12 February 2007

FT: 'Vigilance' called for as hedge funds boom

Fast growth in the global hedge fund industry requires a 'vigilant' stance by governments and central banks, the G7 meeting in Essen concluded at the weekend. Germany won support - from the US and Britain among others - for a package of proposals intended to encourage greater transparency in the hedge fund industry, without calling into question its economic benefits. 'Whenever something is growing as quickly as this, it bears looking at,' said Hank Paulson, US Treasury secretary.

Although the global financial system has been relatively free of financial crises in recent years, European central bankers and finance ministers in particular have expressed concern about hidden 'systemic' risks that may have been created by hedge funds, particularly given the opaqueness and complexity of many deals. The US has also stressed investor protection.

Britain and the US were wary of any initiative that could have created regulatory hurdles for hedge funds and the Germans, who hold the presidency of the group, had tailored their proposal accordingly, scaling back their original ambition to agree on a set of instruments to monitor hedge funds by the end of the year.

The focus among G7 countries in recent months has been on encouraging voluntary steps by the industry and on the risk management by regulated institutions, such as banks, that act for hedge funds. Still, Germany is hopeful member states will agree concrete measures to improve transparency under Japan's presidency of the G7 next year.

Speaking after the Essen meeting, Jean-Claude Trichet, president of the European Central Bank, said there had been 'a lot of reflection in the industry' but not yet agreement on standards and codes that would form a system of self-assessment.

Under the proposals agreed at the weekend, Gerald Corrigan, former president of the New York Federal Reserve, who compiled a report in 2005 on ways to improve the stability of financial markets, will help encourage contacts between national finance ministries and hedge fund managers.

The communiqué confirmed that the Financial Stability Forum, an international organisation bringing together the financial industry, regulators and central bankers, would be asked to update its 2000 report on 'highly leveraged institutions'.

Along with other advanced financial techniques, hedge funds 'have contributed significantly to the efficiency of the financial system', the Essen communiqué said. 'Nevertheless, the assessment of potential systemic and operational risks associated with these activities has become more complex and challenging. Given the strong growth of the hedge fund industry and the instruments they trade, we need to be vigilant.'

Axel Weber, president of Germany's Bundesbank, said: 'Vigilant means that we are anything other than complacent.' Rodrigo Rato, International Monetary Fund managing director, said the evolution of recent financial markets had helped spread risk 'but there are maybe new vulnerabilities possible'.

© Financial Times