Looser Credit Controls And Higher Leverage May Bring On Hedge Fund Regulation

by Phillip Morton, Investors Offshore.com

21 May 2004

As banks compete for a larger slice of the lucrative hedge fund market, the growing availability of cheap credit is making it easier for many funds to increase their leverage, a fact that may lead national regulators to impose tighter regulation on the sector, a recent survey has found.

The study of 36 hedge funds by industry consultant Greenwich Associates revealed that almost one-third have increased their use of leverage over the past year, whilst one-quarter reported that their prime broker had increased their available credit over the last six months.

"Without a doubt, the ability of hedge fund managers flush with capital — including pension capital — to shop from multiple prime broker offerings is contributing to the overall growth of the hedge fund industry," observed Greenwich Associates consultant Tim Sangston.

He asked: "The question is whether the industry is growing too fast. Has it become too easy to set up a hedge fund? Has it become too easy to get capital? Has it become too easy to leverage?"

Adds Greenwich Associates consultant Peter D'Amario: "There's a growing perception that the money flowing into hedge funds today is not just coming from wealthy individuals and endowments who can absorb a hit if things go awry," says Peter D'Amario. "Regulators and the media have become keenly interested in the fact that the pension funds of corporate and public workers are now coming into play."

According to a recent Financial Times report Stephen Drayson, head of the UK Financial Services Authority’s wholesale investment bank group, is understood to have questioned at least six banks in the last few months with regard to their prime brokerage operations, in particular the provision of leverage, clearing, and other services to hedge funds.

With the writing apparently on the wall, Greenwich Associates is advising hedge funds, particularly those in Europe and the United States accepting business from public and private pension funds, to prepare for tighter regulation in the not-too-distant future.

"Whether or not new regulation is inevitable, there are steps that market participants can take now to avoid the perception that the industry brought it upon itself," concluded Mr Sangston.

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