounts has primary filing responsibilities.  Accordingly, it is expected that U.S. financial intermediaries (such as U.S. brokers and U.S. custodians) will do the majority of the reporting.  You should coordinate with your custodian to avoid duplicate reporting.

U.S. investment advisers using foreign brokers/custodians will have to report those holdings themselves.

In determining whether a U.S. adviser falls under the $1 billion reporting limit, the adviser should aggregate:

1)      All of its U.S. clients’ and U.S Funds’ reportable foreign securities, including directly held portfolio investments in foreign funds and foreign limited partnerships, that are not held by a U.S.-resident custodian, plus

2)      All securities issued by such adviser’s U.S. funds directly to foreign investors (without a U.S. custodian).

Long and short positions should not be netted and only the gross long position should be reported.

The following types of securities are specifically excluded from the reportable securities definition: short term securities, bankers’ acceptances, derivative contracts (including forward contracts to deliver securities), letters of credit, bank deposits and annuities.

Form SLT must be filed with the Federal Reserve Bank, no later than the 23rd calendar day of the month following the month of reporting. The form may be submitted electronically, by mail or fax.  For 2011, the form will be required only on a quarterly basis.  The Form SLT filings will be required on a monthly basis starting Jan. 31, 2012.  Treasury has stated that the contents of individual filings will be held confidential.

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The SEC recently released a National Exam Risk Alert outlining the various threats posed by master/sub-account relationships. These account types have gained in popularity within the institutional market, largely due to the ease of market access for the sub-account traders.

The master account is typically an entity with a LLC or LLP structure that provides the broker-dealer’s MPID to the sub-accounts in order to trade on platforms provided by the master account. These account arrangements can be used to dodge the recently effective Market Access Rule (Rule 15c3-5) if the sub-account owners are not known to the broker-dealer. Additional threats posed by the master/sub-account structure include:

• Money laundering
• Insider trading
• Market manipulation
• Data security risks
• Unregistered broker-dealer activity
• Excessive leverage

Regulators are looking closely at these account arrangements during routine examinations. The SEC is seeking proof from broker-dealers to ensure that they have the required controls and procedures in place to manage the additional financial and regulatory risks imposed upon them when they provide another person with market access via a master/sub-account relationship.

View the SEC’s National Exam Risk Alert

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The UCITS Alternative Index Team is delighted to present the latest edition of the UAI Quarterly Industry Survey for Q3 2011. Based on answers from market participants, the report provides insight information on the state and evolution of the UCITS hedge fund industry.

The study was sent to all market participants receiving the UCITS Alternative Index performance updates. We take this opportunity to warmly thank all respondents.

The first part of the survey focuses on recent performances while the second part concentrates on future allocation trends and investment opportunities.

Key Findings

• Fund of Hedge Funds and Long/Short Equity funds are the most disappointing strategies in 2011.
• Investors are most likely to increase their allocation to Macro and CTA funds, rather than decrease it, and are most likely to decrease their allocation to Event Driven and Long/Short Equity funds.
• 44% of respondents expect systematic strategies to perform better than discretionary strategies in Q4.
• 51% of respondents believe the current market environment will have either a positive impact or no impact at all on the growth of UCITS hedge funds.

However, 60.7% of respondents believe recent performances will have a negative impact on new UCITS hedge funds launches.

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The Credit Suisse Alternative Beta Strategies team today released Hedge Fund Investing: How to Optimize Your Portfolio . The report examines how hedge fund replication can be used to help mitigate risks that are inherent with hedge fund investing.

Dr. Jordan Drachman, Head of Research for Alternative Beta Strategies at Credit Suisse, summarized some key conclusions from the report (available here), “Over the past few years, exceptionally volatile markets have left hedge fund investors faced with a number of specific challenges, including a lack of transparency and liquidity, along with cash drag — the diminished performance that comes from holding too much cash. As a result, hedge fund replication, which aims to track the performance of hedge fund indices without investing directly in hedge funds, has grown in popularity as investors seek to manage their hedge fund allocations more efficiently.”

Peter Little, Head of Portfolio Management and Implementation for Alternative Beta Strategies at Credit Suisse, continued, “The daily liquidity profile of hedge fund replication strategies enables a range of applications, including liquidity management, tactical risk management and hedging. As market uncertainty has risen, we see clients leveraging these features in a number of ways. For example, we have seen a significant rise in the use of inverse exposure strategies, which seek to enable an investor to hedge against broad and strategy-specific risks without losing capacity with existing hedge fund managers. With continued uncertainty on the horizon, we expect interest in the space to intensify.”

The Credit Suisse Liquid Alternative Beta Index (“CSLAB”), which aims to reflect the performance of the overall hedge fund industry, finished down 3.41% in September. Overall, CSLAB is down 4.36% year-to-date versus a loss of 15.36% for the Dow Jones Global Index, a proxy for global equity markets.

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The UCITS Alternative Blue Chip Index is down -1.07% this week, ending the month with a negative performance of -1.47%. All strategies are down for the week, with Commodities (-7.49%) and Emerging Markets (-4.21%) the worst performers. This has been a rough month for those two strategies as they experience their worst drawdowns since the beginning of the year.

Apart from Commodities and Emerging Markets, Event-Driven is down -1.38% while other strategies lie between -1% and 0%. In total, only 10 out of the 50 constituent funds of the Blue Chip Index are positive this week.

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