Hedge fund managers recoil at the idea of revealing details of their proprietary trading models or portfolio positions, arguing that it would undermine their competitive proposition.
A recent discussion paper issued by the London School of Economics and Political Science in conjunction with International Asset Management says that while there are “compelling” reasons why some form of regulation is desirable, arguments for regulating hedge funds solely to protect consumers are unconvincing.
The paper fights a host of accusations commonly levelled at hedge funds. They are destabilising, overly levered and constitute counterparty risk. They use up market liquidity and are prone to commit fraud.
On the contrary, it says, hedge funds aid price discovery, asset diversification and competition.
The paper, Highwaymen or Heroes: Should Hedge Funds be Regulated?, contends that the existing regulatory structure is unsuitable for hedge funds and would either be ineffective or cause irrevocable harm to the industry.
The report says that the systemic risk from hedge funds stems from a large fund’s collapse, not the on-going regular trading activities of solvent funds. Therefore regulations should aim at containing the fall-out from any such default so as to minimise market disruption.
The authors suggest this can best be achieved by instituting a formal resolution whereby the regulator, prime brokers and client banks are all legally obliged to ensure that the fund be unwound as quickly as possible. They caution that this resolution process should not be confused with a bail-out. Also no public money must be used to avoid “moral hazard problems”.
Swift action taken by the US Federal Reserve when it learned of the pending collapse of LTCM is cited as a good example of a timely and efficient resolution process.
The Fed brought together all the key client banks to encourage an orderly winding down of LTCM’s positions, thereby helping to avert economic crisis. No public funds were used and the Fed limited its intervention to managing the process.
However, the report warns that potential conflicts of interest could undermine the whole process. It asks: “Might the exposure of prime brokers to the hedge funds lead them to allow the fund to ‘gamble for resurrection’ through taking on even more risk?”
It is suggested that the proposed resolution process will only be successful if every party involved is properly incentivised to fulfil their reporting obligations.
If these potential conflicts of interest could be avoided the resolution process could work. But it is a big “if” which raises questions about enforcement of obligations and the willingness of all involved to bear the cost of the process. At the end of the day, can the hedge fund industry be trusted to act in the interests of the investor?
See News & Analysis, p7
Business booms down under
The US and Europe may be the world’s largest fund management markets but it appears business is growing fastest down under.
Australia’s investment fund assets are increasing at almost double the international growth rate, according to the Fédération Européenne des Fonds et Sociétés d’Investissement and the Investment Company Institute.
Fund assets rose in the third quarter by 5.4 per cent to $547bn (e423bn). This compares with a rise of 3.6 per cent in worldwide fund assets over the same period to $14,500bn.
The chief source of new money was savings arising from compulsory defined contribution superannuation scheme payments.
Currently, nearly 45 per cent of Australia’s investment funds are either managed by foreign-owned companies or by a joint venture between a domestic and a foreign financial institution.
Of the top 10 fund managers in Australia, five are foreign institutions – State Street Global Advisors, Axa Asia Pacific Holdings, Barclays Global Investors, Deutsche Asset Management and UBS Global Asset Management - and one – ING/ANZ - is a joint venture.
The most common type of investment mandate won by foreign managers in Australia is global equity. These developments, allied to the growing willingness of Australia’s larger superannuation schemes to embrace alternative assets, would seem to bode well for global managers wishing to try their luck in the world’s fourth largest fund management market.
Henry Smith, editor, henry.smith@ft.com
