Commission heads towards light-touch for hedge funds

Concerns on the transparency of hedge funds and the threat that they might pose to financial stability are being exp-ressed ahead of an open hearing on investment funds next week (19 July). Indications are that the European Commission, which will be hosting the hearing, will be taking a light-touch approach to regulation of hedge funds, having reacted positively to a banking industry report on the sector published last week (4 July).

Dubbed the wild card of the investment industry, hedge funds are a high-risk business. The absence of regulatory provisions promoting transparency means that companies often have no way of knowing how much of their stock is held by hedge funds. Businesses can find themselves at the mercy of mystery funds that borrow and lend voting rights among themselves to engineer a desired outcome.

Barbara Stearns-BlSsing, of the European employers' federation UNICE, which will be participating in the hearing, said: "Companies need to know who their shareholders are. UNICE would like to see a lower general disclosure threshold for major holdings from the current 5%, as foreseen by the EU Transparency Directive, to 3%."

Volatile capital flows driven by the collapse of highly speculative funds could have potentially disastrous consequences for financial markets and banks. The tendency towards 'crowding' of trades, whereby hedge funds employ similar strategies in the same areas, magnifies the problem.

The European Central Bank (ECB) made its worries on the issue known in a report last month. ECB spokesperson Wiktor Krzyzanowski said that the ECB was supportive of a proposal made by the Deutsche Bundesbank on voluntary rankings of hedge funds by rating agencies. ECB Vice-President Lucas Papademos had described the idea as "a proposal which merits consideration and further study". But the bank will not be represented at the Commission' s hearing.

Wolf Bangs, spokesperson for the Bundesbank, said: "It [ranking] would be in the interests of investors and hedge funds themselves. Hedge funds are currently not under supervision because of a number of issues, including [special] interests." He cited many hedge funds being located in offshore locations, such as the Cayman Islands, as another reason why efficient supervision was needed.

But such a system would be self-regulated. Andrew Hilton, director of the London-based Centre for the Study of Financial Innovation, said: "It's got to be mandatory. If not, funds that are not performing well won't admit it. The issue is [that] nobody knows the amounts invested and where they are invested. Hedge funds are obviously very risky. Let's learn what leverage they have, where they're invested, real facts rather than guesswork."

The bankers' report, compiled by the representatives of groups such as Goldman Sachs and Citibank, recommends that extra regulation for hedge funds is likely to fail and that the best way to improve protection for investors is to raise the threshold for minimum investment to 50,000 euro. Reacting to the report, the Commission said that hedge funds had "made a positive contribution to sound functioning of financial markets without receiving intensive scrutiny/oversight from regulators".

A White Paper setting out measures to boost the efficient development of the European funds sector is planned for later this year.

Concerns on the transparency of hedge funds and the threat that they might pose to financial stability are being exp-ressed ahead of an open hearing on investment funds next week (19 July). Indications are that the European Commission, which will be hosting the hearing, will be taking a light-touch approach to regulation of hedge funds, having reacted positively to a banking industry report on the sector published last week (4 July).