G7 Finance Ministers Move Towards Hedge Fund Regulation

by Ulrika Lomas, for LawAndTax-News.com, Brussels

16 February 2007

Last weekend's G7 meeting in Essen partially accepted Germany's push for greater hedge-fund regulation, commissioning an update on a year 2000 report by the Financial Stability Forum, a panel set up after financial crises in the 1990s to monitor global market solidity.

"Given the strong growth of the hedge fund industry and the instruments they trade, we need to be vigilant," said the G7.

Germany's finance minister Peer Steinbrück, who hosted the meeting has been working towards an agreement on hedge funds ever since a group of funds crossed the country's finance sector, famously being described as 'locusts' after their involvement in the 2005 coup at Deutsche Boerse, which saw investors in Deutsche Boerse remove Chief Executive Werner Seifert and Chairman Rolf Breuer.

Sandy Weill, former CEO of New York-based Citigroup reportedly called on the G7 meeting to apply greater controls on the hedge funds industry, but the US and the UK headed off attempts by the Germans to install mandatory regulation this year.

Following the meeting, the Alternative Investment Management Association (AIMA), a global hedge fund and alternative investment industry association responded to the G7 statement, welcomed the G7's agreement that hedge funds have contributed significantly to the efficiency of the financial system. AIMA points out that hedge fund managers are already sharing information and data with their regulators – who have not expressed specific concerns nor backed up calls for further disclosure. Additionally European managers already have to comply with a multitude of European wide regulations such as MiFID and CAD2.

The G7 statement referred to the possible development of a voluntary code of conduct; AIMA believes that such an idea has neither relevance nor meaning in this context of existing regulations. AIMA says it would welcome the opportunity to contribute to an update of the 2000 report on Highly Leveraged Institutions by the Financial Stability Forum – AIMA has also noted that the original report, whilst relating to the collapse of Long Term Capital Management in 1998, also focused on other market participants aside from the hedge fund industry.

At the recent Davos Forum, a member of the European Central Bank's Governing Council said that a Code of Conduct would be better than more regulation. Council member Axel Weber told Reuters that a voluntary code of conduct by the hedge fund industry would be an important first step towards improving transparency. 'I prefer a market-based orientation to regulatory actions,' said Weber, 'but we have to see how deep we can wade into these waters by having an open dialogue with the hedge funds.'

'We need to try hard and we need to make a bigger effort to get the industry to make more voluntary commitments and maybe do a bit of arm-twisting along the way,' he added.

The approach of the US is more to tighten the rules for investment in hedge funds: the Securities and Exchange Commission said recently that it is planning to increase the minimum net worth of a hedge fund investor from the current US$1m to $2.5m.

There are transparency concerns as well, though. In Washington recently, William Donaldson, ex-Chairman of the SEC said: 'The rulemaking doesn't address the ongoing problem of the rapid growth of hedge funds and the lack of knowledge that regulators have; it is an increasing concern not only in the United States, but to regulators around the world.'

Perhaps pushed by institutions wanting to reduce the risks of their hedge fund investments, a number of senior US regulators, both in Congress and at the SEC, are moving in the direction of stricter regulation, although the courts' demolition of the SEC's registration plans last year should hardly give them encouragement. On the other hand, the new Democrat ascendancy in Congress will perhaps open the flood-gates to a tide of restrictive Democrat-inspired legislation.

Last year saw bad news from a number of hedge funds. Apart from the high-profile US$6bn loss by Amaranth, which is now liquidating itself, a large fund run by Vega Asset Management Partners was said to have lost 25% of its value in just two months. Vega managed a total of more than US$10bn in 2004, but reportedly now has less than US$6bn under management. Of course, that may be due to redemptions, not losses. Who knows?

Vega's losses are thought to have been incurred on short positions in sovereign bonds, and a bet that the Japanese yen would appreciate against the euro.

Investor sentiment favours larger fund managers, such as the highly successful Man Group, and many observers say that a period of consolidation is likely as smaller, weaker funds run for cover in the arms of their larger peers.

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