Friday, May 04, 2007

Transfer of Risk Issue Looms Large for Hedge Fund Regulators

By James Hamilton, J.D., LL.M.

The transfer of risk to hedge funds via credit derivatives and other financial instruments reduces the ability of regulators and central bankers to have a clear picture of where risk sits in the financial system, noted Financial Services Authority CEO John Tiner. In his view, this scenario is more than academic since it raises real questions regarding the ability of regulators to monitor and manage financial stability.

In remarks to the Association of Corporate Treasurers, the senior official also noted other issues surrounding hedge funds, including the need to ensure adequate disclosure and accurate valuations. He mentioned that the FSA has been putting in place a regulatory regime to deal with these risks in a proportionate way, including addressing the question of whether hedge funds should be available to retail investors. There is no reason to prevent informed retail customers from accessing this type of risk, he emphasized. The FSA recently issued a consultation paper on the retailization of funds of alternative investment funds.

While hedge funds are not necessarily the biggest institutions, continued the CEO, their impact should not be underestimated. Given their active management, they can represent up to 50% of daily liquidity on the London Stock Exchange. Although the funds are not within the FSA’s regulatory remit, the hedge fund managers are. There are over 300 hedge fund managers in London, representing some 90 per cent of EU hedge fund business.

In his view, the FSA has designed a sensible fit for purpose regulatory approach for this sector, including a regular survey of prime brokers which helps the regulator assess leverage in the hedge fund market. Since this is limited to UK prime brokers only, Mr. Tiner praised the idea put forth by the Minister for the City of London to discuss, at the upcoming G8 Summit, the extension of regulation to other major markets in order to collect aggregate data.