SEC Wants More Information About Digital Assets Holdings From Hedge Funds

The Securities and Exchange Commission (SEC) and Commodities Futures Trading Commission (CFTC) want to know more about trading strategies employed by hedge funds and their digital asset holdings, according to multiple reports this morning. The two agencies have approved a proposal that will change Form PF – filed by private funds – to require more disclosures about these holdings. Currently, digital asset holdings are reported in the “Other” investments category of Form PF.

The changes were triggered by growth in size of both – hedge funds and crypto – industries. The SEC’s proposal states that hedge funds managed $9.8 trillion worth of assets during the third quarter of 2021. The cryptocurrency market surpassed $1 trillion in valuation for the first time in January 2021, touched a peak of more $3 trillion in November when bitcoin price set a record, and is currently valued at $1.2 trillion.

Bloomberg calls the proposal, which is out for comment, “one of the biggest increases” in regulation for the private fund industry in a decade. The SEC says the proposal will help them assess new sources of potential systemic risk.

What Does The Proposal Contain?

One of the questions posed by the agencies is related to the level of detail required for digital assets. Should they ask filers to detail the type and form of digital asset owned by them? For example, does the token assign rights – governance or otherwise – to token holders? Should they distinguish between central bank digital currencies (CBDCs) and other digital assets that are unbacked? Given the current implosion of crypto hedge funds, the answer to these questions has implications for the way in which funds characterize themselves and their strategies.

If the SEC’s proposal is implemented, there will be compliance costs to consider. Bryan Corbett, chief executive officer of the Managed Funds Association, alluded to such costs in a statement, referring to the proposal’s demands as “new burdens” that are of “dubious utility”.   

Hedge Funds and Crypto

There is not much publicly available data about investments in crypto by mainstream hedge funds. While the SEC proposal details investments running into trillions of dollars into equity and derivatives by hedge funds, it does not have figures on disclosures related to crypto by hedge funds.

A report by consulting firm PwC earlier this year stated that the average crypto hedge fund, and this refers to funds that are focused exclusively on investing in crypto markets, investing in cryptocurrencies had $20 million in assets under management and the average ticket size was $0.5 million. By hedge fund standards, both numbers are small.

The current state of turmoil in crypto – a pandemic bull run followed by a vertiginous crash in prices and its ecosystem – is hardly cause for hedge funds to flood into the asset class. But the SEC’s action may be a sign of things to come.

The most important question in the proposal is the one that is not stated: What is the regulatory status of cryptocurrencies? The SEC and CFTC have been wrangling over the rights to police the crypto ecosystem. Meanwhile, there is an absence of clarity about crypto’s regulatory status. While bitcoin is considered a commodity by both agencies, a raft of court cases involving one of the biggest names in crypto may determine the status of other cryptocurrencies. Perhaps then, hedge funds may begin to see crypto as a viable asset class.

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