By Stephen Taub
When Todd Groome boards an airplane, it is not unusual for him to see familiar faces among the crew or to be greeted by name. After all, he enjoyed top-tier status at both United Airlines and British Airways during his five and a half globe-trotting years at the International Monetary Fund as adviser in the monetary and capital markets department. “It feels good—and depressing—that you know them,” Groome concedes.
Since becoming nonexecutive chairman of the Alternative Investment Management Association, a London-based trade association for the hedge fund industry, in January 2009, Groome has not missed a beat...or a flight.
Based in the United States, Groome continues to circle the globe, spending much of his time in AIMA’s offices around the world, visiting some of the approximiately 1,150 members in roughly 45 countries, as well as regulators. Unlike most trade associations, which represent just one or two constituencies, AIMA advocates on behalf of virtually all participants in the hedge fund industry, including managers both large and small; investors including funds of funds and institutions; prime brokers and other service providers such as accountants and lawyers. The diverse constituency requires a deft balancing act, although Groome is quick to point out that “a lot of what we do is to represent the manager. There is no industry if there are no managers.”
Groome has been in the financial services industry his entire career since graduating from the University of Virginia School of Law in 1984. The 51-year-old, who graduated summa cum laude with a bachelor of arts in economics from Randolph-Macon College and also received a masters in business administration from the London Business School, has more than 19 years of investment banking and legal experience related to financial institutions in the United States, Europe, and the Asia-Pacific region.
Before moving to London in 1989, Groome was an attorney with Hogan & Hartson in Washington, D.C., focusing primarily on bank regulatory issues and merger and capital-raising activities for banks and savings institutions. He then joined Merrill Lynch in London and New York as part of the financial institutions group, working in M&A, advisory, and debt and equity financing for banks and insurance companies, before serving as managing director and head of the financial institutions groups of Deutsche Bank and Credit Suisse in London, focusing primarily on debt capital markets and capital and balance sheet management.
At the IMF, Groome was an adviser on financial stability analysis and policy considerations in the monetary and capital markets department. He was responsible for multilateral surveillance activities and review of capital markets issues in the financial markets, focusing on structural issues that may influence medium-term financial stability considerations.
Groome, who was scheduled to leave the IMF in the summer of 2008 but stayed on longer due to the global financial crisis, says he took the job at AIMA after being wooed by executive director Florence Lombard, who had run AIMA for 16 years as chief executive, and outgoing chairman Christopher Fawcett. “It was time to do something else,” says Groome, stressing he has spent much of his career looking at financial stability issues. He also noted that AIMA, which this year is celebrating its 20th anniversary, recently altered its mission to focus more heavily on engaging with policy makers and regulatory authorities.
On a recent trip to New York City, Groome sat down with contributor Stephen Taub to discuss the regulatory issues confronting hedge funds and how his group plans to address them.
Is it hard to speak on behalf of managers and investors? Is there a conflict?
Most times their interests are not at odds. Without managers having the ability to operate in an efficient and profitable industry, there would be no industry at all. We seek to create or maintain an environment in which hedge funds can thrive. The differences, when they exist, are usually around contractual terms. I am a big fan of providing greater transparency and letting the two parties create a contract to their liking. Let the free market reign.What are some of the items on the regulatory agenda or priorities?
A couple of things. First, we support the registration of managers. Consistent with that, we also support the periodic reporting of systemically relevant information to the supervisors they register with.Should every hedge fund be required to register?
We support proposals that call for registering managers with $100 million under management and up. As part of the registration process, authorities want to make sure the manager is fit for the business. Managers, through registration, should provide things they provide now—their experience, information about people on their team, their systems, infrastructure, accountants, lawyers, prime brokers. Broad-based information like that. I support registration at the manager level, not at the fund level.What is the distinction?
Often when you have a conversation with some authority regarding why they want to register a fund, it becomes clear that they want to regulate the fund. Registration of the fund can be a code word for product-level regulation. And few in our industry, including investors, want that level of prescriptive regulation, because then you have regulators setting leverage limits, liquidity standards, redemption schedules. That is too much micromanagement of the investment contract. Numerous investors have come out strongly against that kind of product regulation. On the other hand, registration of the manager should create a supervisory dialogue, which contributes to the stated goal of financial stability analysis.What role should hedge funds play in the financial stability discussion?
Policy makers agree hedge funds were not the cause of the crisis. This was a banking crisis. However, when they rewrite the regulatory framework in the financial services sector, hedge funds will be part of the conversation, and that is not illogical, given the larger role nonbanks, including hedge funds, play in financial markets today. They play a role in a variety of markets around the world. So, if they get the registration and reporting process right, hedge funds will be able to contribute to public sector analysis of financial stability. In addition, the next time there is a bump in the financial markets, and G-20 officials discuss financial stability ramifications, there will be people at the table mandated by governments who will know what is going on at the hedge funds. This should help improve the understanding and perception of hedge funds.What should hedge funds be required to report?
The periodic reporting of systemically relevant information should include concentration levels, liquidity conditions, volatility and leverage. The goal of reporting should be to improve financial stability analysis. As a global industry, we recognize that we have a role to contribute to that type of analysis.Should all funds with more than $100 million in AUM be required to report this information?
