10 April 2008

FT: Australia aims regulatory fire at hedge funds

Hedge fund managers who thought they had escaped blame for the credit crunch should take a look Down Under if they want to find out what politicians have in store for them.

Hedge funds operating in Australia have been put on notice that a crackdown on short-selling is on the way, to deal with fears that the current rules could encourage the spreading of false and misleading rumours. Short-selling is in widespread use by investment banks and mainstream investors seeking to profit from falling shares, but it is most closely associated with hedge funds.

Many hedge funds are becoming concerned that the political climate is shifting against them as politicians look for easy targets, even as they thought voluntary codes in the UK and US could head off the threat of further regulation.

“It is very convenient to say it is all the fault of the shadowy hedge funds,” said Andrew Baker, deputy chief executive of the Alternative Investment Management Association, one of several representing hedge funds.

“In the medieval ages people used to say the same thing about witches.”

Still, many managers are hoping that their ability to move offshore to avoid new rules means policymakers are likely to lambast hedge funds in public but take little action.

Peter Harrison, chief executive of $2.5bn London hedge fund MPC Investors, put the chances of increased pressure for hedge fund transparency at more than 50 per cent, with the danger of a “snowball effect”.

“Will the storm clouds gather? I think they will,” he said. “But I don’t think it is going to go that much further because the practicalities of additional regulation are too difficult.”

So far the evidence is piecemeal, but it is worrying some top fund managers enough that they are discussing whether they need to step out of the shadows to demystify their practices.

Iceland has accused hedge funds of ganging up on its banks and its currency, while investigations into short-selling of HBOS in the UK and Lehman Brothers and Bear Stearns in the US are widely presumed – so far without firm evidence – to be looking at possible collusion by hedge funds to drive down prices.

The European Parliament is examining whether hedge fund regulations need changing, while in London the industry faces a likely inquiry by the Treasury select committee of MPs.

But Australia generates the biggest worries for managers. A number of the country’s best-known companies, including ABC Learning Centres, investment group Babcock & Brown and QBE Insurance, have criticised short-sellers after inaccurate market rumours hurt their share prices.

There have also been claims that hedge funds have been hunting in packs, aggressively shorting stocks with the intention of pushing prices down to trigger margin calls for investors who borrowed to buy shares – turning them into forced sellers.

On top of efforts by the Australian Securities Exchange and the Australian Securities and Investments Commission, the market regulators, to improve transparency, Kevin Rudd, prime minister, said last week that rules would be changed to improve disclosure. “The recent volatility in stock markets has been exacerbated by the lack of transparency surrounding the increasingly prevalent practice of short-selling,” he said in a visit to London.

The government has identified transparency around “covered” short-selling as an ambiguous area that needs to be addressed.

There are questions over whether covered short-selling, where stock is borrowed to ensure delivery, requires reporting under Australia’s Corporations Act.

Critics claim it leaves the market vulnerable to some potentially disturbing practices, because “naked” shorts – where the seller does not own and has not borrowed shares – are limited to an approved list of big companies and to a maximum of 10 per cent of the shares. Naked short positions also have to be disclosed.

The changes adopted in Australia are likely to watched closely in other jurisdictions, where short-selling has also come under fire. Naked shorting to drive down prices is banned in the US, although allowed in the UK, while emerging markets such as China block shorting altogether.

By James Mackintosh and Peter Smith

© Financial Times