By Amy Leisinger, J.D.
The International Organization of Securities Commissions (IOSCO) has published its biannual report on the global hedge fund marketplace, key regulatory changes, and the potential systemic risks posed by the industry. IOSCO’s survey assembles information from national authorities on hedge fund activities and is designed to enable regulators to share information and observe trends regarding exposure, leverage, liquidity management, funding, and trading activities in the hedge fund industry.
Using data as of September 30, 2016, IOSCO’s report notes that, in the span of two years, the global assets under management of 1,971 surveyed hedge funds increased by 24 percent to $3.2 trillion, likely as a result of enhanced reporting requirements, market performance, consolidation of smaller funds, and/or growth through net new investment. To avoid double counting, IOSCO scaled down data sets of other jurisdictions where hedge funds were likely also to have reported to the SEC on Form PF, but the data implies that 76 percent of the global total is held with primarily U.S.-based hedge fund managers, the organization reports. According to IOSCO, the Cayman Islands remains the domicile of choice for hedge funds, with 53 percent of the global total by NAV, and the portion of funds domiciled in Europe and Asia continues to be very limited.
IOSCO found that values for interest rate derivatives dominate as to gross exposures per asset class. After derivatives, equities represented the next highest total in both long and short exposure. Equity long/short was the most widely used investment strategy, followed by global macro and fixed income arbitrage, both of which might be expected to make extensive use of government bonds, according to the report.
Across the sample funds, IOSCO found total gross notional exposure to all asset classes (adding short positions to long positions) was $22.7 trillion, which, divided by the $3.2 trillion global NAV, shows a gross leverage of 7.1x—an increase from 5.1x in 2014. However, the report notes that one of the factors affecting the calculation is the inclusion of notional values of interest rate and FX derivatives, which may exaggerate the level of exposure. Recalculating to exclude those categories results in a gross exposure of $9.8 trillion and a more modest gross leverage of 3.1x, IOSCO explains. The amount of leverage used by hedge funds may vary widely depending on investment strategy, but the data show prime brokers still represent the largest source of financial leverage for hedge funds with an increased reliance on repo markets, according to the report.
Further, IOSCO found that, in the aggregate, hedge funds maintain liquidity buffers and portfolio liquidity exceeds investor liquidity by a wide margin across different time periods, suggesting that funds should be able to meet investor redemptions through orderly liquidation. In addition, 3.8 percent of hedge fund assets involve liquidity management tools, such as gates, suspensions, or side pockets, the report states.
IOSCO found that hedge funds across the sample posted total collateral of more than $2.7 trillion, with the amount posted in the form of cash and equivalents falling slightly. In the realm of trading and clearance, the portions of cash securities traded on exchange versus over-the-counter were relatively equal, except with respect to derivatives, which traded higher OTC, the report concludes.