No. You’ll end up with information overload. It is also not practical to assume any supervisor has the people and systems to gather and use all of this information. As for the industry, no one wants to incur costs without clear supervisory benefits. It seems impractical to require all registered funds to report on a regular basis. I think managers with at least $1 billion AUM makes more sense. At year-end 2008, there were about 320 hedge fund managers with about $1 billion AUM, including 210 to 215 in the U.S. If the goal is financial stability, it makes sense to focus on larger hedge fund firms, and this group represents about 75% of assets in the industry. You don’t need to go to the smaller guy. It just raises costs with little benefit. So, it’s nice to want to gather information, but they must have supervisory capacity to gather the information, analyze it and use it in a useful way so they are not just increasing costs but creating a benefit to financial market stability and analysis.What is your overriding goal?
We need to provide the right amount of information without overburdening the industry. Then we need to seek consistency of application around the world. So, if you are located in three to five locations, you want to be able to register in one place and be recognized and accepted elsewhere. We want supervisors to share information on a confidential basis, so you are not generating five or six different reports. Inconsistency means greater costs. And if information is different from country to country, it also makes it difficult for supervisors to talk to each other. The private sector doesn’t want the extra costs, and the public sector doesn’t want inconsistency of data.Are most of the countries in which hedge funds operate comfortable with having consistent rules and regulations?
Most countries have similar goals to improve financial stability but may differ on how to develop the regulatory framework to achieve their goals. The European Union is currently most out of step with the process. We try to spend time in jurisdictions where hedge funds are most populated—the U.S. and the U.K. The U.S. and U.K. authorities, which comprise 80% to 85% of the industry, are in agreement on about 80% of the issues. We also have put a lot of effort into Hong Kong and Singapore, and a good effort into Australia and Japan, where the industry is very healthy.Should there be consistent standards for creating side pockets, gates and other related issues?
I do not believe so. These are product issues that are best dealt with by the manager and the investor, through disclosure and transparency.What do you think of the provision in the House financial regulatory bill that requires hedge funds and other private investment pools with more than $10 billion in assets to pay into a fund for rescuing failed companies, while other financial institutions will be assessed if they have more than $50 billion?
Hedge funds are being treated unfairly. Remember, in the recent financial crisis, no hedge fund put any other financial institution into distress from their relationship as a counterparty or otherwise. There is still too much confusion on risk factors related to hedge funds, such as leverage. Hedge funds are not nearly as leveraged as banks and brokerages. More importantly, if you are really trying to understand financial stability issues, leverage is not a risk in and of itself. Leverage is more ofan amplifier of market or other risks, such as concentration, volatility levels and
liquidity levels.
What is the future of hedge funds?
Due to demographic models in the world and fiscal pressures, you and I will have increased responsibility for our own long-term savings, such as retirement and health care. If you must manage more of your own money, would you want to be long only for the next 20 or 30 years, or to have someone dynamically manage your money? Some form—maybe not a form we know today—of hedge funds is going to evolve to be a very mainline type of product over the next 5 to 10 years, in large part because of demand. If you look at the gap of hedge fund and mutual fund performance, hedge funds clearly outperform, particularly in down markets. If you have to manage your own money, you will demand that kind of protection. Hedge funds are the best vehicle to provide a preservation of capital in most markets.Hedge funds will be offered to nonaccredited investors?
In some form, I believe there will be such a demand. And the reason I bring it up is that that may change the investor protection discussion. I don’t see it in the U.S. for a while. First you may see it come through the fund-of-funds world, for example, for investors with $500,000 or up net worth. Then it could come down even further. But first it would likely be offered as a fund-of-funds product by the Merrill Lynches, Fidelitys, Pimco—those guys.Do many hedge fund managers want to offer their products to non-accredited investors?
Globally, one could easily imagine more investors seeking more active investment and portfolio management, given as they are having to increasingly manage their long-term liabilities or target income levels. So people will likely be much more sensitive to the risks inherent in long-only portfolios and hedge funds provide better risk-adjusted returns and superior preservation of capital. Hedge funds outperform dramatically during down markets.What is the biggest challenge or risk facing hedge funds today?
Headline risk. Insider trading. Fraud. If a large fraud emerges, that would be very damaging to the industry. We must police ourselves properly.Has the Galleon insider trading scandal damaged the industry?
People recognize insider trading exists way beyond hedge funds.Is there a risk that the smallest funds—say, those managing $30 million — may be more likely to commit fraud if they are not required to register or report?
The premise of our current regulatory discussions is about financial stability. If you try to mix up preventing fraud you get something different. For me, preventing fraud—the cost-benefit analysis—is better transparency, better disclosure. And investors are the first line of defense. If the manager is a fraudster, let’s get some transparency out there. If I am an investor in your fund, I have to decide whether or not I can live with the information you provide me.Even many large successful hedge funds don’t provide much detailed information to investors.
When I hear this, I tell investors to walk away. If you are not satisfied with the disclosure provided, another manager will give you the disclosure you desire. This is not meant to sound wishy-washy, but as a relatively small industry, we are fortunate to be composed of professionals of very high integrity. And everyone knows each other. People know people in the industry. If there is a place where the old motto “Your word is your bond” still exists, it is in our industry.What are the goals of AIMA?
We have multiple missions. The organization is built around providing information to the hedge fund industry. This includes education tools, and best practices and guidelines on a wide array of issues—start-ups, due diligence on funds of funds, administration and custody issues, including information for managers and investors. Our more recent role is advocating on behalf of the industry. When we talk to members of Congress, the SEC, FSA, G-20, they recognize we bring a global and broad industry perspective, not a national conversation. We have a diverse membership, both geographically and professionally. We are not just advocating for one corner of the hedge fund world.
