Hedge Funds 'Safe To Fail', Say Fund Managers
Wednesday, July 13, 2011

As the US Financial Stability Oversight Council (FSOC) considers which non-bank financial institutions pose a systemic risk to the financial system and are therefore in need of stronger regulation, the Alternative Investment Managment Association (AIMA) has said that no hedge fund trading today should be deemed as systemically important.

London-based AIMA, the global hedge fund association with over 1,250 corporate members, has reiterated its "strong belief" that no hedge fund manager based or operating in the US or elsewhere currently poses a risk to financial stability, pointing out that, during 2008, more than 1,400 individual hedge funds closed or were liquidated in an orderly manner.

“We believe that no single hedge fund firm today is sufficiently large, leveraged, complex or interconnected that its failure or financial stress would cause a market disruption sufficient to destabilise the financial system,” said AIMA Chairman Todd Groome.

“We note that the UK’s Financial Services Authority have stated that, based on their risk reporting framework, none of the large hedge funds they have examined currently poses ‘a significant systemic risk to the financial system,’" Groome added. "We also note that the FSA’s hedge fund survey has found that major hedge funds ‘did not pose a potentially destabilising credit counterparty risk’, and that the levels of leverage employed were ‘relatively low’, which ‘suggests a contained level of risk’”.

AIMA also argues that, although it is a USD2 trillion global industry, the hedge fund sector is "comparatively small, dispersed and quite heterogeneous" compared to other much larger sectors of the financial services industry. AIMA also stressed that hedge fund firms employ significantly lower levels of leverage than banks and some other financial institutions.

Groome continued: “The 2008 experience shows that hedge funds are ‘safe to fail’, even if they are not fail-safe. Moreover, hedge fund activities do not typically contribute to procyclical market dynamics; they tend to be contrarian or to look for market inefficiencies and, through their investment activities tend to make markets more efficient. As such, hedge funds enhance diversity of market behaviour, and thus contribute positively to financial stability.”

Nonetheless, AIMA continues to support proposals for the registration of hedge funds with national secutiries regulators because this will make the financial markets more transparent, and thus reduce the risk of financial shocks, such as the 1998 collapse of Long Term Capital Management, which was highly leveraged and was bailed out by other financial institutions under the supervision of the Federal Reserve.

“By having managers register with and report to the Securities and Exchange Commission and other national authorities, including FSOC, more data will be available to allow better monitoring and assessment of markets. As such, hedge funds can contribute to a more effective systemic risk monitoring system,” added Groome.

Last month, the SEC adopted rules that impose new registration requirements on advisers to hedge funds and other private funds, while establishing new exemptions from such registration and reporting requirements for certain advisers.

Advisers to private funds have previously been able to avoid registering with the SEC because of an exemption that applies to advisers with fewer than 15 clients – an exemption that counted each fund as a client, as opposed to each investor in a fund. As a result, some advisers to hedge funds and other private funds have remained outside of the SEC's regulatory oversight even though those advisers could be managing large sums of money for the benefit of hundreds of investors. This new requirement, according to SEC Chairman Mary L. Schapiro, will therefore "fill a key gap in the regulatory landscape".