The collapse in cryptocurrency prices this year has left US regulators scrambling to understand the risks digital asset markets could pose to the wider economy.
They may soon incorporate hedge funds into the effort.
The Securities and Exchange Commission issued a proposal on August 10 that would require large hedge funds to report their cryptocurrency exposure using a confidential file known as Form PF.
Created after the 2008 financial crisis, Form PF was designed to help regulators spot bubbles and other potential stability risks in the otherwise opaque ecosystem of private funds that manage money for wealthy individuals and institutions.
The potential addition of cryptocurrency data to reporting requirements for hedge funds comes as the SEC and its sister agency, the Commodity Futures Trading Commission, weigh a broader set of updates that would expand the scope of Form PF .
The two agencies agreed to the changes after consulting with the Treasury Department and the Federal Reserve about potential financial stability risks to the private funds industry. SEC Chairman Gary Gensler noted that the total assets of private funds are approaching the size of assets in the banking sector, which has grown more slowly in the wake of post-crisis regulatory requirements.
“A very large part of our financial system is growing, and it’s growing faster, and it’s about to overtake the entire commercial banking system, which has much less regulation and much less transparency,” Gensler said on Aug. 10.
The Aug. 10 proposed rule would add “digital assets” as a new asset class to Form PF and define the term. It seeks comment on whether funds should report detailed information about the cryptocurrencies they hold, such as identifying them by name or describing their characteristics.
In the proposal, SEC staff noted that many hedge funds have recently formed to invest in crypto, while some existing hedge funds have begun adding them to their portfolios.
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Gensler, a Biden appointee, has compared cryptocurrencies to the Wild West and often highlights the need for more investor protections in the market. Asked in a virtual press conference whether regulators currently have enough visibility into hedge funds’ exposure to crypto, he replied “No.”
So far, the recent drop in the prices of digital tokens like bitcoin has been relatively contained in the crypto market. But the implosion of a cryptocurrency-focused hedge fund, Three Arrows Capital, earlier this summer created a chain reaction that drove several of its creditors into bankruptcy.
Regulators worry that these dominant effects could spread to mainstream markets if mainstream financial institutions increase their adoption of cryptocurrencies before proper guardrails are in place.
The total value of the crypto market has hovered around $1.2 billion recently, down from a November high of nearly $3.1 billion, according to data website CoinGecko.
Beyond crypto, the proposal would require hedge funds with more than $500 million in net assets to report more information on Form PF about their investment exposures, portfolio concentrations and debt arrangements.
“Collecting this information would help the commissions and [financial-stability regulators] better look at how the big hedge funds interconnect with the broader financial services industry,” Gensler said.
SEC commissioners voted 3-2 along party lines to issue the proposal, which will be made available to the public before the agencies decide whether to complete the changes. Republican SEC commissioners Hester Peirce and Mark Uyeda voted against it, questioning whether the government really needs all the information the new version of Form PF would collect.
The CFTC, which is also controlled by Democrats, was scheduled to vote on the proposal on the afternoon of August 10.
Bryan Corbett, the president of the hedge fund industry lobbying group in Washington, said the new requirements would create compliance costs that would ultimately be borne by hedge fund investors and make it more difficult for investors to enter the market. new fund managers.
“Currently, alternative asset managers provide extensive information to regulators,” Corbett said. “The SEC should focus on making better use of this information rather than imposing new burdens on fund managers that are of dubious utility.”
Write to Paul Kiernan at paul.kiernan@wsj.com
This article was published by Dow Jones Newswires, a service of the Dow Jones Group
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