FSA Says Hedge Funds Not a Risk to System
August 12, 2010
Hedge funds don’t pose a potentially destabilizing systemic risk in the United Kingdom -- and potentially Europe.
So concludes the U.K’s Financial Services Authority in a report analyzing 50 of the largest hedge funds operating in that market. Those 50 hedge funds represented nearly $345 billion of assets under management.
“We do not consider that there has been a material change in risks to financial stability since October 2009,” says the FSA. That was the first survey on assessing possible sources of systemic risk from hedge funds the regulator conducted.
The results of the latest survey, taken in April 2010, backs the FSA’s approach on light regulation of hedge funds. This comes at a time when hedge funds have come under the scrutiny of regulators worldwide who believe their lightly regulated activities contributed to the global financial crisis.
London remains the dominant center for the European hedge fund industry with an estimated 85 percent of the market. The European Commission in Brussels has proposed new regulations governing hedge funds in the 27-national European Union which the U.K.’s FSA and Bank of England have consistently opposed. The FSA has said that as many as 40 percent of the world’s hedge funds won’t be able to access investors in the European Union if the legislation – the Alternative Investment Fund Managers Directive – is passed.
Among the key findings of the survey: hedge funds are using more leverage reflecting an increased risk appetite since October 2009; hedge funds are borrowing more through repurchase agreements and less through their prime brokerages; and positions held by hedge fund did not comprise a particularly large proportion of any total asset class, apart from convertible bonds; and hedge funds have further diversified their credit exposures to bank counterparties
The FSA said that overall hedge fund leverage increased from 244 percent in October 2009 to 272 percent in April 2010 with fixed-income arbitrage and multi-strategy funds accounting for the greatest hike. Of all the types of leverage the FSA studied-- collateralized borrowing under prime brokerage agreements, repurchase agreements or swaps and contracts for difference, financing through repo deals grew the most.
The survey also found that the maximum potential credit exposure of any bank to any single hedge fund was about $600 million. That means that no hedge fund borrowed more than $600 million from a single bank without collateral.
The goal of the hedge fund survey is for the FSA to better understand the use of leverage, footprint in various asset classes, the scale of any asset/liability mismatch and credit counterparty risks.
Such an analysis is necessary for the FSA to determine whether the financial illness of a particular hedge fund could have a domino effect on the overall market.
