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UK FSA Chairman Warns Hedge Funds They May Face Direct Regulation

Press Release

08 May 2000

Speaking at the Morgan Stanley Dean Witter Inaugural European Hedge Fund Forum Dinner last week, UK Financial Services Authority Chairman Howard Davies warned hedge funds that they may face direct regulation if progress is not made on the recent recommendations on highly leveraged institutions (HLIs) made by a Financial Stability Forum (FSF) working group, which he chaired.
The working group, which published its report last month and then had its conclusions endorsed by G7 Finance Ministers, made three main sets of recommendations:

- Improved counterparty risk management in institutions that provide leverage to HLIs and in HLIs themselves.

- Support for greater disclosure and transparency. Many governments and regulators are prepared to support market-based discipline, built on enhanced disclosure, but accept that if this does not work then a more rigorous approach may be required.

- On the evidence that HLIs can materially influence market dynamics, small, open economies need to improve their market monitoring so they are not taken by surprise by market movements. More importantly, market participants should agree guidelines for trading practices that can be adapted to work in such small, open economies.

“If you cannot give smaller open economies some kind of assurance that they will not be subject to repeated speculative attacks, then there is a clear risk that they will close up. And that would be in nobody’s long-term interest.” Mr Davies said.

Mr Davies outlined two questions relating to highly leveraged institutions that the FSF had asked the working group to consider:

- If a hedge fund can become large enough and leveraged enough to threaten the collapse of the whole financial system, should it not be subject to some sort of prudential oversight by regulators?

- Was it possible for the actions of highly leveraged institutions to destabilise small, open economies and were there ways of helping such economies protect themselves?

Mr Davies concluded by issuing a warning to HLIs: “I hope there is progress on the recommendations I have outlined. If there is not, and particularly if there is another market destabilising collapse, then we might find ourselves developing a closer and more formal relationship with the hedge fund industry, something which I am sure you do not want.”

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