The FSA’s analysis revealed no clear evidence to suggest that any individual fund posed a significant systemic risk to the financial system during 2009. However, this position could change and future surveys will be an important tool in identifying emerging risks.
The FSA has an important role to play in assessing and mitigating systemic risk as FSA carries out its supervisory and regulatory functions. It has been suggested that hedge funds could pose a source of systemic risk to the financial system and this paper describes some of the survey work the FSA has carried out to address the issue.
The FSA believes that, in the case of hedge funds, systemic risk could arise through two main channels:
1. The credit channel
If hedge funds suffer losses on their investments, then once investors’ capital has been eroded, losses would be borne by creditors. Where the failing fund is large, or there are a number of funds involved, then this could destabilise creditors, who might be systemically important in their own right.
2. The market channel
In a number of asset classes, hedge funds may be significant investors and/or providers of liquidity. As a result, it is possible for their collective impact to be one of the drivers of unsustainable asset price upswings in certain markets. And, in particular, in moments of financial crisis, forced selling by hedge funds may cause downward price adjustments to overshoot.
Conclusion
Surveying managers of hedge funds and some of their key bank counterparts helps to inform FSA’s supervisory work and improve its understanding of any systemic risks that might arise through the activities of hedge funds.
The results from this survey work were mostly in line with expectations.The HFACS data suggests that on 31 October 2009 major hedge funds did not pose a potentially destabilising credit counterparty risk across the surveyed banks. HFS data shows a relatively low level of ‘leverage’ under the FSA’s various measures and suggests a contained level of risk from hedge funds at that time.
While the analysis revealed no clear evidence to suggest that, from the banks and hedge fund managers surveyed, any individual fund posed a significant systemic risk to the financial system at the time, this position could change and future surveys will be an important tool in identifying emerging risks.
It is also notable that the Alternative Investment Fund Managers Directive, which is currently under negotiation in Europe, may at some point in the future require national supervisory authorities such as the FSA to collect certain data from alternative investment fund management sectors, including hedge funds. The FSA hopes that its work in this area can contribute to the ongoing debate about the Directive.
The FSA’s intention is to repeat these surveys at six-monthly intervals and build a time series of data that will help it monitor trends in hedge funds as they relate to systemic risk. Discussions are taking place within the Financial Stability Board and IOSCO to ensure consistency in the timing and content of systemic risk data collection for hedge funds and we hope our work will help inform that process. A consistent and proportionate global approach will help deliver G20 commitments of better coordination between regulators and, through improved data sharing, the clearer identification of global risks.
© FSA - Financial Services Authority
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